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

A sovereign borrows heavily in a foreign currency and has limited foreign exchange reserves. Which feature most directly raises its risk of default relative to a sovereign that borrows mainly in its own currency?

Borrowing heavily in foreign currency raises default risk because the government cannot print the foreign currency needed to service the debt. It depends on reserves and export earnings, whereas a local currency borrower can monetize or inflate away its obligations.

  1. AIt cannot create the foreign currency needed to service debt by printing moneyCorrect
  2. BIt can inflate away the real value of its liabilities
  3. CIts central bank can monetize the debt without limit
  4. DIts creditors are mainly domestic residents

Explanation

Foreign currency debt must be repaid in a currency the government cannot issue, so reserves and export earnings constrain it. Local currency borrowers can print money or inflate, and domestic creditors usually lower rollover risk, so the other options describe features that reduce default risk.

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