L2 Flashcards
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Country risk
any macro/micro risk that effects (or could) an investment in a foreign country
Soverign risk
gov fails to honour their debt obligation to creditors
Country risk componets
- political
- economci
- financial
Polictical risk factors
- international conflicts e.g., sanctions
- ethnic violence, political coup
- expropriation of foreign owned assets
- unexpected changes to the rule of the game
- buracracy and corruption in host gov
international conflicts
Polictical risk factors
could lead to:
* loss current earnings, market share
* face large pen for viloating sanctions
expropriation of foreign owned assets
Polictical risk factors
worst case- gover takes org sub with no sub
every state has the right to exploit its wealth and control over natutal resoruces
can get back through negotiation or intervention of home
Unexpected changes in rule of game
Polictical risk factors
increase taxes
tighten enviromental standards
increase exchange controls
Economic risk
health of host country economy
* gdp
* exch stability
* inflation
* employment
important to an org as it effects demand for goods, market comp, labour cost, etc
Financial Risks
host gove capacity and willingness to honour foreign debt
* gov debt/gdp
defaults have a spreading effect on banking systems sustainability. effects banks funding terms for private sector
How do they measure the country risk
PRS group scale:
International Country Risk Guide (ICRG)
ICRG weights
Financial- 25%
Economic- 25%
Political- 25%
Risk Ratings- ICRG
1- 59.9 high
60-69.9 med
70- 100 low
- financial and economic risk is measured between 1-50
covers over 140 countries
Political risk Components ICRG
6p- law & Order
12p- gov stability
12p- invest profile
Economic risk Components ICRG
this is countries economic prospertity
5p- GDP per head of population
10p- annual inflation rate
Financial risk Components ICRG
this is the state capaictiy to earn foreign exchange to repay foreign currency debt
10p- exchange rate stability
10P- Foreign debt as a % of GDP
ICRG allows comps to:
compare risk of doing buis in a country
monitor time variation of risk in a country
WB’s worldwide goverance indicators
- process of selecting, monitoring, replacing goe
- abiility to create and implement sound economic policies
- respect of the rules
on a scale between -2 (very risk) and +2 (low risk)
WB Governace indicators
1. process of selecting gov, etc,.
voice and accountability
political stability
WB Governace indicators
2.create sound economic policy
goverment efficiency
regulatory quality
WB Governace indicators
3.Repsect of Rules
Rules of law
Control of corruption
Soverign Risk
Goverment Defaults
solution: massive debt restrucutre/ Austerity
austerity
goverment cuts on public debt through public spending
Why is soverign debt such a problem
Cant take the country to court
goverment isnt able to bottow as easily going fwd
can cause an economic crisis to worsen
Measures of sovering Risk
Soverign Credit Spread
CDS (Soverign default swaps
Soverign Credit Ratings
Soverign Credit Spreads
yield (gov)- yield (Bench mark gov)
yield gov= interest rate of gov debt securities to soverign
bench= interest rate of benchmark default free debt securuites with similar charateristics
captures market perception of risk
CDS
Protection seller agrees to compensate the protection buyer if a defualt event occurs before maturity
seller charges a premium for protection
* reflects cost of getting protection
CDS spread = annual CDS premium
CDS and Credit Spread advantages and disadvanatages
+ move quickly in response to LT and transitory developments in soverign risk
-might not be available for soverign risk, if the country is less active in the capital market
-might be noisy (contaminated by liquidty risk premium)
SCR
rating agecnices fwd looking opinion on the prob of soverign defaults
-less timely than CDS/ Credit Spreads
+determined by an accurate assessing model
Soverign risk Spill over to corps: Channels
- Financial
- FISCAL
- Other
- Rating
Sov risk Financial channel
banking secotr sensitive to soverign risk, crowds out loans to corp
Sov risk Fiscal Channel
Busi linkages that a corp might have with gov:
hold equities
Sov risk Other
Capital control Measures
tax increase
asset expropriation
Sov risk Rating Channel
-corp debt is risker than soverign, hence the corp rating is capped at soverign risk of country
- when risk rises, firms with higher rating than sov will go down first
- vulnerable firms more likely to be downgraded- corp managers need to adjust their invest and financial polies in reposnse
Impact of soverign risk for corp financing and investing
Capital structure
investment
cost of debt
Managing country risk
shows systematic risk
should be accounted for in projects apprisials
purchase Protection e.g. BIT
BIT
Bilateral Investment Treaties
* treaty between home and host state to protect FDI projects
* gives strong incentive for host to honour its obligation under international law and its agreement with FDI investors
BIT example UK-Colombia 03/2010
Protects British investors doing business in colombia and vice versa
provision
* fair and equitable treatment - damages to assets during war
* free transfer of money in and out
* limit host state to expropriate foreign invest
Polticial Risk Insurance
3 common groups of risk events
1. currecny incovertiblity and non transferability
2. expropriation of assets
3. war, terrorist attacks
protection providers:
- overseas prviate investment corp (OPIC)
-
Covid 19 sover risk
measured soverign risk with 5 year CDS prem
findings
* soverign risk increases with the spread
* Across different countries, the pandemic affects sovereign risk differently.
* A strong public finance profile and solid macroeconomic fundamentals can help reduce the negative impact of the pandemic on sovereign risk
Across different countries, the pandemic affects sovereign risk differently.
high fiscal space countries affected less than low fiscal space
