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

A manufacturer has a plant in a country whose sovereign rating is downgraded. Its revenues are in local currency, costs are largely imported in USD, and it has no hedges. Which implication for the firm's exposure is most appropriate?

Operating margins are exposed to local currency depreciation, which often accompanies a sovereign downgrade. With revenues in local currency and costs in USD, depreciation raises costs relative to revenue, producing real economic exposure rather than merely accounting translation effects.

  1. AOperating margins are exposed to depreciation of the local currency, which often accompanies a sovereign downgradeCorrect
  2. BExposure is eliminated because revenues and the plant are in the same country
  3. COnly the firm's equity beta is affected; cash flows are unchanged
  4. DOnly translation risk arises, with no economic impact

Explanation

Sovereign stress commonly coincides with currency depreciation. Local revenue with USD costs squeezes margins, creating economic (operating) exposure, not just accounting translation.

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