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FRM Part I · FRM Exam Part I · Country Risk: Determinants, Measures, and Implications

A country's USD-denominated sovereign bond has a default spread of 3.0%. The annualized standard deviation of its equity market is 24% and the annualized standard deviation of its sovereign bond is 16%. Using the relative volatility approach (default spread scaled by the ratio of equity to bond volatility), what is the country risk premium?

The country risk premium is 4.5%. Equity volatility of 24% divided by bond volatility of 16% gives a ratio of 1.5, and multiplying the 3.0% sovereign default spread by 1.5 yields 4.5%, reflecting that equities are riskier than the country's bonds.

  1. A4.5%Correct
  2. B2.0%
  3. C3.0%
  4. D7.5%

Explanation

Ratio = 24%/16% = 1.5. CRP = 3.0% x 1.5 = 4.5%. The 2.0% option inverts the ratio (3.0 x 16/24). The 3.0% option ignores scaling.

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