Deck 14: Sovereign Risk

Question 1

Export revenue may be highly variable due to the quantity of exports and the prices that may be realized on the exported products.

Answer 1

True

Question 2

Sovereign country risk exposure is a result of the FI's inability to be fully diversified.

Answer 2

False

Question 3

Prior to World War II, most international debt was in the form of bank loans.

Answer 3

False

Question 4

International loan contracts that contain cross-default provisions allow the country to select specific lenders for special default treatment.

Question 5

International bond finance is more likely to be rescheduled than international loan finance because of the relatively fewer lenders involved with a loan finance issue.

Question 6

Sometimes banks received criticism because domestic governments take special political steps to reduce the probability that foreign borrowers will default or repudiate their debt contracts, an occurrence that could cause financial harm to the domestic banks.

Question 7

The larger the import ratio of a country; the higher is the probability that the country will have to schedule its debt payments.

Question 8

All of the following are relevant determinants of sovereign risk exposure: the rate of domestic money supply growth; the variance of export revenue, and the size of the population.

Question 9

A lending decision to a firm in a foreign country should involve both a credit risk analysis and a sovereign risk analysis.

Question 10

In international finance, the investment ratio measures the amount of real investment relative to the gross national product of the country.

Question 11

In the statistical modeling of the country risk analysis, the investment ratio is considered to have a negative impact on the probability of rescheduling because the larger expenditures on investment infrastructure leaves less funds for debt payment.

Question 12

If the credit risk of a foreign borrower is good, then the sovereign country risk is irrelevant.

Question 13

Sovereign country risk is largely independent of the credit standing of the foreign borrower.

Question 14

Sovereign risk involves restrictions placed on borrowers and investors regarding the movement of funds into and out of a foreign country.

Question 15

Rescheduling loans is easier than renegotiating payments on bonds because the same FIs typically form loan syndicates that create cohesiveness in negotiations.

Question 16

The Economist Intelligence Unit is a rating of sovereign risk based on economic and political risk within a country.

Question 17

FIs that lend to foreign entities often need to make provisions to their loan loss reserves.

Question 18

In international finance, the variance of export revenue is based solely on the quantity of product available for export.

Question 19

The debt service ratio of a country should be negatively related to the probability of rescheduling.

Question 20

Lenders often are willing to reschedule debt payments to avoid forcing the borrower into outright bankruptcy.

Question 21

Both the debt service ratio and the import ratio typically have low systematic risk elements in a CRA analysis.

Question 22

Buyers of LDC debt in secondary markets typically are large FIs who are willing to accept write-downs of loans on their balance sheets.

Question 23

Sellers of LDC debt in secondary markets include small FIs wishing to disengage themselves from the LDC market.

Question 24

The export revenue variance (VAREX) should be negatively related to the probability of debt rescheduling.

Question 25

CRA statistical credit scoring models are very adept at capturing political risk events such as strikes, elections, corruption, etc.

Question 26

One problem with using CRA statistical credit scoring models to evaluate sovereign credit risk is the classification into only two possible outcomes.

Question 27

From the perspective of the lending FI, the risk of a well-diversified portfolio of loans should be less than weighted average risk of the individual loans.

Question 28

The export revenue variance (VAREX) ratio tends to have high systematic risk elements in a CRA analysis.

Question 29

One cost of rescheduling for a lender is the potential placement of the lender on a regulatory watch or problem list.

Question 30

In exchange for the loss of some present value of the interest and principal on a loan after a rescheduling, the lender avoids the permanent loss that would result from a default.

Question 31

By rescheduling its debt, a borrower raises the present value of its future payments in hard currencies.

Question 32

A positive relationship is considered to exist between domestic money supply growth and the probability of rescheduling debt.

Question 33

Traditional country risk analysis (CRA) that is based on discriminant statistical models often suffers from problems of using data that is not current.

Question 34

Trading activity and investor confidence in foreign debt increased in the early 2000s.

Question 35

The advantage to the borrowing country of a Brady bond versus a loan from an FI is the much longer maturity and thus the lower payment schedule of a Brady bond.

