FRM Part II · FRM Exam Part II · Country Risk: Determinants, Measures, and Implications
Country Y has a sovereign default spread of 3.0% based on its rating. The annualized standard deviation of its equity index is 24% and that of its sovereign bond index is 16%. The mature market equity risk premium is 5.0%. Using the relative equity market standard deviation approach, what is the total equity risk premium for Country Y?
The total equity risk premium is 9.5%. The country risk premium equals the 3.0% default spread times the volatility ratio of 24/16, or 4.5%, and adding the 5.0% mature market premium gives 9.5%.
- A9.5%Correct
- B8.0%
- C7.0%
- D10.5%
Explanation
Country risk premium = 3.0% x (24/16) = 3.0% x 1.5 = 4.5%. Total premium = 5.0% + 4.5% = 9.5%. Adding only the unscaled spread gives 8.0%, which ignores the volatility ratio.
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