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

A sovereign issuer borrows in its own currency and has a floating exchange rate. Compared with a sovereign that borrows mainly in a foreign currency, the first issuer's credit risk is most likely:

The domestic-currency borrower most likely has lower credit risk, because it can raise taxes or create its own currency to service debt. A foreign-currency borrower must obtain foreign exchange it cannot create, so denomination matters for sovereign default risk.

  1. Ahigher, because it cannot print foreign currency
  2. Bunaffected, because currency of denomination is irrelevant
  3. Clower, because it can create domestic currency to service its debtCorrect

Explanation

A sovereign with domestic-currency debt can use taxation and monetary financing to meet obligations, which lowers default risk, though it may cause inflation. Foreign-currency debt requires the sovereign to obtain foreign exchange, which it cannot create. Currency of denomination is therefore highly relevant to credit risk.

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