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FRM Part I · FRM Exam Part I · Country Risk: Determinants, Measures, and Implications

A bank holds a sovereign bond whose issuer has a local-currency rating higher than its foreign-currency rating. A corporate in that country earns revenue only in local currency but has foreign-currency debt. Which implication for the corporate's credit risk is most appropriate?

The corporate faces transfer and convertibility risk, so its foreign-currency debt rating is typically capped near the sovereign's foreign-currency rating. The sovereign can restrict access to hard currency, and the corporate's local-currency revenues do not protect it from that restriction.

  1. AThe corporate is always rated at or above the sovereign foreign-currency rating
  2. BThe corporate faces transfer and convertibility risk, so its foreign-currency debt is typically capped near the sovereign foreign-currency ratingCorrect
  3. CThe corporate faces no currency risk because the sovereign local-currency rating is higher
  4. DThe sovereign ceiling applies only to local-currency debt

Explanation

Foreign-currency debt service depends on access to hard currency, which the sovereign can restrict through convertibility or transfer controls. Hence the corporate's foreign-currency rating is generally constrained by the sovereign foreign-currency rating. The local-currency rating is not relevant to this liability.

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