The concept of a country risk premium refers to an increment in interest rates that would have to be paid for loans and investment projects in a particular country compared to some standard. One way of establishing the country risk premium for a country is to compare the interest rate that the market establishes for a standard security in the country, say central government debt, to the comparable security in the benchmark country, say the United States. For the securities to be comparable they must have the same maturity and involve payment in the same currency, say U.S. dollars. The reason the payments must be the same is that otherwise the differential in the interest rates would reflect the differential rates of inflation in the two countries instead of solely the market-perceived risk of nonpayment. The interest rate that is relevant is the market-determined yeild to maturity rather than the coupon interest rate. The coupon interest rate is valid only if the issuers are careful to set the coupon rate so that it is equal to the yield to maturity of the security.

For example, suppose the U.S. government has a currently issued five year bond that has a yield to maturity of 6 percent and the government of Poland borrows dollars by selling a five year bond that pays in dollars and the yield to maturity of that bond is 8 percent. The country risk premium for Poland would be 2 percent or, as such premiums are often expressed, 200 basis points. The two percent is the correct value providing the yields to maturity are expressed as instantaneous rates. If they are expressed as effective annual rates then the correct computation of the risk premium ρ is as follows:

1+ρ = (1+0.08)/(1+0.06) = 1.01887
and thus
ρ = 0.01887