Factors to Consider for Country Risk Premium

Explanation

The appropriate country risk premium for a developing country is influenced by various factors that reflect the unique characteristics and risks associated with investing in such a market. In this case, the investor is considering investing in a security of a company in a developing country that exhibits specific characteristics. Let's go through each of the provided answer choices and explain why the correct answer is the most appropriate.

A. liquidity risk, exchange rate risk, financial risk, business risk, balance sheet risk:

1. Liquidity risk: While infrequent trading is mentioned, it falls under the liquidity risk category. However, this is not the primary concern highlighted in the scenario.
2. Exchange rate risk: The fact that the country has a depreciating exchange rate indicates the presence of exchange rate risk, which should be considered by the investor.
3. Financial risk: This term generally refers to the risk associated with a company's financial structure and its ability to meet financial obligations. The scenario does not provide any specific information regarding financial risk, so it may not be a significant factor in determining the country risk premium.
4. Business risk: This risk category considers factors specific to the operations and industry of the company being invested in. The scenario mentions low operating leverage, political unrest, and volatility, which can all be considered elements of business risk.
5. Balance sheet risk: The scenario does not provide any explicit information related to balance sheet risk. Therefore, it may not be a significant consideration in determining the country risk premium.

B. financial risk, liquidity risk, exchange rate risk, country risk, business risk:

1. Financial risk: As mentioned earlier, the scenario does not provide specific information regarding financial risk. Hence, it may not be a significant factor to consider in this case.
2. Liquidity risk: Although infrequent trading is mentioned, it is not the primary concern highlighted in the scenario.
3. Exchange rate risk: The scenario explicitly states that the country has a depreciating exchange rate, which indicates the presence of exchange rate risk that should be considered.
4. Country risk: This term encompasses the various risks associated with investing in a particular country, including political risks, economic risks, legal risks, and social risks. The scenario mentions political unrest and high inflation, which are indicators of country risk.
5. Business risk: As mentioned earlier, the scenario highlights low operating leverage, political unrest, and market volatility, which are elements of business risk. This risk category is relevant for evaluating the risk premium.

C. business risk, variability risk, country risk, exchange rate risk, financial risk:

1. Business risk: As previously discussed, the scenario mentions factors related to business risk, such as low operating leverage, political unrest, and market volatility.
2. Variability risk: This risk term is not explicitly mentioned in the scenario, and its relevance is unclear in this context.
3. Country risk: As explained earlier, the scenario indicates political unrest and high inflation, which are indicators of country risk.
4. Exchange rate risk: The scenario explicitly states that the country has a depreciating exchange rate, highlighting the presence of exchange rate risk.
5. Financial risk: Similar to the previous answer choices, the scenario does not provide specific information regarding financial risk.

Based on the analysis, the most appropriate answer is B. financial risk, liquidity risk, exchange rate risk, country risk, business risk. This option includes the key risk factors mentioned in the scenario, such as exchange rate risk, country risk (including political unrest and inflation), and business risk (including low operating leverage and market volatility). While liquidity risk and financial risk are also important considerations in investment analysis, the scenario does not provide sufficient information to consider them as significant factors in determining the country risk premium.