VRM 5 Flashcards
What is country risk?
Country risk refers to the risks associated with the foreign countries where firms operate, impacting profitability and investments.
What are the sources of country risk?
- GDP growth rate
- Political risk
- Legal risk
- Economic structure
How does GDP growth rate affect country risk?
A nation’s GDP growth rate is impacted by economic cycles, and developing countries often face larger declines in GDP during recessions.
Define political risk.
Political risk is the risk that changes in government or government decisions will significantly affect a business’s profitability.
What are the two types of sovereign default?
- Foreign currency default
- Domestic or local currency default
What is legal risk?
Legal risk is the risk of losses due to inadequacies or biases in a country’s legal system, affecting property rights and contract enforcement.
What factors influence a country’s sovereign default risk?
- Total indebtedness
- Social security commitments
- The tax base
- Political environment
What is the importance of economic structure in country risk assessment?
A diversified economy reduces risk as reliance on a few commodities can lead to severe distress during demand drops.
What does the International Property Rights Index measure?
It measures the risks associated with investing abroad, focusing on legal and political stability, property rights, and intellectual property protection.
True or False: Authoritarian governments tend to create more political risk than democracies.
False. The impact of government type on political risk is debatable.
What are the consequences of sovereign default?
- Loss of reputation
- Difficulty in raising funds
- Economic downturn
- Political instability
- Credit rating downgrade
- Decrease in export volume
Fill in the blank: The Global Peace Index measures _____ in countries.
[violence]
What are the limitations of composite risk measures?
- Different scoring methods
- Lack of standardization
- Potentially misleading scores
What is the correlation between corruption and country risk?
Higher levels of corruption typically increase country risk, impacting business operations and profitability.
What is the significance of the tax base in assessing sovereign default risk?
A stable and diversified tax base reduces the chance of default by providing reliable revenue for debt servicing.
What are some notable examples of local currency default?
- Brazil in 1990
- Russia in 1998
What is the role of rating agencies in measuring sovereign default risk?
Rating agencies assess various factors like total debt, political environment, and economic stability to measure default risk.
What are the key determinants of a country’s competitive advantage according to Michael Porter?
- Factor Conditions
- Demand Conditions
- Related and Supporting Industries
- Firm Strategy, Structure, and Rivalry
What is the relationship between economic diversification and investment risk?
Countries with diversified economies are less vulnerable to economic distress from demand drops compared to those reliant on few commodities.
How do political stability and corruption affect investment decisions?
Stable political environments and low corruption levels are preferred as they enhance business profitability and reduce risk.
What does the corruption index published by Transparency International indicate?
It measures the perceived levels of corruption in different countries, with lower scores indicating higher corruption.
What are the primary commitments of the government that affect sovereign default risk?
To pay pensions and provide health care.
How does an increase in government commitments impact the country’s default risk?
It reduces free cash to service debt, increasing default risk.
What must a rating agency assess regarding the tax base?
The size and reliability of the tax base.
How does a diversified economy affect the tax base in terms of default risk?
It tends to provide a more stable tax base, reducing the chance of default.
What is the relationship between political environment and sovereign default risk?
Autocracies are sometimes argued to be more likely to default than democracies.
What is a potential alternative to default for governments?
Printing money.
Why is the independence of the central bank important?
It affects the extent to which government can print money as an alternative to default.
What does implicit guarantees refer to in the context of sovereign debt?
Backing of a country by stronger countries during financial difficulties.
What is the credit spread for sovereign debt?
The excess interest paid over the risk-free rate in that currency.
What is one source of credit spread data?
The credit default swap market.
What are credit default swaps (CDS)?
Insurance contracts providing payoffs if a country defaults within a specified period.
How do CDS differ from traditional insurance contracts?
CDS can be used by speculators.
What was the controversy surrounding speculators in the sovereign credit default swap market in 2010?
Speculators were blamed for driving up Greek CDS spreads, worsening Greece’s financial problems.
What is the correlation between credit spreads and ratings?
There is a strong correlation between them.
What is one advantage of credit spreads over credit ratings?
Credit spreads are more granular and provide extra information on repayment ability.
How do credit spreads react to new information compared to credit ratings?
Credit spreads adjust more quickly to new information.
What is one disadvantage of credit spreads?
They are more volatile than ratings.
What factors can cause shifts in credit spreads that are unrelated to default risk?
Liquidity and investor demand.
