Chapter.14 Exam Questions Sovereign Risk - Financial Institutions 10e Complete Test Bank by Anthony Saunders. DOCX document preview.
Chapter 14 Sovereign Risk
KEY
1. If the credit risk of a foreign borrower is good, then the sovereign country risk is irrelevant.
2. FIs that lend to foreign entities often need to make provisions to their loan loss reserves.
3. Sovereign country risk exposure is a result of the FI's inability to be fully diversified.
4. Sovereign country risk is largely independent of the credit standing of the foreign borrower.
5. A lending decision to a firm in a foreign country should involve both a credit risk analysis and a sovereign risk analysis.
6. 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.
7. During 2014, Argentina defaulted on government debt and also passed legislation that led to default on $30 billion of corporate debt owed to foreign creditors.
8. Through June of 2012, the cost of bailouts required to keep Greece’s reform efforts moving forward and to remain part of the European Union totaled more than $480 billion.
9. Multiyear restructuring agreements (MYRAs) involves the rescheduling of debt payments of foreign governments.
10. Lenders often are willing to reschedule debt payments of foreign corporations to avoid forcing the borrower into outright bankruptcy.
11. A foreign government’s decision to keep a domestic corporation from making debt payments to outside investors automatically makes the corporation a bad credit risk for the investor.
12. Sovereign risk involves restrictions placed on borrowers and investors regarding the movement of funds into and out of a foreign country.
13. Lending to a foreign party is a two-step decision involving both sovereign risk and interest rate risk.
14. When making a loan decision to a foreign party, an FI should consider sovereign risk above credit risk.
15. 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.
16. Prior to World War II, most international debt was in the form of bank loans.
17. Rescheduling loans is easier than renegotiating payments on bonds because the same FIs typically form loan syndicates that create cohesiveness in negotiations.
18. International loan contracts that contain cross-default provisions allow the country to select specific lenders for special default treatment.
19. 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.
20. The Economist Intelligence Unit is a rating of sovereign risk based on economic and political risk within a country.
21. The total debt service ratio of a country should be negatively related to the probability of rescheduling.
22. The larger the import ratio of a country; the higher is the probability that the country will have to schedule its debt payments.
23. In international finance, the investment ratio measures the amount of real investment relative to the gross national product of the country.
24. 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.
25. In international finance, the variance of export revenue is based solely on the quantity of product available for export.
26. Export revenue may be highly variable due to the quantity of exports and the prices that may be realized on the exported products.
27. The export revenue variance (VAREX) should be negatively related to the probability of debt rescheduling.
28. A positive relationship is considered to exist between domestic money supply growth and the probability of rescheduling debt.
29. Traditional country risk analysis (CRA) that is based on discriminant statistical models often suffers from problems of using data that is not current.
30. Country risk analysis (CRA) statistical credit scoring models have difficulty measuring political risk events.
31. One problem with using country risk analysis (CRA) statistical credit scoring models to evaluate sovereign credit risk is the classification into only two possible outcomes.
32. Country risk analysis (CRA) statistical credit scoring models are very adept at capturing political risk events such as strikes, elections, corruption, etc.
33. 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.
34. The export revenue variance (VAREX) ratio tends to have high systematic risk elements in a country risk analysis (CRA).
35. Money supply growth and the import ratio tend to have low systematic risk elements in a country risk analysis (CRA).
36. 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.
37. Both the total debt service ratio and the import ratio typically have low systematic risk elements in a country risk analysis (CRA).
38. By rescheduling its debt, a borrower raises the present value of its future payments in hard currencies.
39. Rescheduling may cause the borrower to lose future borrowing opportunities for investment projects.
40. 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.
41. One cost of rescheduling for a lender is the potential placement of the lender on a regulatory watch or problem list.
42. As recent economic conditions improved, trading volumes in the secondary market for LCD and EM debt reached approximately $6.5 trillion in 2011.
43. Buyers of LDC debt in secondary markets typically are large FIs who are willing to accept write-downs of loans on their balance sheets.
