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

An analyst compares two sovereigns. Country X has a debt-to-GDP ratio of 60% and most debt is long-dated, fixed-rate and denominated in its own currency. Country Y has a debt-to-GDP ratio of 60% but a large share of its debt is short-term and denominated in US dollars, while its export base is narrow. Which assessment is most consistent with the determinants of sovereign default risk?

Country Y has the higher default risk. Although debt-to-GDP is equal, its short maturities create rollover risk, its dollar denomination creates currency mismatch, and a narrow export base limits hard-currency earnings. Debt composition and external capacity matter alongside the debt level.

  1. ABoth countries have equal default risk because debt-to-GDP is identical
  2. BCountry X has higher default risk because long-dated debt is more costly to service
  3. CCountry Y has higher default risk because debt structure, currency mismatch and weak hard-currency earnings add to rollover and foreign exchange riskCorrect
  4. DCountry Y has lower default risk because short-term debt is cheaper

Explanation

Debt level is only one determinant. Short maturities create rollover risk, dollar debt creates currency mismatch, and a narrow export base limits hard-currency inflows. Option A ignores composition. Option D confuses lower interest cost with lower default risk.

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