International Finance Assignment No.

2 Exe-MBA (2010-13)

Country Risk

Submitted by: Amit Panday – 2010E31 Kaustubh Bhagwat – 2010E29 Rahul Dudhe – 2010E32 Satish Shinde – 2010E34 Neeta Kelkar – 2010E25

.............................................................................................................................9 ............... 4 Political Risk........................................Contents Contents. 3 Economical Risk................................................................................................................................................... 7 Calculation of Country Risk using Stock Market Data.............................................................................................................................. 2 Financial Risk...........................................

Country Risk Country risk refers to the risk of investing in a country.1.  Reputational risk (fraud)  Legal risk  IT risk . Instrument. dependent on changes in the business environment that may adversely affect operating profits or the value of assets in a specific country. Bonds)  Funding Liquidity (Pay bills or liabilities)  Market Risk  Stock Prices  Interest Rates  Foreign Exchange Rates  Commodity Prices  Operational Risk Risk arising from execution of a company's business functions. Money Mkt. Govt. There are two types of liquidity risk:  Asset Liquidity (Stock. The Country Risk can be obtained by multiple factors such as: • • • Financial Risk Economical Risk Political Risk Financial Risk  Liquidity Risk The risk stemming from the lack of marketability of an investment that cannot be bought or sold quickly enough to prevent or minimize a loss.

4% in 2010 and by about 8% in full year 2011.  India. 1. has great economic potential due to its large labor force. Best’s assessment of three categories of risk: Economic. strong growth has returned. Economic Risk: Moderate . Growth has been strong.Economical Risk AMB Country Risk Report. Political and Financial System Risk.1.1. with GDP expanding by 10.India India country Risk Rating: 4  The Country Risk Tier (CRT) reflects A. averaging nearly 9% in the years leading up to 2008.M. and expectations of continued growth over the next few years. a CRT-4 country. After a deceleration in 2008 and 2009.

Financial System Risk: High  The insurance industry is regulated by the Insurance Regulatory and Development Authority (IRDA). in light of the positive growth outlook and relatively high inflation.1. world’s 10th largest economy as measured by gross domestic product (GDP). 1.2. .  In 2010. though to a lesser degree than the services sectors. GDP is expected to continue to grow by about 8% per year in the years ahead. India.  India’s manufacturing industries also contribute to growth.  Capital markets are relatively illiquid and foreign participation is limited.  The Indian government is working to align its regulatory and accounting standards with international best practices.  Strong domestic demand maintains India’s strong GDP growth rates. the government formed a Financial Development and Stability Council (FDSC) that will coordinate the efforts of the financial sector regulators in India.  Monetary policy has been tight and is likely to remain so into 2012.

Political Risk: High  Income disparity in India is significant. as some of the major cities have been the scene of terrorist bombings.  Some progress on ant-corruption reform has been made in the wake of protests.1.  National security has become a focus in India. Peace talks have resumed in 2011. but it is still considered insufficient by many.3.  The bilateral relationship with Pakistan is strained. as approximately one third of the population lives in poverty. but little substantive progress has been made. .1.

Political Risk Factor:  It is the Likelihood that government or bureaucratic inefficiencies. Political Risk Summary:  It is a radar chart that display scores for nine different aspects of political risk scored on scale of 1-5 with 1 being the least amount of risk and 5 being the highest amount of risk. societal tensions.1. or international tensions will cause adverse developments for an insurer or investor. the efficiency of the government bureaucracy and the appropriateness and effectiveness of the government’s economic policies.1.Political Risk 1. inadequate legal system. CATEGORY International policy DEFINATION transactions Measures the effectiveness of the exchange rate regime and currency management Measures the ability of a country to effectively implement Monetary Policy Measures the ability of a country to effectively implement Fiscal Policy Measures the overall quality of the environment and ease of doing business business Monetary Policy Fiscal Policy Business environment Labor flexibility Measures the flexibility of the labor market. 1.  Political risk comprise the stability of the government and society.4.5. Measures the degree of stability in a government Measures the degree of social stability including human development and political rights Measures the degree of stability in the region Measures the transparency and level of corruption in the legal system Government stability Social stability Regional stability Legal system . the effectiveness of diplomatic international relationships. reliability and integrity of the legal systems and of the business infrastructure. including the company’s ability to hire and fire employees.

M. Best’s country risk Tiers. mature insurance industry framework. legal systems and business infrastructure. nascent insurance industry. all countries are placed into one of five tiers ranging from CRT-1 denoting stable environment with the least amount of risk to CRT-5 denoting countries that pose the most risk. Low human development and social instability. US and Libya was studied to understand the effect of all the nine aspects of political risk. sophisticated financial system regulation with deep capital markets.S. Country Risk Tier CRT-1 Definition Predictable and transparent legal environment. Political Risk Summary Highlights for India with comparison against US and Libya  The political risk summary for three Country India. Cou ntry U. partially to fully inadequate regulatory structure. Relatively unpredictable and non-transparent legal environment. legal systems and business infrastructure. Unpredictable and opaque political. legal and business environment with limited or non-existent capital markets.6.A.1. with underdeveloped capital markets.  As per the A.1. India CRT-4 Libya CRT-5 .

