Country Risk Premium - CRP
Categories: International, Stocks, Bonds, Trading
Following the 2008 financial crisis, every major developed economy exploded their balance sheet and dramatically increased their debt load. Then, a decade later, a lot of those bills came due. As a result, many countries from Mexico to Italy, from Brazil to Greece, have seen their debt problems hammer their currency values and drive up borrowing costs.
Investors have a lot of choices of what countries’ bonds to purchase and what foreign stocks to buy. With bonds, countries with a higher risk of default will naturally see interest rates rise, since lenders want a greater return for the risks they are taking as bond buyers in those countries.
With individual equities, companies in foreign countries are subject to political risk and broader economic uncertainty compared to firms in more developed, stable markets.
Risk premiums for bonds are defined by the spread between one nation’s interest rates and the interest rates for the less development nation’s bonds.
But on the individual equity side, investors need to utilize CAPM and add the country risk premium of one foreign stock compared to a stock from a more stable economy. CAPM has its flaws. But if you’re going to learn the industry standard, you might as well know how capital risk premiums are traditinoally calculated using that model.
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All right we're picking daisies, marigolds, lilies so uh how do we [Pictures of flowers]
rephrase in Italian? Like, we want to fill a portfolio basket with just stocks [Pouring a glass of red wine]
representing the overall financial health of Italy. Is Italy healthy? While
they smoke a lot they drink a lot of wine they eat a bunch of pasta but there
always seems to be a woman from some small village who's celebrating her [Old woman at a birthday party]
117th birthday over there. Well a country basket is just an index fund of
stocks representing a country. Like we're doing Korea... South we're gonna have
in that basket dunno some Samsung, a load of Daewoo, a hunk of Hyundai and some [Company stocks being added to the basket]
nice barbecue on the side. That'd be our Korean country basket and it's a good
basket to fill if you're just bullish on a country but not really sure which
flower on which to place your bets. It's like instead of trying to decide between [The stocks in the basket turn into flowers]
roulette or poker or slots... Well you just buy stock in Las Vegas
Sands you know you bet on the entire casino, and bueno Fortuna you know good [Someone checking their cards in a casino]
luck there pal, doesn't the house always win? Yeah so why do people keep going there?...