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

An analyst at a global bank wants a forward-looking, market-based gauge of the default risk of a emerging-market government. Which of the following is the most direct market-based measure of that risk for a sovereign that issues foreign-currency debt?

The sovereign CDS spread is the most direct market-based measure because it is a traded price that reflects investors' current expectations of default likelihood and loss severity. Ratings, debt ratios and historical default frequency are slower-moving or backward-looking and are not market prices.

  1. AThe sovereign's credit default swap spreadCorrect
  2. BThe sovereign's most recent credit rating from an agency
  3. CThe ratio of external debt to GDP
  4. DThe country's historical frequency of default over the past century

Explanation

A sovereign CDS spread is a traded price that updates continuously and reflects market views of default probability and loss given default. Ratings and debt ratios are slower-moving fundamentals, and historical default frequency is backward-looking.

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