Define political and sovereign risk. How are companies impacted? What can a company do to mitigate as much of that risk as possible? Give examples.
Sovereign risk is made up of political risk that arises when a foreign nation refuses to comply with a previous payment agreement, as is the case with sovereign debt. Sovereign risk also impacts personal investors. There is always risk to owning a financial security if the issuer resides in a foreign country.
Sovereign risk is the chance that a central bank will implement foreign exchange rules that will significantly reduce or negate the worth of its forex contracts. It also includes the risk that a foreign nation will either fail to meet debt repayments or not honor sovereign debt payments.
How are companies impacted?
First, there is a fiscal channel, whereby increased sovereign risk may force a government to take fiscal actions that affect corporations by, for example, increasing taxation, reducing subsidies, or lowering the value of implicit and explicit government guarantees.
Sovereign risk also impacts personal investors. There is always risk to owning a financial security if the issuer resides in a foreign country. For example, an American investor faces sovereign risk when he invests in a South American-based company. A situation can arise if that South American country decides to nationalize the business or the entire industry, thus making the investment worthless.
How to mitigate risk?
It is found that firms in countries with little economic freedom and corrupt or unstable governments can lower their default risk by holding assets in countries with stronger property rights and by cross-listing stock on exchanges with stricter disclosure requirements.
Define political and sovereign risk. How are companies impacted? What can a company do to mitigate...
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