| Summary: | Thesis (MBA) -- Stellenbosch University, 2010. === As major corporate entities are investing into Sub-Saharan Africa and other African countries at a
fast pace, percentages like the weighted average cost of capital (WACC) and the impairment
discount rate, are becoming important measurements of assessing current investments for
impairment and/or proposals of future capital investments. One of the important constituents of
these percentages is the country/equity risk premium. The country risk premium can be defined as
the price for taking risk for investing in that specific country. A widely used method to determine
the country risk premium is to multiply the country bond default spread with an equity to bond
market risk adjustment.
Country bond default spreads are the spreads that investors charge for buying bonds issued by the
country. These ratings measure default risk, rather than equity risk, but they are affected by many
factors that drive equity risk, like the stability of a country’s currency, the budget and trade
balances and the political stability. Analysis that uses spreads as a measure of country risk,
usually adds them to both the cost of equity and debt of entities that trade in that country.
There are several ways in determining the bond default spreads, but it is most often done in a
random and unsystematic manner. Two of the major obstacles in determining these spreads for
countries, especially countries of sub-Saharan Africa, are when countries do not issue bonds in
another currency such as Euro or US dollar and/or do not have a sovereign credit rating.
What could also be a measure of country risk, are the two major country risk polls conducted
globally: 1) Euromoney Country Risk Poll; and 2) PRS (Political Risk Group) Composite Risk
Ratings. Most of sub-Saharan African countries form part of these risk polls. The usefulness of
the PRS scores as a measure of country risk has been previously examined to find that they are
correlated with the cost of capital of emerging markets.
The aim of the research is to overcome the obstacles in determining default spreads for countries
such as sub-Saharan Africa where bond markets are inactive and/or sovereign credit ratings are
not assigned, by deriving a predictive model. The predictive model is derived by analysing the
relationship between the available estimated default spreads that are assigned to a specific
country, depending on their Moody’s sovereign local currency rating and the countries’ respective
country risk scores conducted by Euromoney and PRS respectively. The stability of the
relationship is also analysed by comparing the prediction of the sub-Saharan’s Africa default
spreads based on the 2010 predictive model to the analyses conducted on 2008 data sets.
Other similar models have been developed, but this model is focused on the total risk score of a
country and not only on the credit risk or related constituents. One of the definitions of country risk
is that it relates to the likelihood that changes in the business environment will occur that reduce
the profitability of doing business in a country, which can negatively affect operating profits as well
as the value of assets. One can conclude that this derived model is a good reflection of prevailing
political and economic stability of the countries and a useful measure of country risk that can be
used in assessing the profitability of current investments in a specific country and for proposals of
future capital investments.
Key words: Country bond default spreads, Sovereign credit ratings, Euromoney risk scores, PRS
composite ratings, sub-Saharan African countries.
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