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

A portfolio manager estimates an equity country risk premium by scaling the sovereign default spread. A country is rated Ba1 with a default spread of 3.0%. Average equity market volatility in the country is 24% and the average volatility of its sovereign bond market is 16%. The mature market equity risk premium is 5.0%. Using the default spread scaled by the relative equity-to-bond volatility, and adding the mature premium, what is the total equity risk premium for the country?

The total equity risk premium is 9.5%. Scale the 3.0% default spread by the equity-to-bond volatility ratio of 1.5 to get a 4.5% country risk premium, then add the 5.0% mature-market premium.

  1. A8.0%
  2. B9.5%Correct
  3. C7.5%
  4. D12.2%

Explanation

Relative volatility = 24/16 = 1.5. Country risk premium = 3.0% x 1.5 = 4.5%. Total = 5.0% + 4.5% = 9.5%. The 8.0% option omits scaling; 7.5% scales but incorrectly uses 2.5% by skipping the spread.

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