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P1.T4.601. Composite measures of country risk (Damodaran)

Nicole Seaman

Director of FRM Operations
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Learning Objectives: Evaluate composite measures of risk that incorporate all types of country risk and explain limitations of the risk services. Compare instances of sovereign default in both foreign currency debt and local currency debt, and explain common causes of sovereign defaults.

Questions:

601.1. According to Awath Damodaran, if we want to use a single measure in order to evaluate country risk, which of the following is most TRUE?

a. Because there are no reliable, authoritative publishers (or service providers) of measures of country risk, the best approach is to use sovereign bond yields
b. Although services that measure country risk with summary scores do provide some valuable information about risk variations across countries, it is unclear how useful these measures are for investors due to method differences
c. Country risk scores, such as Political Risk Services (PRS) measures for example, should be mapped to a ratio scale (as opposed to ordinal scale) so the investor's discount rate can be a direct linear function of the country risk measure
d. While there are several publishers of measures of country risk, practitioners should use only measures the comport with the industry standard Global Country Risk Rating Methodology (GCRRM) due to built-in standardization benefits


601.2. In the last 50 years, which region accounts for more of the sovereign debt defaults (in US dollar terms) than any other?

a. Latin America
b. Sub-Saharan Africa
c. Central/Eastern Europe
d. Middle East (including Egypt)


601.3. The most direct measure of country risk is sovereign default risk, which refers to the risk of default when lending to a country's government. A country's government can either default on foreign currency (i.e., borrowing denominated in a foreign currency) or they can default on debt that is dominated in their own local currency. According to Damodaran, which of the following statements is TRUE about sovereign defaults?

a. Countries who issuer their own fiat currency never have a valid, logical, economic reason--much less a need--to default on debt issued in their local currency
b. While it is theoretically possible for a sovereign to default on local (domestic) currency debt, there has been no such default since the Bretton Woods Conference
c. If a country is heavily occupied by companies who own local currency assets funded by foreign currency debt, this country is likely to prefer a local currency devaluation over a local currency default
d. A country might prefer to default on local currency debt rather than issue currency because printing money promotes inflation which, in turn, encourages investors to abandon financial assets and shift to real assets

Answers here:
 
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