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FRM Part I · FRM Exam Part I · Country Risk: Determinants, Measures, and Implications

A country has a long history of defaulting on its sovereign debt, including repeated restructurings. According to the standard discussion of the sources of country risk, how does this history most likely affect its present risk assessment?

A long record of defaults raises the country's assessed risk. Default history is a recognised determinant of future default likelihood and of access to capital markets, so past restructurings signal weaker institutions and repayment willingness, and lenders demand higher spreads as compensation.

  1. AIt has no bearing, because each default is an independent event
  2. BIt raises assessed risk, because default history is a determinant of future default probability and market accessCorrect
  3. CIt lowers assessed risk, because restructured debt is smaller
  4. DIt affects only equity risk and not sovereign bond risk

Explanation

Default history is a recognised determinant of country risk. Countries that defaulted repeatedly tend to be more likely to default again and face higher borrowing costs. Defaults are not independent, restructuring does not lower assessed risk, and sovereign bonds are directly affected.

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