DEFINITION of 'Micro Risk'

Micro Risk is a type of political risk that refers to political actions in a host country that can adversely affect selected foreign operations. Micro risk can come about from events that may or may not be in the reigning government's control.

 

BREAKING DOWN 'Micro Risk'

For example, diplomatic tension with Country A has caused the citizens of Country B to vandalize all Country A based companies situated in Country B. In this example, only operations from Country A were faced with adverse situations. Operations from other countries were not affected.

Political Risk

All this falls under the general heading of political risk. Political risk is the risk an investment's returns could suffer as a result of political changes or instability in a country. Instability affecting investment returns could stem from a change in government, legislative bodies, other foreign policy makers or military control. Political risk is also known as "geopolitical risk," and becomes more of a factor as the time horizon of an investment gets longer.

Companies that operate internationally, known as multinational businesses, can purchase political risk insurance to remove or mitigate certain political risks. This allows management and investors to concentrate on the business fundamentals while knowing losses from political risks are avoided or limited. Typical actions covered include war and terrorism.

A related concept is country risk, which refers to a set of risks associated with investing in a particular country.  Country risk varies from one country to the next, and can include political risk, exchange-rate risk, economic risk, and transfer risk. In particular, country risk denotes the risk that a foreign government will default on its bonds or other financial commitments. In a broader sense, country risk is the degree to which political and economic unrest affect the securities of issuers doing business in a particular country.

Country risk is critical to consider when investing outside of the United States. Because factors such as political instability can cause great turmoil in financial markets, country risk can reduce the expected return on investment (ROI) of securities. Investors may protect against some country risks, like exchange-rate risk, by hedging; but other risks, like political instability, do not have an effective hedge. 

Some of the micro, country and political risks may be found in a company's filings with the Securities and Exchange Commission (SEC) or a prospectus if it is a mutual fund. Nearly all multinational companies face these risks and many of them insure to what extent they can against them.
 

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