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

Which of the following is a reason that weak legal systems and corruption raise a country's risk for investors?

Weak legal systems and corruption raise country risk because they undermine enforcement of contracts and property rights and add hidden costs, making the cash flows investors actually keep more uncertain. They do not stabilise currency or reduce expropriation risk, and may increase it.

  1. AThey guarantee higher cash flows to offset risk
  2. BThey weaken contract and property rights enforcement, increasing uncertainty about the returns investors can keepCorrect
  3. CThey reduce the volatility of the local currency
  4. DThey eliminate the risk of expropriation

Explanation

Weak legal systems and corruption make contracts and property rights hard to enforce and add hidden costs, so investors face greater uncertainty about the cash flows they retain. They do not guarantee higher cash flows, stabilise currency, or remove expropriation risk; they tend to increase it.

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