Skip to content

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

Which statement best describes a key limitation of using the sovereign default spread alone as the country risk premium for equities?

The main limitation is that equities are more volatile than sovereign bonds, so the default spread tends to understate the premium equity investors demand. That is why practitioners often scale the spread by the ratio of equity to bond volatility.

  1. AEquity markets are generally more volatile than government bond markets, so using the bond spread may understate the premium equity investors requireCorrect
  2. BThe default spread is unobservable for countries that issue debt in foreign currency
  3. CThe default spread always exceeds the true equity country risk premium
  4. DThe default spread incorporates only mature-market risk

Explanation

Equities are riskier than the sovereign bonds, so a premium based on the bond spread alone tends to understate equity risk; scaling by relative volatility addresses this. The spread is observable for foreign-currency bonds, it is not always larger than the equity premium, and it does reflect country-specific risk rather than only mature-market risk.

Did you get it right without looking?

One question tells you little. A timed set on Country Risk: Determinants, Measures, and Implications shows your real accuracy, how long you take and where you lose marks.

Practise Country Risk: Determinants, Measures, and ImplicationsFree diagnostic mock

More Country Risk: Determinants, Measures, and Implications questions