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

An analyst values a Brazilian company with cash flows in US dollars. The US 10-year Treasury yield is 4.0%, Brazil's sovereign US-dollar bond yield is 7.5%, and the US-dollar default-free benchmark is the Treasury yield. Using the sovereign default spread approach, what is the country default spread for Brazil?

The country default spread is 3.5%, found by subtracting the US Treasury yield of 4.0% from Brazil's dollar-denominated sovereign bond yield of 7.5%. The spread isolates compensation for sovereign default risk because both bonds are in the same currency.

  1. A3.5%Correct
  2. B4.0%
  3. C7.5%
  4. D11.5%

Explanation

The default spread is the sovereign dollar bond yield minus the default-free rate of the same currency: 7.5% - 4.0% = 3.5%. Adding the two yields (11.5%) is a sign error. The yields themselves are not spreads.

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