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

A credit officer reviews why sovereign ratings are considered an imperfect measure of country risk for valuing corporate cash flows. Which limitation is most accurate?

Sovereign ratings focus on default risk of government debt and are updated infrequently, so they do not fully capture the wider country risks, such as expropriation or economic disruption, that affect companies operating there.

  1. ASovereign ratings measure only default risk on government debt and do not directly capture the broader operating or expropriation risks that firms in the country face, and they change infrequentlyCorrect
  2. BSovereign ratings cover only corporate bonds and exclude governments
  3. CSovereign ratings are updated in real time and therefore overreact to news
  4. DSovereign ratings are available only for developed markets

Explanation

Ratings focus on the government's ability and willingness to repay, not on firm-level exposure to country risks, and they adjust slowly. Ratings exist for many emerging markets, and they are not real-time.

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