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

Which of the following best explains why a country with a low debt-to-GDP ratio may still be assigned high country risk?

A country with low government debt can still be high risk because weak legal systems, corruption and arbitrary policy-making expose investors to risks such as expropriation, contract repudiation and unpredictable regulation. Country risk depends on political and institutional quality as well as the debt burden.

  1. ADebt ratios are the only determinant of sovereign default, so low debt implies low risk
  2. BA weak legal system, corruption and arbitrary policy-making can raise risk for investors independent of the government's debt burdenCorrect
  3. CLow debt always implies the currency will be devalued
  4. DHigh country risk is defined only by the size of the country's population

Explanation

Country risk reflects political structure, legal systems, institutions and economic factors, not leverage alone. Weak property rights, corruption and policy unpredictability raise expropriation and operating risk even when the government debt burden is small. The other options assert false absolutes.

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