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

A manufacturer in an emerging market earns 70% of its revenues from exports to developed markets and sources inputs locally. A risk manager is deciding how to assign the country risk premium to this firm and says that a firm's exposure should depend on where it operates and earns revenue, not simply where it is incorporated. Which approach to estimating firm exposure is most consistent with this view?

The most consistent approach weights the country risk premium by the share of revenues or production from each country or region. Exposure to country risk comes from where a firm operates and earns income, not its place of incorporation, so a heavy exporter bears a smaller share of its home country's premium.

  1. AApply the full country risk premium of the country of incorporation to every firm there
  2. BWeight the country risk premium by the share of revenues or production derived from each country or regionCorrect
  3. CApply no country risk premium to firms that export
  4. DApply the premium only to the firm's debt, not equity

Explanation

Operating exposure comes from where revenues and production occur, so the premium should be a weighted average across the countries in which the firm operates. Applying the full premium by incorporation ignores the export revenue. Excluding exporters entirely ignores local production and cost exposure.

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