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CFA Level I · CFA Level I Exam · Credit Analysis for Government Issuers

A sovereign issues debt denominated in its own currency and has a flexible exchange rate and an independent central bank. Compared with a sovereign borrowing mainly in foreign currency, its credit risk is most likely:

Credit risk is most likely lower for local currency debt, because the sovereign can raise taxes or, if necessary, create money to repay. Foreign currency borrowers must obtain that currency from exports or reserves, which makes repayment riskier and ratings typically lower.

  1. Ahigher, because it must buy foreign currency to repay
  2. Bunaffected, because currency of denomination never matters
  3. Clower, because it can raise taxes or, in extremis, create currency to repayCorrect

Explanation

Local currency debt gives the government extra means to service debt, such as taxation and monetary financing, so default risk is generally lower than for foreign currency debt. Option A describes foreign currency borrowing, and currency of denomination does matter.

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