44. Sellers of LDC debt in secondary markets include small FIs wishing to disengage themselves from the LDC market.
45. 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.
46. 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.
47. 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.
48. One advantage of swapping a sovereign loan for a bond is the capability to sell the bond in the secondary market.
49. In the LCD and EM debt markets, sovereign bonds have historically been issued in foreign currencies.
50. In the LCD and EM debt markets, sovereign bonds must be collateralized by domestically-issued government bonds.
51. Under the doctrine of sovereign immunity, creditors cannot force repayment of the debt.
52. Performing loans in the LDC debt market are loans on which the foreign country is making promised payments.
53. A sovereign country’s negative decisions regarding its debt obligations or the obligations of its public and private organizations may take on two forms: repudiation and rescheduling.
54. Repudiation is an outright cancelation of all current and future debt obligations by a borrower.
55. Debt rescheduling is considered a rare form of sovereign risk event.
56. Euromoney Country Risk Scores (ECR) is an online community of economic and political experts that provide real time scores in 15 categories that relate to financial, geographic, and racial risk.
57. Which of the following is a reason why an international loan rather than a bond financing makes rescheduling more likely?
A. There are generally fewer FIs in any international lending syndicate compared to geographically dispersed bondholders.
B. Many international loan syndicates comprise the same groups of FIs, which adds to FI cohesiveness in loan renegotiations.
C. Many international loan contracts contain cross-default provisions that state if a country were to default on just one of its loans, all the other loans outstanding would also become in default.
D. None of the above are like reasons.
E. All are likely reasons.
58. Which of the following statements regarding total debt service ratio (TDSR) are untrue?
A. TDSR = total debt services minus exports
B. The ratio of a country’s principal repayments and interest paid to the value of its exports.
C. The larger the debt repayments are in relation to export revenues, the greater the probability that the country will have to reschedule its debt.
D. There should be a positive relationship between the size of the total debt service ratio and the probability of rescheduling.
E. None of the statements are untrue.
59. 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.
60. 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.
61. 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.
62. 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.
62. Which of the following observations concerning international loan cross-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 the options.
64. The Euromoney Country Risk 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.
64. 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.
66. 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.
67. In international finance, the total 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.
68. 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.
69. 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.
70. 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 total debt service ratio.
B. The import ratio.
C. The variance of export revenue.
D. The investment ratio.
E. Domestic money supply growth.
71. The relationship of this variable with the probability of rescheduling is often disputed.
A. The total debt service ratio.
B. The import ratio.
C. The variance of export revenue.
D. The investment ratio.
E. Domestic money supply growth.
72. 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 total debt service ratio.
B. The import ratio.
C. The variance of export revenue.
D. The investment ratio.
E. Domestic money supply growth.
73. 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.
74. 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.
75. Investors are willing to purchase rescheduled less developed country (LDC) and emerging market (EM) debt because of
A. political pressure.
B. the potential for capital gains.
C. tax considerations.
D. side payments from FIs.
E. misinformation.
76. High rates of domestic inflation impact the credit scoring model of sovereign country risk exposure through which of the following variables?
A. The total debt service ratio.
B. The import ratio.
C. The variance of export revenue.
D. The investment ratio.
E. Domestic money supply growth.
77. 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 total debt service ratio.
B. The import ratio.
C. The variance of export revenue.
D. The investment ratio.
E. Domestic money supply growth.
78. 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.
79. What is the approximate yield on a 20-year 10 percent annual coupon less developed country (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.
Feedback:
80. What is the approximate yield on a 20-year 10 percent annual coupon less developed country (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.
Feedback:
81. Which of the following makes international loan rescheduling more likely than international 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 the options.
82. 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.
83. 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.
84. 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.
85. 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 subsidies 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.
86. 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.
87. 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.
88. 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.
89. 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.
90. 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 "savings" 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.
