Sovereign benchmarks

For sovereign benchmarks, domestic government bond returns are used to compute term structures and key rate returns. For UBOR/swap benchmarks, key rate returns can be computed directly from market yields. 

The additional compensation or spread over the benchmark yield that investors will require reflects the additional risks the investor faces by acquiring a security that is not issued by a sovereign government. These yields spreads (discussed later in the chapter) will depend not only on the risks an individual issue is exposed to but also on the level of benchmark yields, the market s risk aversion, the business cycle, and so on. 

An investor follows a strategy that involves going long of a Latin American sovereign bond. The bond is currently yielding 350 bp over the benchmark US Treasury bond. If the sovereign bond falls in price then the investor will purchase it. The investor expects that the target price for the purchase should be when the spread is 400 bp. 

First, as mentioned earlier, there is usually no universal benchmark in a given market. Again, a possible approach, used in Barra s models, is to introduce a swap spread factor that describes the average spread between sovereign and swap rates and can conveniently allow spread risk to be expressed with respect to the LIBOR/swap curve when interest rate risk factors are originally based on the sovereign yield curve. 

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