Country Risk and Sovereign Risk Analysis

The previous two chapters have addressed issues in firms’ exposure to foreign exchange risk – how transaction cash flows, firm value, and consolidated financial statements are subjected to foreign exchange rate fluctuations and how to manage the three types of foreign exchange exposure. Firms engaged in foreign business activities are not only exposed to uncertainties in foreign exchange markets – they are additionally susceptible to adverse events in the host country concerning the political climate, the economic environment, the financial condition, and the social institution. That a firm’s financial performance and interests are adversely affected by the events and uncertainties in the political climate, the economic environment, the financial condition, and the social institution of the host country is referred to as country risk.