Country Risk Management in Global Financial Markets Financial Markets and Institutions Prof. Dr. Dayand Arora 09.12.2012 B...
Outline <ul><li>1. Introduction </li></ul><ul><li>2. Country Risk </li></ul><ul><li>     2.1 Types of Country Risk </li></...
1. Introduction <ul><li> “ Country risk refers to the collection of risks associated with investing in a foreign country a...
2. Country Risk 2.1 Types of Risk <ul><ul><li>Market risk (systematic risk)  : The day-to-day fluctuations in a security’s...
2. Country Risk 2.1 Types of Risk <ul><ul><li>Sovereign risk:  A government becomes unwilling or unable to meet its loan o...
2.2 Risk Assessment Today <ul><li>Market risk </li></ul><ul><ul><li>CAPM  </li></ul></ul><ul><ul><li>Standard deviation an...
2.2 Risk Assessment Today <ul><ul><li>Use credit rating agencies (Moody's, S&P, Fitch): Focus on financial analysis to rat...
Source: Accenture Research (2011) / Online: http://www.accenture.com/us-en/Pages/insight-ihp-imperatives-growth-emerging-m...
3. Example Japan <ul><li>General information </li></ul><ul><li>Fourth largest insular state in the world </li></ul><ul><li...
3. Economy <ul><li>General information </li></ul><ul><li>Industrialized, free market economy with some elements of a direc...
3. Contagion Risk <ul><li>1960s to 1980s economic growth </li></ul><ul><li>In 1990s the Bubble economy burst </li></ul><ul...
3. Contagion Risk <ul><li>Highly vulnerable to falls and rises in global demand  </li></ul><ul><li>Consumer demand stimula...
3. Credit and Default Risk <ul><li>Deficit  7,9 % of GDP </li></ul><ul><li>Debt  of 9.7 trillion USD </li></ul><ul><li>Est...
3. Sovereign Risk <ul><li>Saving rate in Japan was always very high  </li></ul><ul><li>Large economic power </li></ul><ul>...
3. Exchange and Interest Rate Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011  http://forecastchart.com/c...
3. Market Risk <ul><li>Financial markets affected by crises  </li></ul><ul><li>Financial markets relatively smoothly until...
3. Market Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011  http://www.bloomberg.com/markets/rates-bo...
3. Market Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011
4. Risk Assessment: Brazil Quick Facts Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011  <ul><li>Largest c...
4. Market Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011  <ul><li>Long-term bonds reflect investors...
Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011  4. Market Risk <ul><li>Linked to  contagion risk </li></...
4. Economic Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011  <ul><li>Stabile, steadily decreasing </...
4. Economic Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011  <ul><li>Gross Domestic Product (GDP): m...
4. Economic Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011  <ul><li>GDP shown in PPP per capita </l...
4. Sovereign Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011  <ul><li>Relatively low, since reserves...
Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011  4. Sovereign Risk
Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011  4. Sovereign Risk <ul><li>Current Account Balance: count...
4. Interest Rate Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011  <ul><li>Floating exchange rates (2...
4. Interest Rate Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011  <ul><li>Linked to exchange rate </...
4. Political & Transfer Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011  <ul><li>Hyperinflation  fro...
5. To conclude… <ul><li>Diversify </li></ul><ul><li>Don’t trust just one agency </li></ul><ul><li>Risks are interrelated  ...
6. References <ul><ul><li>Capital Market Liberalization and Development. Jose Antonio Ocampo, Joseph E. Stiglitz. </li></u...
6. References <ul><ul><li>Internet sources </li></ul></ul><ul><ul><li>http://www.investopedia.com </li></ul></ul><ul><ul><...
6. References <ul><ul><li>Internet sources </li></ul></ul><ul><li>http://www.indexmundi.com/japan/economy_overview.html </...
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Country Risk Management in Global Financial Markets - Phifer, Sachapow, Armesto Parra

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I worked on this presentation with two other students for our Financial Markets, Institutions & Investments class as a part of our B.A. in International Business.

