Kenneth R. Szulczyk

We calculate a country's score, x, by using Equation 1. Variable, wi, indicates a weight
while the score is one of the factors listed above. A weight is positive and ranges between zero
and one. For example, if an analyst weighs all factors equally, then every weight is set to 0.25,
and a country's score equals the average of its four factors. Furthermore, the weights must sum
to one, which we show in Equation 2. After an analyst calculates a country's score, the score
always ranges between zero and 100 because the weights sum to one. Finally, an analyst could
adjust the weights to reflect his or her preferences. For instance, some analysts view debt
management as an extremely important factor. Thus, they could assign a greater weight to this
factor and reduce the weights to the other factors.

x=w 1 ScoreEI+w 2 ScoreDM+w 3 ScorePF+w 4 ScoreSF (1)

w 1 +w 2 +w 3 +w 4 = 1 (2)

A country’s score lies between 0 and 100. If a country possesses a low score, then analysts
and economists would add a large risk premium to the risk-free interest rate. Thus, a country’s
basis points (bps) are greater for lower scores. Moreover, investors could adjust the weights and
grades to reflect different time horizons. Therefore, the different weights yield distinctive risk
forecasts for short term, medium term, and long-term investment. For example, some analysts
assign more weight to debt management and political factors for short-term investments while
they assign more weight to economic indicators and structural factors for long-term investments.
The Risk Rating Method appears objective because an analyst calculates a country's risk
rating from economic data. However, the formula weights are subjective because an analyst
selects the weights arbitrarily. Consequently, this method is an art rather than a science.

International Credit Rating Agencies....................................................

International credit-rating agencies do not focus on risk for particular companies but
assess investment risk associated with countries. Risk reflects the overall danger to international
investors in investing in a particular country because every country has a variety of institutions,
laws, and customs. For example, you transferred money to a Jamaican company for a coffee
shipment. Company eagerly accepted your money, but it had failed to deliver your coffee. In
developed countries, you could sue a company to enforce a contract, but Jamaica has weak
institutions, and, unfortunately, judges and magistrates may not enforce contracts. Investor’s
legal options vary by country. Some countries, their governments impose harsh rules,
regulations, and taxes on businesses, imposing hardship on any business venture.
Two well-known credit agencies are A.M Best and Coface. A.M. Best is an international
credit agency that classifies country risk into five tiers. Scale uses Roman numerals and ranges
from I to V with I being the lowest risk while V being the highest risk. Table 2 shows a
country's rating for 2012. A.M. Best assesses country risk by analyzing outside factors that can
affect an insurer's control and a country’s ability to meet its obligations to its policyholders.