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

An analyst at a global asset manager estimates the equity risk premium for a country by taking a mature-market equity risk premium and adding a country risk premium (CRP). Which approach to estimating the CRP uses the spread of the country's U.S. dollar-denominated government bond over the U.S. Treasury bond of similar maturity?

The default spread approach estimates the country risk premium from the yield spread between the country's dollar-denominated sovereign bond and a U.S. Treasury of similar maturity, because the spread reflects the market's pricing of sovereign default risk in a common currency.

  1. ADefault spread on sovereign bondsCorrect
  2. BRelative equity market volatility approach
  3. CCredit rating-based lookup of a historical premium
  4. DImplied premium from local equity index dividends

Explanation

The default spread approach measures country risk as the yield difference between the country's foreign-currency government bond and a risk-free benchmark of the same maturity and currency. The other options use equity volatility, rating tables, or implied market pricing, not the bond spread directly.

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