FRM Part I · FRM Exam Part I · Country Risk: Determinants, Measures, and Implications
A 5-year sovereign CDS on Country Y trades at 240 basis points. The 5-year US Treasury yield is 4.00%. An analyst uses the CDS spread as the country default spread. Ignoring any adjustments for the CDS-bond basis, what is the estimated 5-year USD borrowing yield for Country Y's government?
The estimated yield is 6.40%. The sovereign CDS spread of 2.40% is treated as the default spread and added to the 4.00% risk-free Treasury yield, giving the approximate USD yield at which Country Y could borrow for five years.
- A1.60%
- B4.00%
- C6.40%Correct
- D8.80%
Explanation
Default spread = 240 bp = 2.40%. Adding to the risk-free rate gives 4.00% + 2.40% = 6.40%. Subtracting gives 1.60%, which is the wrong sign; 8.80% wrongly adds the spread twice-scaled.
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