Reading 23: Capital Market Expectations－LOS k country, techniques

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CFA Institute Area 6: Economics
Session 6: Economic Concepts for Asset Valuation in Portfolio Management
Reading 23: Capital Market Expectations
LOS k: Discuss the risks faced by investors in emerging-market securities and the country risk analysis techniques used to evaluate emerging-market economies.

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Which of the following is NOT an indication of high risk in an emerging market economy?

A) A high fiscal deficit.

B) A high current account deficit.

C) A government committed to structural reform.

D) A GDP growth rate of 3%.

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Answer and Explanation

If a government is supportive of structural reforms necessary for growth, then the investment environment is more hospitable. Growth rates less than 4% may indicate that the economy is growing slower than the population, which can be problematic in these underdeveloped countries.

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Which of the following is NOT indicative of low risk in an emerging market economy?

A) A foreign debt level that is 50% of current account receipts.

B) A foreign debt level that is 75% of GDP.

C) A current account deficit that is 2% of GDP.

D) Foreign exchange reserves are twice that of the short-term debt.

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Answer and Explanation

Foreign debt levels greater than 50% of GDP indicate that the country may be overlevered. Debt levels greater than 200% of the current account receipts also indicate high risk. Current account deficits (roughly speaking, imports are greater than exports) greater than 4% of GDP can be problematic because the deficit must be financed through external borrowing. High risk is also indicated when foreign exchange reserves are less than the short-term debt that must be paid off in one year.

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Which of the following statements regarding risk in emerging market economies is least accurate?

A) Their undiversified nature makes them susceptible to volatile capital flows and economic crises.

B) Equity investors should focus on growth prospects and risk.

C) Many emerging countries are dependent on foreign borrowing.

D) The economies are often heavily dependent on consumer durables.

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 Answer and Explanation

Small economies are often heavily dependent on the sale of commodities and their undiversified nature makes them susceptible to volatile capital flows and economic crises.

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