which implies that the economy is slowing down and thus that the market is predicting a greater risk of default. When spreads widen between bonds with different quality ratings it implies that the market is factoring more risk of default on lower grade bonds.  The yield spread analysis also helps investors and interested people understand the market’s trend when it comes to various investment instruments. usually of different credit quality.7. the investors can conclude that the market is factoring more risk of default on the lower grade bonds. A narrowing of spreads between bonds of different risk ratings implies that the market is factoring in less risk due to an expanding economy. Spread in 10 year government bond:  The simplest and most widely used measure of country risk comes from looking at the yields on bonds issued by the country in a currency (such as the dollar or the euro) where there is a default free bond yield to which it can be compared. When the spread is wide between bonds of different quality ratings. The yield spread is the difference between the quoted rates of return on two different investments. The bond spread is subject to volatility and therefore we should take the average of bond .1.Calculation of Country Risk using Stock Market Data 1.

For our analysis we have taken ot for a period of 3 months April 2012 to June 2012. Brazil and Greece considering US as base. 10 year Brazil bond and 10 year Greece bond.  The below graph shows volatility in four countries for 10 year government bond yields for a period of April 2012 to June 2012. 10 year US bond. The below graph shows the relative volatality of India.spread over a period of time. The volatility in spreads is measured by considering US as the base. .  Analysts add default spreads as measures of country risk typically add them on to both the cost of equity and debt of every company traded in that country.  The relative volatality for the countries is measured by taking the average of data for the period under analysis and considering US as the base.  We will compare spread between 10 year government bond issued by RBI in India.

1. as measured by the volatilities of these markets.  A conventional measure of equity risk is the standard deviation in stock prices. If we scale the standard deviation of one market against another. India. Relative Standard Deviation (Country Y) = Standard Deviation (Country Y) Standard Deviation (Country X)  This relative standard deviation when multiplied by the premium used for Country X stock yields a measure of the total risk premium for any market. Then we . Then we calculated the standard deviation of the returns of the stocks.1.Risk Premium (Country X)  For our analysis. higher standard deviations are generally associated with more risk. Relative Equity Market Standard Deviations:  This approach is based on assumption that the equity risk premiums of markets should reflect the differences in equity risk. we obtain a measure of relative risk. Brazil and Greece stock indices from April 2011 to March 2012 on weekly basis. we collected data for closing prices of US.  Equity Risk premium (Country Y) = Risk Premium (Country X) * Relative Standard Deviation (Country Y) Once the Equity Risk Premium has been found out the country risk premium can be found out as follows:  Country Risk Premium (Country Y) = Equity Risk premium (Country Y) .8.

If you scale the standard deviation of one market against another.calculated relative standard deviation of India. higher standard deviations are generally associated with more risk. In the process. .  The equity risk premium reflects fundamental judgments we make about how much risk we see in an economy/market and what price we attach to that risk.9. ATHEX – Greece 1. BOVESPA – Brazil. more risky is the country. The country risk premium (CRP) is higher for developing markets than for developed nations. The below graph shows the relative standard deviation of above countries as calculated above. More the relative standard deviation. you obtain a measure of relative risk.  Thus. a portfolio manager who decides to pull out of the stock market because he feels stocks are over priced is telling you that he thinks that equity risk premiums will increase in the future. Calculation of Country Risk Premium  The additional risk associated with investing in an international company rather than the domestic market. Brazil and Greece considering US as base. BSE Sensex – India. Macroeconomic factors such as political instability.  A conventional measure of equity risk is the standard deviation in stock prices.1. it affects the expected return on every risky investment and the value that we estimate for that investment. volatile exchange rates and economic turmoil causes investors to be wary of overseas investment opportunities and thus require a premium for investing.

94 1. US (Risk prm.1987 0.195500 0. Relative S.2542 0. the relative standard deviation for country X (against the US) would be computed as follows:  Relative Standard DeviationCountry X =Standard DeviationCountry X/Standard DeviationUS  If we assume a linear relationship between equity risk premiums and equity market standard deviations.00 0.S.d.631713555 6.22 0.195500 0.195500 0.2046 0. for instance) the equity risk premium for country X follows:  Equity risk premiumCountry DeviationCountry X X = Risk PremumUS*Relative Standard  Country risk Premium X= ERP X – ERP US EQUITY MARKET VOLATILITIES AND RISK PREMIUMS(FEB 10-12) COUNTRY S.D. For instance.279283887 7.37 0.00 -0.28 1.us)*relative sd ERPcal-ERPus CHINA INDIA ITALY US PHILLIPINES PORTUGAL VIETNAM 0.30 6.195500 0. D.05 1.195500 0.19 0. country/s. ERP country% Country risk prem% % % s.D.13 1.19488491 6 5.098209719 9.195500 0.02 1.801534527 0. Country S.75 0.80 .2996 0.10 3. and we assume that the risk premium for the US can be computed (using historical data.d.53 1.195500 1.751918159 6. U.1835 0.1955 0.