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

A manufacturer in Country X sells most output domestically, but it sources inputs globally and borrows in local currency. An analyst argues that all companies in the country should be assigned the same country risk premium because they share the sovereign's jurisdiction. Which critique is most consistent with the view that country risk exposure is firm-specific?

Exposure varies by firm because it depends on where revenues, production and operations are located. A company earning mostly abroad is less exposed to its home country's risk than a purely domestic firm, so a uniform premium for all companies is inappropriate.

  1. AExposure to country risk depends on where a firm's operations, revenues and production are located, so a company with largely foreign revenues has lower exposure than a purely domestic firmCorrect
  2. BCountry risk applies only to sovereign borrowers and has no effect on corporate cash flows
  3. CCountry risk is fully diversifiable, so no premium should be applied to any firm
  4. DCountry risk exposure depends only on the firm's credit rating, not on where it operates

Explanation

Firms differ in exposure according to the geographic distribution of revenues, production and operations, so a uniform premium over- or under-states risk. Country risk affects corporates through cash flows and financing, is not assumed fully diversifiable here, and is not determined solely by rating.

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