Country risk is the risk that a country has in relation to international financial operations. It affects direct foreign investment and is usually measured through its risk premium.
Country risk determines whether there is an optimal investment scenario in that country or not. If the country risk is high, the risk of investing in that country is higher. When the risk premium of a country is high, the country risk is high.
There are many causes of a high country risk, the political, economic or public safety tone will directly influence the risk premium of that country. Therefore, when an economic agent values direct investment, it must take into account the specific risks that exist in it to make the decision. Likewise, it must also be taken into consideration when issuing debt in that country, since in addition to the risk paid as issuer to investors, country risk will be added.
The risk premium as a measure of country risk
The relationship between country risk and the risk premium is explained by the profitability required by investors to invest in a given country. The riskier it is to invest in a country, the greater the interest that investors will ask for to lend money to that country.
There are financial derivatives that serve to protect against country risk, such as credit default swaps (CDS).
The most important risk factors to take into account in a country are the following:
- Economic effort: Quality and veracity of the country's macroeconomic data, through which its level of economic activity can be seen.
- Political Risk: Democratic level of the institutions that govern them as well as the set of political parties that make up the chambers of representation.
- Debt and debt indicators default: Debt of the country vis-à-vis abroad and debt with respect to GDP.
- Credit rating: Evaluation of your ability to pay and default.
- Market indicators:
- Access to financing from banks: Stability and solvency of the banking system.
- Short-term financing: Liquidity and access to credit.
- Discount for Default: Discounts with commercial effects in case of not being able to face a debt, reducing its penalty.
- Access to the capital market: Access to financing, development of capital market structures and integration with other markets.
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