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Country Risk Management in Global Financial Markets - Phifer, Sachapow, Armesto Parra

  1. 1. Country Risk Management in Global Financial Markets Financial Markets and Institutions Prof. Dr. Dayand Arora 09.12.2012 BIB - WS11/12 Alina Sachapow - s0527005 Gloria Armesto Parra - s0527091 Kasey Navi Phifer - s0523482
  2. 2. Outline <ul><li>1. Introduction </li></ul><ul><li>2. Country Risk </li></ul><ul><li>    2.1 Types of Country Risk </li></ul><ul><li>    2.2 Risk Assessment </li></ul><ul><li>3. Example Japan </li></ul><ul><li>4. Example Brazil </li></ul><ul><li>5. Conclusion </li></ul><ul><li>6. References </li></ul>Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011
  3. 3. 1. Introduction <ul><li> “ 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. </li></ul><ul><li>     </li></ul><ul><li>Important for:  </li></ul><ul><ul><li>The country itself:  </li></ul></ul><ul><li>Discourage foreign investment. </li></ul><ul><li>Harm performance of other financial instruments. </li></ul><ul><li>Lower risk increases the economic performance </li></ul><ul><ul><li>Investors:  </li></ul></ul><ul><li>Reduce expected return. </li></ul><ul><li>Unability of the country to honor its financial commitments. </li></ul>Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011
  4. 4. 2. Country Risk 2.1 Types of Risk <ul><ul><li>Market risk (systematic risk) : The day-to-day fluctuations in a security’s price. </li></ul></ul><ul><ul><ul><li>Credit (default) risk </li></ul></ul></ul><ul><ul><ul><li>Interest rate risk </li></ul></ul></ul><ul><ul><li>Political risk: An investment’s return could suffer due to e.g. change in government, military control, terrorism, civil war, insurrection. </li></ul></ul><ul><ul><ul><li>Macro-level political risk: regulatory changes, corruption, war declarations. </li></ul></ul></ul><ul><ul><ul><li>Micro-level political risk: focus on sector, firm or project specific risk. </li></ul></ul></ul>Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011
  5. 5. 2. Country Risk 2.1 Types of Risk <ul><ul><li>Sovereign risk: A government becomes unwilling or unable to meet its loan obligations. </li></ul></ul><ul><ul><li>Economic risk: changes in economic, social, fiscal and monetary policies (unemployment rate, inflation, recession, natural disasters, GDP growth) </li></ul></ul><ul><ul><li>Exchange rate risk (currency risk): Usually affects businesses that export/import but can also affect international investors. </li></ul></ul><ul><ul><li>Transfer risk: A currency is not able to be sent out of the country due to restricted capital movements by the central bank. </li></ul></ul><ul><ul><li>Contagion risk: Changes in certain factors in one country affect other countries in the region (spillover effect). </li></ul></ul>Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011
  6. 6. 2.2 Risk Assessment Today <ul><li>Market risk </li></ul><ul><ul><li>CAPM  </li></ul></ul><ul><ul><li>Standard deviation and variance: to measure the volatility of the market. </li></ul></ul><ul><li>Country Risk in general </li></ul><ul><ul><li>  Self-analysis of the indicators (GDP growth, inflation, unemployment, etc) </li></ul></ul><ul><ul><li>  Use agencies: Their job is to analyze all these factors. </li></ul></ul><ul><ul><ul><li>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. </li></ul></ul></ul><ul><ul><ul><li>Eurasia Group (GPRI): Incorporates 4 distinct categories of sub-risk into a calculation of macro-level political stability. </li></ul></ul></ul>Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011
  7. 7. 2.2 Risk Assessment Today <ul><ul><li>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. </li></ul></ul><ul><ul><ul><li>Ability to pay: GDP level and growth, external debt, international reserves and inflation rate. </li></ul></ul></ul><ul><ul><ul><li>Willingness to pay: Reputational effects of a country’s default are long lasting. Political risk plays a key role. </li></ul></ul></ul>Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011
  8. 8. 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 Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011
  9. 9. 3. Example Japan <ul><li>General information </li></ul><ul><li>Fourth largest insular state in the world </li></ul><ul><li>127 million inhabitants </li></ul><ul><li>Six climate regions almost daily earthquakes, sometimes large (especially in 1923, 1995, 2011) </li></ul><ul><li>Earthquake in March 2011, a tsunami and damage of a nuclear power plant followed </li></ul><ul><li>-> High risk of natural disasters and large impact </li></ul>Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011
