country risk management in global financial markets - phifer, sachapow, armesto parra

Country Risk Management in Global Financial Markets

Financial Markets and InstitutionsProf. Dr. Dayand Arora09.12.2012BIB - WS11/12

Alina Sachapow - s0527005Gloria Armesto Parra - s0527091Kasey Navi Phifer - s0523482

Outline

1. Introduction

2. Country Risk

2.1 Types of Country Risk

2.2 Risk Assessment

3. Example Japan

4. Example Brazil

5. Conclusion

6. References

Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011

1. Introduction

“Country risk refers to the collection of risks associated with investing in a foreign country and

applies to stocks, bonds, mutual funds, options and futures that are issued within a particular

country.” from Investopedia.

Important for:

• The country itself:

Discourage foreign investment.

Harm performance of other financial instruments.

Lower risk increases the economic performance

• Investors:

Reduce expected return.

Unability of the country to honor its financial commitments.


2. Country Risk2.1 Types of Risk

• Market risk (systematic risk) : The day-to-day fluctuations in a security’s price.

1. Credit (default) risk

2. Interest rate risk

• Political risk: An investment’s return could suffer due to e.g. change in government,

military control, terrorism, civil war, insurrection.

1. Macro-level political risk: regulatory changes, corruption, war declarations.

2. Micro-level political risk: focus on sector, firm or project specific risk.


2. Country Risk2.1 Types of Risk

• Sovereign risk: A government becomes unwilling or unable to meet its loan obligations.

• Economic risk: changes in economic, social, fiscal and monetary policies (unemployment

rate, inflation, recession, natural disasters, GDP growth)

• Exchange rate risk (currency risk): Usually affects businesses that export/import but

can also affect international investors.

• Transfer risk: A currency is not able to be sent out of the country due to restricted capital

movements by the central bank.

• Contagion risk: Changes in certain factors in one country affect other countries in the

region (spillover effect).


2.2 Risk Assessment Today

Market risk

• CAPM

• Standard deviation and variance: to measure the volatility of the market.

Country Risk in general

• Self-analysis of the indicators (GDP growth, inflation, unemployment, etc)

• Use agencies: Their job is to analyze all these factors.

o Institutional Investor (Country Credit Rating -CCR): The survey reports the responses of 75-100

bankers. Respondents rate each country on a scale of 0 to 100.

o Eurasia Group (GPRI): Incorporates 4 distinct categories of sub-risk into a calculation of macro-

level political stability.


2.2 Risk Assessment Today

• Use credit rating agencies (Moody's, S&P, Fitch): Focus on financial analysis to rate the

creditworthiness of the government. Based on per capita income, inflation experience,

external debt burden, unemployment, between others.

o Ability to pay: GDP level and growth, external debt, international reserves and inflation

rate.

o Willingness to pay: Reputational effects of a country’s default are long lasting. Political

risk plays a key role.


Source: Accenture Research (2011) / Online: http://www.accenture.com/us-en/Pages/insight-ihp-imperatives-growth-emerging-markets-summary.aspx

Example Emerging markets are riskier than developed markets


3. Example Japan

General information

• Fourth largest insular state in the world

• 127 million inhabitants

• Six climate regions almost daily earthquakes, sometimes large (especially in 1923, 1995,

2011)

• Earthquake in March 2011, a tsunami and damage of a nuclear power plant followed

• -> High risk of natural disasters and large impact


3. Economy

General information

• Industrialized, free market economy with some elements of a directed economy

• Third largest economy

• Export is about 730.100 million

USD

• GDP 2010 about 5.5 trillion

• Imports of GDP in 2010 12%

• Exports of GDP in 2010 13%


http://www.indexmundi.com/g/g.aspx?v=66&c=ja&l=en

3. Contagion Risk

• 1960s to 1980s economic growth

• In 1990s the Bubble economy burst

• 1997 the Asian crisis started in Thailand and

reached Japan

• Deflation in Japan started

• Deregulation and privatization

• 2000/2001 economic recovery

• Crisis 2002

• Financial crisis in 2008/ 2009

• GDP decreased by 8%


http://upload.wikimedia.org/wikipedia/commons/d/d2/Asian_Financial_Crisis_EN-2009-05-05.png

3. Contagion Risk

• Highly vulnerable to falls and rises in global demand

• Consumer demand stimulated by expansionary fiscal policy

• Ease of deflation

• Tsunami led to fall in GDP by about 4 %

• Less output due to energy deficit and destruction of facilities, less production capacity:

Output fell by 49%

• Post-disaster demand decreased sharply


3. Credit and Default Risk

• Deficit 7,9 % of GDP

• Debt of 9.7 trillion USD

• Estimations that the debt will even rise to 225 % of GDP till the end of the year (OECD

estimates around 215%)

• Comparison: Greece “only” 147 % of GDP

• Downgrading by Moody and

Standard & Poor’s

• Especially indebted in inland



3. Sovereign Risk

• Saving rate in Japan was always very high

• Large economic power

• Reserves are at record level


No Sovereign Risk yet, but something needs to be done


3. Exchange and Interest Rate


http://forecastchart.com/currency-japanese-yen.html

• Recession since the 1990s

• Bank of Japan decreased rates to 0% in March 2001

• To facilitate lending, foster both production and consumption

3. Market Risk

• Financial markets affected by crises

• Financial markets relatively smoothly until earthquake

• Stock market gradual downward trend since crisis in 1980s

• After earthquake on March 11th, drop in Nikkei of about 19%


http://www.finanzen.net/index/Nikkei_225@pkZeit_100000

3. Market Risk


http://www.bloomberg.com/markets/rates-bonds/government-bonds/japan/

3. Market Risk


4. Risk Assessment: BrazilQuick Facts


• Largest country in South

America

• 5th largest in world (geo

and population)

