5. Country Risk
j. describe uses of country risk premiums in estimating the cost of equity;
Why do analysts need to account for country risk?
β seems not be able to capture country risk for companies in developing countries. Analysts often need to add a country spread (country equity premium) to the market risk premium when using CAPM to estimate the cost of equity.
What is the sovereign yield spread of estimating country risk?
Sovereign yield spread represents the yield on a developing country's US$-denominated bond vs. a U.S. Treasury-bond of the same maturity, as a proxy for the country spread.
What is a common approach to adjusting the sovereign yield spread?
Country equity premium = Sovereign yield spread x (Annualized σ of equity index / Annualized σ of the sovereign bond market in terms of the developed market currency)