EU leaders have agreed a further €109bn (£96bn) bailout for Greece, one-third of which will come from private sector bondholders.
After a day of crisis talks in Brussels, the heads of the 17 eurozone member countries and the International Monetary Fund drafted an agreement to allow a selective default by imposing 'haircuts' or losses on bondholders.
The default will be the first on a eurozone bond since the launch of the euro, the FT reports.
Eurozone heads also agreed to lower interest rates on rescue loans to Greece, Ireland and Portugal. The countries will pay about 3.5% - 100-200 basis points lower than at present, and will have their payment schedule extended from 7.5 years to 15-30 years.
Meanwhile the European Financial Stability Fund (EFSF), a €440bn rescue fund, will have new powers to help countries not currently in bailouts, including precautionary lines of credit and the ability to recapitalise any struggling bank in the eurozone, the FT reports.
The EFSF will also be able to buy bonds on secondary markets in exceptional circumstances. German Chancellor Angela Merkel had been the most vocal supporter of haircuts for Greek bondholders, forcing them to shoulder some of the burden of a bailout.
Italian and Spanish 10-year bond yields, which had hit record highs of 5.7% and 6.28% last week, fell to 5.36% and 5.77% respectively, while Greek 10-year bond yields were at 16.54% yesterday.
According to the BBC, Greek premier George Papandreou, said: "We now have a programme and a package of decisions which create a sustainable debt management for Greece.
"This in the end, of course, will mean not only the funding of a programme but it will also mean the lightening of the burden on the Greek people."
The new agreement will cut Greece’s debt to gross domestic product ratio by 24 percentage points.
European markets rose sharply on Thursday in anticipation of a resolution to the sovereign debt crisis.
Bank shares rallied strongly, with RBS closing 4.38% higher, , Lloyds up 3.83%, and Barclays 1.7% up.
In Germany, Commerzbank climbed 9.56% while in France Société Générale rose 6.19% and Credit Agricole closed 5.52% higher.
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