Question 36

Money supply growth and the import ratio tend to have low systematic risk elements in a CRA analysis.

Question 37

CRA statistical credit scoring models have difficulty measuring political risk events.

Question 38

For any given country risk variable, the greater the size of the systematic risk relative to the unsystematic risk, the less important the variable is to the lender.

Question 39

Rescheduling may cause the borrower to lose future borrowing opportunities for investment projects.

Question 40

Both buyers and sellers of LDC debt seem willing to participate in the LDC debt markets for the purpose of rebalancing the country risk exposure on their balance sheets.

Question 41

One advantage of swapping a sovereign loan for a bond is the capability to sell the bond in the secondary market.

Question 42

In international finance, the investment ratio is determined by dividing the value of real investment by the

A)total foreign exchange reserves.
B)real investment.
C)gross national product.
D)value of exports.
E)money supply.

Question 43

In international finance, the import ratio is determined by dividing the value of imports by the

A)total foreign exchange reserves.
B)real investment.
C)gross national product.
D)value of exports.
E)money supply.

Question 44

In international finance, the debt service ratio is found by dividing interest and amortization payments by the

A)total foreign exchange reserves.
B)real investment.
C)gross national product.
D)value of exports.
E)money supply.

Question 45

Which of the following observations concerning loan default provisions is NOT true?

A)They ensure that if a country defaults on just one of its loans, all its other outstanding loans would automatically be put into default as well.
B)They prevent a country from selecting a group of weak lenders for special default treatment.
C)They make the outcome of any individual loan default decision potentially very costly for the borrower.
D)They protect strong lenders in any loan default by guaranteeing the repayment of such defaulted loans.
E)None of these.

Question 46

Which of the following is an example of an exogenous risk?

A)Blocking reform implementation.
B)Regional economic crisis.
C)Increase in political instability.
D)Social tensions that undermine implementation of reforms.
E)Reversing of reform actions by powerful interest groups.

Question 47

Which of the following describes debt rescheduling?

A)Outright cancellation of all current and future debt obligations.
B)Changing the contractual terms of a loan, such as its maturity and interest payments.
C)Direct nationalization of private sector assets.
D)Automatic default of all international loans upon default of any one loan.
E)Debt conversion schemes of debtor countries that signal creditworthiness.

Question 48

Making a lending decision to a party residing in a foreign country is a two-step decision. What are the two steps involved in such a decision?

A)Assessing credit quality of the borrower and sovereign risk quality of the borrower's country.
B)Assessing political economy risk and exogenous risks.
C)Assessing sovereign risk quality of the borrower's country and other country risks.
D)Rescheduling of existing loans and deciding on the terms for new loans.
E)Assessing the foreign exchange risk involved and the security that can be provided by the borrower.

Question 49

Which of the following describes debt moratoria?

A)Delay in repaying interest and/or principal on debt because of government prohibition of such action.
B)Special reserves created on the balance sheet against which to write off bad loans.
C)The official terminology for a sovereign loan rescheduling.
D)Debt issued by a country that is swapped for an outstanding loan to that same country.
E)Changing the contractual terms of a loan, such as its maturity and interest payments.

Question 50

The Institutional Investor Index is based on

A)spread of the required interest rate on a country's debt over LIBOR.
B)a number of economic and political factors weighted according to their relative importance in determining country risk problems.
C)surveys of the loan officers of major multinational banks.
D)combined economic and political risk on a 10-point (maximum) scale.
E)key economic ratios for each regional grouping.

Question 51

Performing loans in the LDC debt market are loans on which the foreign country is making promised payments.

Question 52

Which of the following variables can have a negative impact on the probability of rescheduling in the credit scoring model to estimate sovereign country risk exposure?

A)The debt service ratio.
B)The import ratio.
C)The variance of export revenue.
D)The investment ratio.
E)Domestic money supply growth.

Question 53

Which of the following describes debt repudiation?

