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P1.T4.915. Country risk measures and historical instances of sovereign default (Damodaran)

Nicole Seaman

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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:

915.1. Political Risk Services (The PRS Group) provides numerical measures of country risk for more than a hundred countries. Its International Country Risk Guide (ICRG) rating "comprises 22 variables in three subcategories of risk: political, financial, and economic. A separate index is created for each of the subcategories. The Political Risk index is based on 100 points, Financial Risk on 50 points, and Economic Risk on 50 points. The total points from the three indices are divided by two to produce the weights for inclusion in the composite country risk score."

As of July 2018, according to Damodaran, Taiwan's composite (ICRG) score was 85. Which of the following is TRUE?

a. Taiwan is very low risk
b. This score is irrelevant for investment purposes
c. This score can be neither normalized nor standardized
d. This score cannot be used to rank Taiwan against other countries


915.2. Damodaran paper includes a brief "[examination of] the history of sovereign default, by first looking at governments that default on foreign currency debt (which is understandable) and then looking at governments that default on local currency debt (which is more difficult to explain)." In regard to this history, which of the following statements is TRUE?

a. Since 2000, there have been only two sovereign defaults
b. Countries with sufficient natural resources have rarely experienced a sovereign default
c. Countries have been more likely to default on bank debt owed than on sovereign bonds issued
d. Since 1975, the Asia/Pacific region has accounted for more sovereign debt defaults in dollar value terms than any other region


915.3. Damodaran examines and compares two different types of sovereign default: governments that default of foreign currency debt and governments that default on local currency debt. He says it is more difficult to explain the latter (i.e., default on local currency). According to him, which of the following is TRUE?

a. Currency devaluation is almost a free lunch with few visible costs
b. Prior to 1971, the gold standard often provoked periods of widespread currency devaluation
c. Greece's membership in the Euro proved that a shared currency enables the vital tool of currency devaluation as a means to avoid default
d. A country whose companies' local currency assets are funded by foreign currency debt may prefer to default in their local currency debt rather than devalue their currency

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