  10. 10. 3. Economy <ul><li>General information </li></ul><ul><li>Industrialized, free market economy with some elements of a directed economy </li></ul><ul><li>Third largest economy </li></ul><ul><li>Export is about 730.100 million USD </li></ul><ul><li>GDP 2010 about 5.5 trillion </li></ul><ul><li>Imports of GDP in 2010 12% </li></ul><ul><li>Exports of GDP in 2010 13% </li></ul>Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 http://www.indexmundi.com/g/g.aspx?v=66&c=ja&l=en
  11. 11. 3. Contagion Risk <ul><li>1960s to 1980s economic growth </li></ul><ul><li>In 1990s the Bubble economy burst </li></ul><ul><li>1997 the Asian crisis started in Thailand and reached Japan </li></ul><ul><li>Deflation in Japan started </li></ul><ul><li>Deregulation and privatization </li></ul><ul><li>  </li></ul><ul><li>2000/2001 economic recovery </li></ul><ul><li>Crisis 2002 </li></ul><ul><li>Financial crisis in 2008/ 2009 </li></ul><ul><li>GDP decreased by 8% </li></ul>Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 http://upload.wikimedia.org/wikipedia/commons/d/d2/Asian_Financial_Crisis_EN-2009-05-05.png
  12. 12. 3. Contagion Risk <ul><li>Highly vulnerable to falls and rises in global demand </li></ul><ul><li>Consumer demand stimulated by expansionary fiscal policy </li></ul><ul><li>Ease of deflation </li></ul><ul><li>Tsunami led to fall in GDP by about 4 % </li></ul><ul><li>Less output due to energy deficit and destruction of facilities, less production capacity: Output fell by 49% </li></ul><ul><li>Post-disaster demand decreased sharply </li></ul>Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011
  13. 13. 3. Credit and Default Risk <ul><li>Deficit 7,9 % of GDP </li></ul><ul><li>Debt of 9.7 trillion USD </li></ul><ul><li>Estimations that the debt will even rise to 225 % of GDP till the end of the year (OECD estimates around 215%) </li></ul><ul><li>Comparison: Greece “only” 147 % of GDP </li></ul><ul><li>Downgrading by Moody and Standard & Poor’s </li></ul><ul><li>Especially indebted in inland </li></ul>Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 http://www.indexmundi.com/g/g.aspx?v=143&c=ja&l=en
  14. 14. 3. Sovereign Risk <ul><li>Saving rate in Japan was always very high </li></ul><ul><li>Large economic power </li></ul><ul><li>Reserves are at record level </li></ul>Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 No Sovereign Risk yet, but something needs to be done http://www.indexmundi.com/g/g.aspx?v=145&c=ja&l=en
  15. 15. 3. Exchange and Interest Rate Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 http://forecastchart.com/currency-japanese-yen.html <ul><li>Recession since the 1990s </li></ul><ul><li>Bank of Japan decreased rates to 0% in March 2001 </li></ul><ul><li>To facilitate lending, foster both production and consumption </li></ul>
  16. 16. 3. Market Risk <ul><li>Financial markets affected by crises </li></ul><ul><li>Financial markets relatively smoothly until earthquake </li></ul><ul><li>Stock market gradual downward trend since crisis in 1980s </li></ul><ul><li>After earthquake on March 11 th , drop in Nikkei of about 19% </li></ul>Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 http://www.finanze n.net/index/Nikkei_2 [email_address]
  17. 17. 3. Market Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 http://www.bloomberg.com/markets/rates-bonds/government-bonds/japan/
  18. 18. 3. Market Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011
  19. 19. 4. Risk Assessment: Brazil Quick Facts Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 <ul><li>Largest country in South America </li></ul><ul><li>5th largest in world (geo and population) </li></ul><ul><li>Presidential republic since 1889 </li></ul><ul><li>Central bank interest rate 11,5% </li></ul><ul><li>Inflation ca. 6,79% </li></ul>
  20. 20. 4. Market Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 <ul><li>Long-term bonds reflect investors’ trust / belief in market </li></ul><ul><li>Don’t forget to note the coupon (higher elasticity) </li></ul>
  21. 21. Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 4. Market Risk <ul><li>Linked to contagion risk </li></ul><ul><li>Russia’s “Rubble Crisis” of ‘98 made investors wary of all BRIC countries </li></ul>
  22. 22. 4. Economic Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 <ul><li>Stabile, steadily decreasing </li></ul><ul><li>Not a serious risk (US unemployment ca. 9%) </li></ul>
  23. 23. 4. Economic Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 <ul><li>Gross Domestic Product (GDP): monetary value of all finished goods and services within a country, per year </li></ul><ul><li>Volatile, but risk is small (fairly independent with own resources) </li></ul>
  24. 24. 4. Economic Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 <ul><li>GDP shown in PPP per capita </li></ul><ul><li>Quite small compared to US ($47K in 2010) </li></ul>
  25. 25. 4. Sovereign Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 <ul><li>Relatively low, since reserves have increased more quickly than debt </li></ul>