A)Changing the contractual terms of a loan, such as its maturity and interest payments.
B)Direct nationalization of private sector assets.
C)Outright cancellation of all current and future debt obligations.
D)Automatic default of all international loans upon default of any one loan.
E)Debt conversion schemes of debtor countries that signal creditworthiness.

Question 54

In the LCD and EM debt markets, sovereign bonds have historically been issued in foreign currencies.

Question 55

Which is NOT a key economic ratio in credit scoring models to estimate sovereign country risk exposure?

A)The debt service ratio.
B)The import ratio.
C)The variance of export revenue.
D)The discount on rescheduled debt.
E)Domestic money supply growth.

Question 56

The Euromoney Index for a given country currently is based on the

A)spread of the required interest rate on that country's debt over LIBOR.
B)a number of economic and political factors specifically weighted according to their relative importance in determining country risk problems.
C)a combined economic and political risk survey of economists and political analysts presented on a 100-point scale.
D)surveys of the loan officers of major multinational banks.
E)historical default rates of that country's loans.

Question 57

Under the doctrine of sovereign immunity, creditors cannot force repayment of the debt.

Question 58

The advantage to the lender (purchaser) of a Brady bond versus a loan to a foreign country is that U.S. Treasury bonds serve as collateral for Brady bonds.

Question 59

The relationship of this variable with the probability of rescheduling is often disputed.

A)The debt service ratio.
B)The import ratio.
C)The variance of export revenue.
D)The investment ratio.
E)Domestic money supply growth.

Question 60

In the LCD and EM debt markets, sovereign bonds must be collateralized by domestically-issued government bonds.

Question 61

Each of the variables in the credit scoring model of sovereign country risk

A)cannot be measured independently.
B)has a systematic and unsystematic component.
C)has a predictable and an unpredictable component.
D)is determined by a weighted risk index.
E)has a high systematic risk element.

Question 62

What is the approximate yield on a 20-year 10 percent annual coupon LDC bond selling at 75 cents on the dollar? (choose the closest answer)

A)10 percent.
B)40 percent.
C)14 percent.
D)25 percent.
E)Cannot be determined.

Question 63

Which of the following is a benefit to the lender in a loan rescheduling?

A)The FI may become locked into a particular loan portfolio structure.
B)Rescheduling may close the market for future loans.
C)Rescheduling may create interruptions in the flow of international trade since letters of credit may be more difficult to acquire.
D)Rescheduling may lower the present value of future payments in hard currencies.
E)The FI may receive additional fees, collateral, and option features on the loan.

Question 64

The allocation of country resources between present and future consumption is measured by which of the following variables of the credit scoring model of sovereign country risk exposure?

A)The debt service ratio.
B)The import ratio.
C)The variance of export revenue.
D)The investment ratio.
E)Domestic money supply growth.

Question 65

Which of the following is true of Brady bonds?

A)They are uncollateralized.
B)They have a shorter maturity and a higher than promised coupon (yield) than the original sovereign loans.
C)The benefit from Brady bond is the "saving" from lower interest spreads required on such bonds.
D)Their value partly reflects the value of collateral underlying the principal and/or interest on the issue.
E)Their value fully reflects the credit risk rating of the country issuing the bonds.

Question 66

Commodity price and quantity risk is measured by which of the following variables in the credit scoring model to estimate sovereign country risk exposure?

A)The debt service ratio.
B)The import ratio.
C)The variance of export revenue.
D)The investment ratio.
E)Domestic money supply growth.

Question 67

What is the approximate yield on a 20-year 10 percent annual coupon LDC bond selling at 25 cents on the dollar? (choose the closest answer)

A)10 percent.
B)40 percent.
C)14 percent.
D)25 percent.
E)Cannot be determined.

Question 68

Which of the following is true of sovereign bonds?

A)They are bonds backed by collateral.
B)Brady bonds are replacing them because of their higher interest rates.
C)Their benefit is the "saving" from not having to pledge U.S. Treasury bonds as collateral.
D)Their value partly reflects the value of collateral underlying the principal and/or interest on the issue.
E)They are not a segment in the secondary market for sovereign debt.

