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

An analyst values a Brazilian-operating firm in US dollars. The US 10-year Treasury yield is 4.0%, the equity risk premium for a mature market is 5.0%, and the firm's beta is 1.2. The analyst adds a country risk premium of 3.0% to the cost of equity and applies it as a flat additive amount. What is the resulting USD cost of equity?

The cost of equity is 13.0%. Add the risk-free rate of 4.0%, the beta-scaled mature market premium of 1.2 times 5.0%, which is 6.0%, and the flat 3.0% country risk premium. The country premium is added without scaling by beta in this approach.

  1. A10.0%
  2. B12.0%
  3. C13.0%Correct
  4. D15.6%

Explanation

Cost of equity = 4.0% + 1.2 × 5.0% + 3.0% = 4.0% + 6.0% + 3.0% = 13.0%. Option 10.0% omits the country premium. Option 12.0% omits the beta of 1.2 on the mature premium (4+5+3). Option 15.6% multiplies the country premium by beta (4+1.2×8=13.6 is not this; 15.6 arises from other misuse), which is not the flat additive approach described.

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