How to Find the Country’s Risk free Rate

Adjust the local currency government borrowing rate (bond rate) for default risk to get a riskless local currency rate.

l  You can get this from Moody’s Website on Sovereign Ratings

l  If it is not triple A (AAA), you have to take out the default risk.

Example 1)

In November 2013, The Indian government rupee bond rate was 8.82% .
The local currency rating from Moody’s was Baa3, and the default spread for Baa3 rated country bond was 2.25%.

Riskfree rate in Rupees: 8.82%- 2.25%= 6.57%

Example 2)

In November 2013, Chinese Renminbi government bond rate was 4.30% and the local currency rating was Aa3, with a default spread of 0.8%.

Riskfree rate in Chinese Renminbi: 4.30%-0.8% = 3.5%

Three paths to estimating sovereign default spreads

1.    Sovereign dollar or euro denominated bonds: the difference between the interest rate on a sovereign US dollar bond, issued by the country and US treasury bond rate can be used as the default spread.

For example, in November 2013, the 10 year Brazil bond denominated in US dollars had a yield of 4.25% and the US 10 year T-bond rate traded at 2.75%.
Default spread: 4.25-2.75= 1.50

2.    CDS spread: obtain the default spread for soverigns in the CDS market. The CDS spread for Brazil in November was 2.50%.

3.    Average spread: If you know the sovereign rating for a country, you can estimate the default spread based on the rating.
In November 2013, Brazil rating was Baa2, yielding a default spread of 2%.