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CMA Final · Risk Management in Banking and Insurance · Sovereign Risk and Insolvency Risk

Which statement about sovereign risk is most accurate?

Sovereign risk is the chance that a government fails to honour or restructures its debt, and creditors find enforcement difficult because of sovereign immunity. Printing local currency does not create foreign exchange, so foreign-currency debt can still default.

  1. AA government may default or restructure its own debt, and it cannot be sued easily because of sovereign immunityCorrect
  2. BA sovereign borrower always repays since it can print any currency, so default never occurs on foreign-currency debt
  3. CSovereign risk applies only to private companies in emerging markets
  4. DSovereign risk is eliminated when a bank lends in the borrower's local currency

Explanation

Governments can default or restructure, particularly on foreign-currency debt, and enforcing claims is hard due to sovereign immunity. Printing local currency cannot generate foreign exchange, so the second option is wrong. Sovereign risk concerns governments, not only private firms.

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