Definition of Country Risk
Country risk is a collection of risks that are associated with investing in a foreign country instead of investing in the domestic market. The risks included are exchange rate risk, economic risk, political risk, and sovereign risk or transfer risk and by which there is a risk of capital being frozen for Government action. Each country has different type of country risk, some having higher risks would not encourage any type of foreign investments.
While some countries risks can have a greater impact on the overall economy most other countries do not create a greater impact. There are several causes that contribute to country risk, namely, mismanagement and unrest of labour and overall economy, political unrest and several other such factors. New economic policies are then put into practice that can result in the expropriation of assets, controlling the cash flow, and high taxes and tariff rates for foreign investors.
What is Country Risk Premium?
Country Risk Premium is the additional risk that is related with investing in an international company instead of the market in the country. The country risk premium or CRP is higher for developing markets.
Estimating a Country Risk Premium
If the country risk is not spread out, due to many reasons like the risk related to the spread across similar markets, or if the investor is not known globally, it is important to estimate the country risk premium. There are two ways that country risk premiums can be calculated; one approach is based on the historical risk premiums of the country and the other approach we make use of the equity risk premium by comparing the market price of stocks and how much cash flow is expected. Historical premium would be nothing but the previous trends of the market and how the country risk premium was before the current times.
Companies would not stop investing in foreign market as there might be a lot of risk involved but the business otherwise is at it peak when the foreign markets are involved. Country risk cannot be completely eliminated from the economy. America being the most popular place that investors look forward to invest in has its own risks with the economy and other factors that is usually responsible for country risks. As there are plenty of companies who want to invest in the emerging markets all across the globe, the investors who invest in foreign markets should be globally spread which is a big factor in minimizing the country risk premium.