FRM Part I · FRM Exam Part I · Country Risk: Determinants, Measures, and Implications
A sovereign issues a 10-year US dollar bond yielding 6.8%, while a 10-year US Treasury bond yields 4.3%. Using the sovereign bond-spread approach to country risk, what is the default spread implied for this sovereign?
The implied default spread is 2.5%. It equals the sovereign's dollar bond yield of 6.8% minus the 10-year US Treasury yield of 4.3%, because the spread over a risk-free bond in the same currency and maturity isolates compensation for sovereign default risk.
- A2.5%Correct
- B4.3%
- C6.8%
- D11.1%
Explanation
The default spread is the yield on the sovereign's dollar-denominated bond minus the risk-free yield on a bond in the same currency and maturity. 6.8% - 4.3% = 2.5%. Adding the yields (11.1%) is a sign error; the other options just report one of the yields.
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