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

A dollar-denominated bond issued by Country X yields 7.40%, while a US Treasury of the same maturity yields 4.15%. The five-year sovereign CDS spread on Country X is 2.60%. Assuming the bond spread is the yield difference to the Treasury, what is the bond spread and how does it compare to the CDS spread?

The bond spread is 7.40% minus 4.15%, which equals 3.25%. Compared with the 2.60% CDS spread, the bond spread is 0.65% wider. This positive gap between bond spread and CDS spread is the difference arising from basis effects such as liquidity or funding differences.

  1. A3.25%, which is 0.65% above the CDS spreadCorrect
  2. B3.25%, which is 0.65% below the CDS spread
  3. C2.60%, which equals the CDS spread
  4. D11.55%, which is far above the CDS spread

Explanation

Bond spread = 7.40% - 4.15% = 3.25%. Comparing with the CDS spread of 2.60% gives 3.25% - 2.60% = 0.65% above. Option 2 reverses the sign of the difference, and option 4 adds the yields instead of subtracting.

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