  26. 26. Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 4. Sovereign Risk
  27. 27. Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 4. Sovereign Risk <ul><li>Current Account Balance: country‘s net trade in goods & services plus net earnings (rents, interests, profits, dividends, pension fund pymts etc. </li></ul><ul><li>Calculated on exchange rate basis, not PPP </li></ul>
  28. 28. 4. Interest Rate Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 <ul><li>Floating exchange rates (2002 depreciation compared to other countries) </li></ul>
  29. 29. 4. Interest Rate Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 <ul><li>Linked to exchange rate </li></ul><ul><li>Held relatively stabile </li></ul>
  30. 30. 4. Political & Transfer Risk Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011 <ul><li>Hyperinflation from exchange rate devaluations in austerity program, growing public deficit, imbalanced finances & wages </li></ul><ul><li>Led to TRANSFER RISK with F. Collor de Mello’s 18-month asset freeze </li></ul>
  31. 31. 5. To conclude… <ul><li>Diversify </li></ul><ul><li>Don’t trust just one agency </li></ul><ul><li>Risks are interrelated </li></ul><ul><li>Nothing is 100% certain </li></ul>Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011
  32. 32. 6. References <ul><ul><li>Capital Market Liberalization and Development. Jose Antonio Ocampo, Joseph E. Stiglitz. </li></ul></ul><ul><ul><li>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. </li></ul></ul><ul><ul><li>International Financial Management. Jeff Madura, Roland Fox. </li></ul></ul><ul><ul><li>The Economics of Money, Banking and Financial Markets. Frederic S. Mishkin. </li></ul></ul><ul><ul><li>The CIA World Fact Book (data compiled by indexmundi.com) </li></ul></ul>Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011
  33. 33. 6. References <ul><ul><li>Internet sources </li></ul></ul><ul><ul><li>http://www.investopedia.com </li></ul></ul><ul><ul><li>http://www.investorwords.com </li></ul></ul><ul><ul><li>http://www.creditworthy.com/topics/countryrisk_define.asp  </li></ul></ul><ul><ul><li>http://www2.bot.or.th/fipcs/Documents/FPG/2551/EngPDF/25510381.pdf </li></ul></ul><ul><ul><li>http://www.tradingeconomics.com/brazil/indicators </li></ul></ul><ul><ul><li>www.indexmundi.com </li></ul></ul><ul><ul><li>www.wikipedia.org </li></ul></ul><ul><li>http://www.stat.go.jp/english/data/cpi/1581.htm </li></ul><ul><li>http://www.de.emb-japan.go.jp/j_info/wirtschaft.html </li></ul><ul><li>http://www.de.emb-japan.go.jp/j_info/index.html </li></ul><ul><li>http://nachrichten.t-online.de/erdbeben-der-staerke-5-2-erschuettert-fukushima-/id_50925074/index </li></ul><ul><li>http://nachrichten.t-online.de/warnung-vor-nuklearer-explosion-in-fukushima/id_51214834/index </li></ul><ul><li>http://japan-infos.de/kategorie/japan-wirtschaft </li></ul><ul><li>http://www.spiegel.de/wirtschaft/soziales/0,1518,785074,00.html </li></ul><ul><li>http://www.faz.net/aktuell/finanzen/anleihen-zinsen/rating-abstufung-das-japanische-menetekel11124095.html </li></ul><ul><li>http://de.wikipedia.org/wiki/Japan </li></ul><ul><li>http://www.oecd-ilibrary.org/economics/country-statistical-profile-japan_20752288-table-jpn </li></ul><ul><li>http://www.asien-auf-einen-blick.de/japan/export.php </li></ul>Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011
  34. 34. 6. References <ul><ul><li>Internet sources </li></ul></ul><ul><li>http://www.indexmundi.com/japan/economy_overview.html </li></ul><ul><li>http://www.cbsnews.com/8301-505123_162-33040102/lehman-bad-risk-management-in-a-sea-of-financial-excess/?tag=bnetdomain </li></ul><ul><li>http://ezinearticles.com/?Risk-Management---A-Case-Study-on-the-Consequences-of-Bad-Risk-Management&id=1527263 </li></ul><ul><li>http://riskviews.wordpress.com/risk-management-failures/ </li></ul><ul><li>http://www.cornerstone.com/files/Publication/cec93271-eee6-4f9a-84cf-631145af6554/Presentation/PublicationAttachment/eddf6dfb-ac2d-464f-b8f5-666faf1b749b/Cornerstone_Research_Risk_Management_Failures.pdf </li></ul><ul><li>http://www3.ambest.com/ratings/cr/reports/Japan.pdf </li></ul><ul><li>http://www.coface.com/CofacePortal/ShowBinary/BEA%20Repository/COM_en_EN/news/_docs/110413CP </li></ul><ul><li>http://blog.hktdc.com/post/199/en/D&B-downgrades-Japan's-Country-Risk-Rating.htm </li></ul><ul><li>http://www.weforum.org/issues/regional-country-risks </li></ul><ul><li>http://taz.vv.sebank.se/cgi-bin/pts3/mc1/mb/mblib.nsf/a-w/03AB82E8E40B447DC125793D002D3EBC/$FILE/Japan_June_2011.pdf </li></ul><ul><li>http://www.economywatch.com/interest-rates/historical-interest-rates.html </li></ul><ul><li>http://data.worldbank.org/country/japan </li></ul><ul><li>http://e.nikkei.com/e/fr/info/nifaq/stockav.aspx#top10gain </li></ul>Alina Sachapow - Gloria Armesto P. - K. Navi Phifer - 9 Dec 2011

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