91. Which of the following are normally traded at very deep discounts from 100 percent?
A. Restructured loans.
B. Brady bonds.
C. Sovereign bonds.
D. Performing loans.
E. Nonperforming loans.
92. The following is an example of a credit scoring model to estimate the probability of debt rescheduling for country I:
Pi= 0.25DSRi+ 0.17IRi- 0.03 INVRi+ 0.84VAREXi+ 0.93 MGi
Where Pi is the probability of rescheduling country I's debt; DSR is the country's total debt service ratio; IR is the country's import ratio; INVR is the country's investment ratio; VAREX is the country's variance of export revenue; and MG is the country's rate of growth of the domestic money supply.
What is an important determinant of rescheduling probability if inflation is a prime concern?
A. The total debt service ratio.
B. The import ratio.
C. The investment ratio.
D. The variance of export revenue.
E. The rate of growth of the domestic money supply.
93. The following is an example of a credit scoring model to estimate the probability of debt rescheduling for country I:
Pi= 0.25DSRi+ 0.17IRi- 0.03 INVRi+ 0.84VAREXi+ 0.93 MGi
Where Pi is the probability of rescheduling country I's debt; DSR is the country's total debt service ratio; IR is the country's import ratio; INVR is the country's investment ratio; VAREX is the country's variance of export revenue; and MG is the country's rate of growth of the domestic money supply.
What is an important determinant of rescheduling probability if country I is providing several incentives to increase domestic savings?
A. The total debt service ratio.
B. The import ratio.
C. The investment ratio.
D. The variance of export revenue.
E. The rate of growth of the domestic money supply.
94. The following is an example of a credit scoring model to estimate the probability of debt rescheduling for country I:
Pi= 0.25DSRi+ 0.17IRi- 0.03 INVRi+ 0.84VAREXi+ 0.93 MGi
Where Pi is the probability of rescheduling country I's debt; DSR is the country's total debt service ratio; IR is the country's import ratio; INVR is the country's investment ratio; VAREX is the country's variance of export revenue; and MG is the country's rate of growth of the domestic money supply.
According to this credit scoring model, the variable that has the highest positive impact on the probability of rescheduling is
A. total debt service ratio.
B. import ratio.
C. investment ratio.
D. variance of export revenue.
E. rate of growth of the domestic money supply.
95. The following is an example of a credit scoring model to estimate the probability of debt rescheduling for country I:
Pi= 0.25DSRi+ 0.17IRi- 0.03 INVRi+ 0.84VAREXi+ 0.93 MGi
Where Pi is the probability of rescheduling country I's debt; DSR is the country's total debt service ratio; IR is the country's import ratio; INVR is the country's investment ratio; VAREX is the country's variance of export revenue; and MG is the country's rate of growth of the domestic money supply.
According to this model, An FI would be most likely to lend to a country with
A. a low total debt service ratio.
B. a high import ratio.
C. a high investment ratio.
D. a low variance of export revenue.
E. a small rate of growth of the domestic money supply.
Feedback: A high import ratio (negatively correlated to probability of rescheduling) will decrease the probability of rescheduling making it a more attractive to lenders.
96. The following is an example of a credit scoring model to estimate the probability of debt rescheduling:
Pi= 0.25DSRi + 0.17IRi − 0.03 INVRi + 0.84VAREXi + 0.93 MGi
Where Pi is the probability of rescheduling country I's debt; DSR is the country's total debt service ratio; IR is the country's import ratio; INVR is the country's investment ratio; VAREX is the country's variance of export revenue; and MG is the country's rate of growth of the domestic money supply.
If two countries are identical in all respects except that country A's total debt service ratio is 1.5, country B's total debt service ratio is 1.25, country A's import ratio is 0.75, and country B's import ratio is 0.90, which country poses the least sovereign country risk?
A. Country A, because the higher total debt service ratio's negative impact on the country's risk exposure outweighs the impact of the lower import ratio effect.
B. Country B, because the higher total debt service ratio's negative impact on the country's risk exposure outweighs the impact of the lower import ratio effect.
