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

A U.S. investor holds a local-currency sovereign bond from an emerging country yielding 9.0%. The U.S. Treasury yield is 3.0%. Local-currency sovereign rating-implied default spread is 2.5%. Assuming the remaining spread reflects expected depreciation, which expected annual depreciation of the local currency is implied (approximate, subtracting)?

The implied expected depreciation is about 3.5% a year. The bond's 6.0% spread over Treasuries, 9.0% minus 3.0%, is first reduced by the 2.5% default spread, leaving 3.5% to compensate for expected local currency depreciation.

  1. A3.5%Correct
  2. B6.0%
  3. C2.5%
  4. D0.5%

Explanation

Total spread = 9.0 - 3.0 = 6.0%. Removing the 2.5% default spread leaves 3.5% attributable to expected depreciation (approximation). The 6.0% option ignores the default spread; 2.5% is the default spread itself.

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