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

An analyst compares two sovereigns with similar debt-to-GDP ratios. Country X issues most debt in its domestic currency to domestic investors. Country Y issues most debt in euros to foreign investors, although its own currency is the peso. Which statement best describes the likely sensitivity of Y's debt burden?

Peso depreciation would raise the peso cost of servicing Country Y's euro-denominated debt, because revenues are in pesos while obligations are in euros. Country X, borrowing domestically in its own currency, is far less exposed to this currency mismatch.

  1. APeso depreciation would raise the peso cost of servicing Y's euro debtCorrect
  2. BPeso depreciation would lower the peso cost of servicing Y's euro debt
  3. CPeso depreciation would affect X's debt burden more than Y's

Explanation

Y's liabilities are in euros while its tax revenue is in pesos. If the peso weakens, more pesos are needed per euro, raising the local-currency burden. X's debt is domestic so is largely insulated from this effect.

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