Question

Country Risk Analysis

Apply one of the country risk analyses explored in the readings to your selected country
What types of risks do you see? How could you mitigate these risks?

Answer 1

Many investors place a portion of their portfolios in foreign securities. This decision involves an analysis of various mutual funds, exchange-traded funds (ETFs), or stock and bond offerings. However, investors often neglect an important first step in the process of international investing. The decision to invest overseas should begin with determining the riskiness of the investment climate in the country under consideration. Country risk refers to the economic, political and business risks that are unique to a specific country, and that might result in unexpected investment losses. This article will examine the concept of country risk and how it can be analyzed by investors.

Types of Risks:

• Economic risk: This risk refers to a country's ability to pay back its debts. A country with stable finances and a stronger economy should provide more reliable investments than a country with weaker finances or an unsound economy.
• Political risk: This risk refers to the political decisions made within a country that might result in an unanticipated loss to investors. While economic risk is often referred to as a country's ability to pay back its debts, political risk is sometimes referred to as the willingness of a country to pay debts or maintain a hospitable climate for outside investment. Even if a country's economy is strong, if the political climate is unfriendly (or becomes unfriendly) to outside investors, the country may not be a good candidate for investment.
• Sovereign risk: This is the risk that a foreign central bank will alter its foreign exchange regulations, significantly reducing or nullifying the value of its foreign exchange contracts. Analyzing sovereign risk factors is beneficial for both equity and bond investors, but perhaps more directly beneficial to bond investors. When investing in the equity of specific companies within a foreign country, a sovereign risk analysis can aid in creating a macroeconomic picture of the operating environment, but the bulk of research and analysis would need to be done at the company level. On the other hand, if you're investing directly into a country's bonds, evaluating the economic condition and strength of the country can be a good way to evaluate a potential investment in bonds. After all, the underlying asset for a bond is the country itself and its ability to grow and generate revenue.