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

A portfolio manager considers adding frontier-market equities. Which is the most accurate implication of rising country risk for an investor holding assets in that market?

Rising country risk raises the return investors require and the discount rates applied, which tends to lower asset values. In crises correlations with global markets also tend to increase, weakening the diversification benefit of holding assets in that country.

  1. AHigher country risk lowers required returns, increasing asset values
  2. BHigher country risk raises required returns and discount rates, tending to reduce asset values, and may also lift correlations with global markets during crisesCorrect
  3. CHigher country risk affects only sovereign bonds, not equities
  4. DHigher country risk has no effect on assets denominated in local currency

Explanation

Greater country risk increases the return investors demand, lowering present values of cash flows. Correlations with global markets also tend to rise in stress, reducing diversification benefits. The other options deny the effect on equities or local-currency assets, which is incorrect.

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