Week 2: Estimating Country Risk Premium

            You are trying to estimate the country risk premium that you would apply to China. You have collected the following information:

  1. China is rated A3 by Moody’s. The typical default spread for A3 rated bonds is 95 basis points.
  2. There are no dollar denominated Chinese bonds outstanding, but the government bond in CY bears an interest rate of 11.15%. Over the last two years, the standard deviation in this bond has been 17.3%.
  3. The Chinese equity index has had an annualized standard deviation of 31.1% over the last 2 years.
  4. The U.S. treasury bond rate is 5%, the historical risk premium of stocks over T.bonds over the last 73 years in the U.S. has been 5.17% and the annualized standard deviation in U.S. equities has been 24.6%. Estimate the country premium for China and the total risk premium for equities using

a. Pure bond default spread approach

b. Relative equity market volatility

c. Market volatility adjusted default spread.