• Presidential republic since

1889

• Central bank interest rate

11,5%

• Inflation ca. 6,79%


4. Market Risk

• Long-term bonds reflect

investors’ trust / belief in

market

• Don’t forget to note the

coupon (higher elasticity)


4. Market Risk• Linked to contagion risk

• Russia’s “Rubble Crisis” of ‘98 made investors wary of all BRIC countries


4. Economic Risk

• Stabile, steadily decreasing

• Not a serious risk (US unemployment ca. 9%)


4. Economic Risk• Gross Domestic Product (GDP): monetary value of all finished goods

and services within a country, per year

• Volatile, but risk is small (fairly independent with own resources)


4. Economic Risk• GDP shown in PPP per capita

• Quite small compared to US ($47K in 2010)


4. Sovereign Risk• Relatively low, since reserves have increased more quickly than debt


4. Sovereign Risk


4. Sovereign Risk• Current Account Balance: country‘s net trade in goods & services plus net

earnings (rents, interests, profits, dividends, pension fund pymts etc.

• Calculated on exchange rate basis, not PPP


4. Interest Rate Risk

• Floating exchange rates (2002 depreciation compared to other countries)


4. Interest Rate Risk• Linked to exchange rate

• Held relatively stabile


• Hyperinflation from

exchange rate

devaluations in austerity

program, growing public

deficit, imbalanced

finances & wages

• Led to TRANSFER RISK

with F. Collor de Mello’s

18-month asset freeze

4. Political & Transfer Risk

5. To conclude…

• Diversify

• Don’t trust just one agency

• Risks are interrelated

• Nothing is 100% certain


6. References

• Capital Market Liberalization and Development. Jose Antonio Ocampo, Joseph E. Stiglitz.

• Country risk in global financial mgmt. (Ch. 41). Claude B. Erb, Campbell R. Harvey and Tadas E. Viskanta. From the book: Risk MagementFinanzmanagement: Grundlagen - Konzepte - Umsetzung. Richard Guserl, Helmut Pernsteiner.

• International Financial Management. Jeff Madura, Roland Fox.• The Economics of Money, Banking and Financial Markets. Frederic

S. Mishkin.• The CIA World Fact Book (data compiled by indexmundi.com)


6. References

Internet sources• http://www.investopedia.com• http://www.investorwords.com• http://www.creditworthy.com/topics/countryrisk_define.asp • http://www2.bot.or.th/fipcs/Documents/FPG/2551/EngPDF/25510381.pdf• http://www.tradingeconomics.com/brazil/indicators• www.indexmundi.com• www.wikipedia.org

• http://www.stat.go.jp/english/data/cpi/1581.htm

• http://www.de.emb-japan.go.jp/j_info/wirtschaft.html

• http://www.de.emb-japan.go.jp/j_info/index.html

• http://nachrichten.t-online.de/erdbeben-der-staerke-5-2-erschuettert-fukushima-/id_50925074/index

• http://nachrichten.t-online.de/warnung-vor-nuklearer-explosion-in-fukushima/id_51214834/index

• http://japan-infos.de/kategorie/japan-wirtschaft

• http://www.spiegel.de/wirtschaft/soziales/0,1518,785074,00.html

• http://www.faz.net/aktuell/finanzen/anleihen-zinsen/rating-abstufung-das-japanische-menetekel11124095.html

• http://de.wikipedia.org/wiki/Japan

• http://www.oecd-ilibrary.org/economics/country-statistical-profile-japan_20752288-table-jpn

• http://www.asien-auf-einen-blick.de/japan/export.php


6. References

Internet sources

• http://www.indexmundi.com/japan/economy_overview.html

• http://www.cbsnews.com/8301-505123_162-33040102/lehman-bad-risk-management-in-a-sea-of-financial-excess/?tag=bnetdomain

• http://ezinearticles.com/?Risk-Management---A-Case-Study-on-the-Consequences-of-Bad-Risk-Management&id=1527263

• http://riskviews.wordpress.com/risk-management-failures/

• http://www.cornerstone.com/files/Publication/cec93271-eee6-4f9a-84cf-631145af6554/Presentation/PublicationAttachment/eddf6dfb-ac2d-464f-b8f5-666faf1b749b/Cornerstone_Research_Risk_Management_Failures.pdf

• http://www3.ambest.com/ratings/cr/reports/Japan.pdf

• http://www.coface.com/CofacePortal/ShowBinary/BEA%20Repository/COM_en_EN/news/_docs/110413CP

• http://blog.hktdc.com/post/199/en/D&B-downgrades-Japan's-Country-Risk-Rating.htm

• http://www.weforum.org/issues/regional-country-risks

• http://taz.vv.sebank.se/cgi-bin/pts3/mc1/mb/mblib.nsf/a-w/03AB82E8E40B447DC125793D002D3EBC/$FILE/Japan_June_2011.pdf

• http://www.economywatch.com/interest-rates/historical-interest-rates.html

• http://data.worldbank.org/country/japan

• http://e.nikkei.com/e/fr/info/nifaq/stockav.aspx#top10gain


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