Question 69

Which of the following is an attempt to measure the absence of governmental constraint on the production, consumption, and distribution of goods?

A)Euromoney Index.
B)Index of Economic Freedom.
C)Corruption Perceptions Index.
D)Economist Intelligence Unit.
E)Institutional Investor Index.

Question 70

Which of the following is a benefit to the borrower in a loan rescheduling?

A)The FI may receive tax benefits.
B)Rescheduling may close the market for future loans.
C)Rescheduling may create interruptions in the flow of international trade since letters of credit may be more difficult to acquire.
D)Rescheduling may lower the present value of future payments in hard currencies.
E)The FI may receive additional fees, collateral, and option features on the loan.

Question 71

Lenders may find it beneficial to reschedule sovereign country debt

A)to avoid political embarrassment.
B)for tax reasons.
C)to avoid marking the balance sheet to market.
D)to maintain good customer relations.
E)to keep from going bankrupt.

Question 72

High rates of domestic inflation impact the credit scoring model of sovereign country risk exposure through which of the following variables?

A)The debt service ratio.
B)The import ratio.
C)The variance of export revenue.
D)The investment ratio.
E)Domestic money supply growth.

Question 73

Which of the following makes international loan rescheduling more likely than bond rescheduling?

A)International loan contracts are not allowed to contain cross-default provisions.
B)Typically there are more FIs in an international lending syndicate compared to the number of potential bondholders.
C)Since World War II more international debt has been in the form of bonds.
D)An international loan syndicate typically comprises the same FIs which allows greater cohesiveness for negotiations.
E)All of these.

Question 74

Which of the following is NOT a reason why international loans are more likely to be rescheduled than international bonds?

A)Governments appear to view the social costs of default on bonds as less critical than on loans.
B)Many international loan contracts contain cross-default provisions that automatically put into default all loans by that country in the case of one default.
C)Banks receive no subsidization from major governments to make international loans.
D)Many international loan syndicates contain the same group of banks which increases the cohesiveness of loan renegotiations.
E)Renegotiation of loans is easier because there are fewer banks in loan syndication than there are bondholders in a debt offering.

Question 75

A possible reason for the high systematic risk of the debt service ratio (DSR) in LDCs and EMs is

A)the tendency of world commodity prices to reflect non-similar economic conditions.
B)the sensitivity of this ratio to rising nominal and real interest rates in the developed, or lending, countries.
C)the tendency of prices and world demands for commodities to reflect simultaneously economic conditions.
D)the discretionary nature of money supply growth for LDC governments.
E)different demands for imports, and wide differences in the scale of vital imports across LDCs.

Question 76

Which of the following is NOT a segment in the secondary market for sovereign debt?

A)Restructured loans.
B)Brady bonds.
C)Sovereign bonds.
D)Performing loans.
E)Nonperforming loans.

Question 77

Lenders may find it costly to reschedule non-accruing sovereign country debt because

A)it is politically embarrassing.
B)of tax reasons.
C)they might be subject to greater regulatory attention.
D)it is detrimental to maintaining good customer relations.
E)bankruptcy costs are high.

Question 78

A possible reason for the high systematic risk of VAREX in LCDs and EMs is

A)the tendency of world commodity prices to reflect non-similar economic conditions.
B)the sensitivity of this ratio to rising nominal and real interest rates in the developed, or lending, countries.
C)the tendency of prices and world demands for commodities to reflect simultaneously economic conditions.
D)the discretionary nature of money supply growth for LDC governments.
E)different demands for imports, and wide differences in the scale of vital imports across LDCs.

Question 79

Buyers are willing to purchase rescheduled LDC and EM debt because of

A)political pressure.
B)the potential for capital gains.
C)tax considerations.
D)side payments from FIs.
E)misinformation.

Question 80

The statistical results of the country risk analysis models

A)may have limited usefulness if parameters are unstable.
B)are not subject to estimation error.
C)cannot be extrapolated to influence financial decision making.
D)are theoretical depictions of underlying relationships.
E)should not change over time.