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

An analyst at a bank wants a forward-looking, market-based indicator of the perceived default risk of a government that issues debt in a foreign currency. Which measure is most directly suited to this purpose?

The sovereign five-year CDS spread is the best choice because it is a market price that updates continuously and reflects investors' current view of default risk. Macroeconomic statistics such as growth, inflation or demographics are backward-looking, slow-moving, and are not direct market-based measures.

  1. AThe sovereign's five-year credit default swap spreadCorrect
  2. BThe country's historical GDP growth rate
  3. CThe sovereign's long-run average inflation rate
  4. DThe ratio of the country's population to its labor force

Explanation

A sovereign CDS spread is observed daily and reflects the market's current pricing of default risk and associated risk premia, making it forward-looking. The other options are slow-moving macroeconomic statistics and are not market prices of default risk.

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