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

A multinational firm is valuing a project in an emerging market. The sovereign default spread is 3.0%, the equity market volatility is 24% and the sovereign bond volatility is 16%. Using the relative equity market standard deviation approach, what is the country equity risk premium if the mature market premium is 5.0%?

The country equity risk premium is 4.5%. It equals the sovereign default spread of 3.0% multiplied by the ratio of equity volatility to bond volatility, 24% divided by 16%, which is 1.5. The scaling reflects that equities are riskier than the sovereign bond.

  1. A3.0%
  2. B4.5%Correct
  3. C6.0%
  4. D9.0%

Explanation

Country equity risk premium = default spread x (equity volatility / bond volatility) = 3.0% x (24/16) = 3.0% x 1.5 = 4.5%. The 9.0% option wrongly adds the mature premium and doubles; 3.0% ignores the volatility scaling; 6.0% inverts nothing correctly (3.0 x 2).

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