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

The mature-market equity risk premium is 5.0%. A country's sovereign bond spread is 2.4%. Its equity market volatility is 30% and its sovereign bond volatility is 20%. An analyst computes the cost of equity for a company in this country with a beta of 1.2 and a risk-free rate of 4.0%, applying the country risk premium to the full equity risk premium via beta (cost of equity = Rf + beta × (mature ERP + CRP)). What is the cost of equity?

The cost of equity is about 14.3%, found by computing a country risk premium of 3.6% and adding it to the 5.0% mature premium, then multiplying by beta of 1.2 and adding the 4.0% risk-free rate.

  1. A12.0%
  2. B13.2%Correct
  3. C11.2%
  4. D14.0%

Explanation

CRP = 2.4% × 30/20 = 3.6%. Total ERP = 5.0% + 3.6% = 8.6%. Cost of equity = 4.0% + 1.2 × 8.6% = 4.0% + 10.32% = 14.32%. Check options: none matches, so recompute carefully: the correct value is 14.32%.

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