Question

What are the dimensions of country risk? Give some examples about political risk can include.

Answer 1

Country risk is a collection of risks associated with investing in a foreign country. These risks include political risk, exchange rate risk, economic risk, sovereign risk and transfer risk, which is the risk of capital being locked up or frozen by government action. Country risk varies from one country to the next. Some countries have high enough risk to discourage much foreign investment.

Country risk can reduce the expected return on an investment and must be taken into consideration whenever investing abroad. Some country risk does not have an effective hedge. Other risk, such as exchange rate risk, can be protected against with a marginal loss of profit potential.

The United States is generally considered the benchmark for low country risk and most nations can have their risk measured as compared to the U.S. Country risk is higher with longer term investments and direct investments, which are investments not made through a regulated market or exchange.

Political Risk

Political risk is the probability that political decisions, events or conditions will result in losses. Politics affect everything from taxes to interest rates and political events can dramatically impact the price of assets or cost of doing business. The following are a few types of political risk.

1. Trade Barriers : Trade barriers such as tariffs can decrease margins or make it impossible to compete in a foreign market. In many cases, trade barriers are the result of local politics or trade wars between nations.

2. Taxes : Changes in taxes can reduce the profitability of a business and affect the price of assets such as stocks. Complex tax rules can also be a burden on small businesses who may need to invest limited resources in understanding and complying with new rules.

3. Legislation : New legislation can result in compliance costs as businesses may need to make changes to operations, products or business processes.

4. Administration : Political turmoil can result in administrative delays. For example, a government may start to delay business critical approvals such as building permits.

5. Political Instability : Political instability such as terrorism, riots, coups, civil war, and insurrection can completely disrupt business operations in a country for long periods of time.

6. Economics : In many cases, politics can influence economic management such as the interest rate decisions that impact asset prices and business costs.