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

Which development is most likely to improve the credit quality of a sovereign issuer that borrows heavily in a foreign currency?

Building foreign exchange reserves relative to external debt most likely improves credit quality. Reserves give the government the foreign currency it cannot create itself, helping it meet foreign-currency obligations. Short-term foreign borrowing and greater foreign ownership raise vulnerability to capital outflows.

  1. AA widening current account deficit financed by short-term foreign borrowing
  2. BA rise in the share of debt held by foreign investors
  3. CA build-up of foreign exchange reserves relative to external debtCorrect

Explanation

Larger reserves relative to external debt give the government foreign currency to meet obligations, reducing default risk. The other developments increase reliance on external funding and vulnerability to capital outflows.

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