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CFA Level I · CFA Level I Exam · Fixed-Income Markets for Government Issuers

A sovereign government issues all of its debt in its own currency and controls its own central bank. Compared with a sovereign that borrows mainly in a foreign currency, the first government's credit risk is most likely:

Credit risk is most likely lower for the local-currency issuer, because it can raise taxes or create domestic currency to pay its debt. A foreign-currency borrower must earn or acquire foreign exchange, which makes default more likely when reserves or export earnings are weak.

  1. ALower, because it can create domestic currency to meet obligationsCorrect
  2. BHigher, because it cannot adjust interest rates freely
  3. CEqual, because sovereign debt carries no default risk

Explanation

A government borrowing in its own currency can in principle raise taxes or have the central bank supply currency to service debt, though this may cause inflation. Foreign-currency borrowers must obtain that currency from exports or reserves. Sovereigns can default, so the third option is wrong, and the second misstates the flexibility of a domestic-currency issuer.

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