The concept of country risk, starts from the premise that the debtor country will pay or not pay its external debt ?; It is an index aimed at protecting the profitability of foreign investors and financial capital.
It does not consider the quality of life of the citizens of nations under the focus of this indicator. Represents a subjective component of the interest rate, directs investments to speculative activities (short-term operations, buy low today to sell high in a short time).
Country Risk is represented by the EMBI + index (Emerging Markets Bond Index Plus), prepared by the investment bank JP Morgan, from the United States, with subsidiaries in several Latin American countries.
It considers the yield of the bonds of a country that pay a certain rate of interest in the markets. Applied primarily to countries in the IMF's sphere of influence.
Therefore, not all countries are under the focus of country risk analysis, according to financial transnationals (read IMF, WB, Paris Club, etc.), these are divided into two groups: Latin American countries and non-Latin American countries.
The Latin American region is made up of Argentina, Brazil, Colombia, Ecuador, Mexico, Panama, Peru and Venezuela.
The non-Latin region is made up of Bulgaria, South Korea, Morocco, Nigeria, the Philippines, Poland, and Russia.
The magnitude of the country risk is determined by the difference between the rates paid for the United States Treasury bonds and those paid for the bonds of the corresponding country.
The benchmark is the US Treasury bond rate, since it is considered to be a “solid” economy, free of “risk” and they “say” if any country has the capacity to honor its debts, that is the United States..
Country risk is calculated as follows: compares the higher the internal rate of return IRR of a long-term bond issued by a given government with respect to the IRR of the United States Treasury bonds, also for the same term.
Country Bond Flip (-) US Treasury Bond Flip = Country Risk
Generally, for the measurement of country risk, 100 points are considered equal to 1%, this means: that if a country has a country risk index of 680 points, it means that the bond issuing country pays a rate (coupon) of 6.80% (680/100) more on the rate of the US Treasury bond.
Example:
Let's consider the IRR of two bonds and a business in Peru:
1. United States Treasury Bond: IRR = 5.50% per year (risk-free investment by definition) and
2. Peruvian government bond: IRR = 10% per year (risky investment), IRR of a business in Peru = 22% (high risk).
Decomposing the IRR of these bonds into their prizes, we have:
- Bonds and business with prize for waiting prize for taking risks US Bond 5.50% 5.50% 0.00% Peruvian Bond 10.00% 5.50% 4.50% Business in Peru 22.00% 5.50% 16.50%
Why the difference in rates? Tc "Why the difference in rates?"
The US government is considered the most solvent payer on the planet (it has the "factory" of dollars), lending it money in the form of a bond is practically risk-free, the rate paid for US bonds, is the risk-free rate used as a reference.
In a different way, the Peruvian government is considered a very poor payer, lending it money in the form of a bond is considered risky.
The reward for risking is greater in the business than in the case of the bond. Analyzing the components of the reward for taking risks in the business we see:
Country risk 4.50% + own business risk 12.00% = premium for risking 16.50%
4.50% + 12.00% = 16.50% Prize for taking risks
There is a premium for the business's own risk, this rate is exclusive to the activity and varies very little over time.
Country risk influences the award for risking doing business in Peru. Then: when the country risk is high, the premium for risking investing in Peru will be high. Here the speculation begins.
Finally, country risk is a unilateral measure, imposed by lenders on most Latin American countries and some from Eastern Europe and Africa.