C. Country A, because the higher total debt service ratio's positive impact on the country's risk exposure outweighs the impact of the lower import ratio effect.
D. Country B, because the lower total debt service ratio's impact outweighs the higher import ratio's impact on the country risk exposure.
E. They both have the same sovereign country risk exposure.
Feedback: Pi = 0.25DSRi + 0.17IR - 0.03 INVR + 0.84VAREX + 0.93 MG
Country A: Pi = 0.25(1.5) + 0.17(0.75) = 0.375 + 0.1275 = 0.5025
Country B: Pi = 0.25(1.25) + 0.17(0.90) = 0.3125 + 0.153 = 0.4655
97. The following is an example of a credit scoring model to estimate the probability of debt rescheduling:
Pi= 0.25DSRi + 0.17IRi − 0.03 INVRi + 0.84VAREXi + 0.93 MGi
Where Pi is the probability of rescheduling country I's debt; DSR is the country's total debt service ratio; IR is the country's import ratio; INVR is the country's investment ratio; VAREX is the country's variance of export revenue; and MG is the country's rate of growth of the domestic money supply.
Two countries are identical in all respects except that country A's total debt service ratio is 1.5, while country B's total debt service ratio is 1.25, and country A's import ratio is 0.75, while country B's import ratio is 0.90. Based only on the effect of these two variables, compare the likely price of debt issued by country A to the likely price of debt issued by country B if both debt issues have the same maturity and coupon payments. Both debt issues are trading in the secondary market.
A. Country B's debt is priced higher because the probability of rescheduling is lower for country B than for country A.
B. Country A's debt is priced higher because the probability of rescheduling is lower for country A than for country B.
C. Country B's debt is priced lower because country B has a lower probability of rescheduling than does country A.
D. Country A's debt is priced lower because country A has a lower probability of rescheduling than does country B.
E. Both debt issues have the same price.
Feedback: Pi = 0.25DSRi + 0.17IR - 0.03 INVR + 0.84VAREX + 0.93 MG
Country A: Pi = 0.25(1.5) + 0.17(0.75) = 0.375 + 0.1275 = 0.5025
Country B: Pi = 0.25(1.25) + 0.17(0.90) = 0.3125 + 0.153 = 0.4655
98. The following is an example of a credit scoring model to estimate the probability of debt rescheduling:
Pi= 0.25DSRi + 0.17IRi − 0.03 INVRi + 0.84VAREXi + 0.93 MGi
Where Pi is the probability of rescheduling country I's debt; DSR is the country's total debt service ratio; IR is the country's import ratio; INVR is the country's investment ratio; VAREX is the country's variance of export revenue; and MG is the country's rate of growth of the domestic money supply.
Two countries are identical in all respects except that country A's rate of growth of the domestic money supply (MG) is 33 percent, while country B's MG is 25 percent, and country A's variance of export revenue (VAREX) is 3.75 percent, while country B's VAREX is 10 percent. Based only on these two variables, which country possesses the most sovereign country risk?
A. Country A because the higher rate of money supply growth is insufficient to overcome the impact of a lower export revenue variance on country risk exposure.
B. Country B because the higher rate of money supply growth has less impact on country risk exposure than the impact of a lower export revenue variance.
C. Country A because the higher rate of money supply growth is sufficient to overcome the impact of a higher export revenue variance on country risk exposure.
D. Country B because the higher rate of money supply growth has a positive impact on country risk that outweighs the impact of a lower export revenue variance.
E. They both have the same sovereign country risk exposure.
Feedback: Pi = 0.25DSRi + 0.17IR - 0.03 INVR + 0.84VAREX + 0.93 MG
Country A: Pi = 0.84(0.0375) + 0.93(0.33) = 0.0315 + 0.3069 = 0.3384
Country B: Pi = 0.84(0.10) + 0.93(0.25) = 0.084 + 0.2325 = 0.3165
99. The following is an example of a credit scoring model to estimate the probability of debt rescheduling:
Pi= 0.25DSRi + 0.17IRi − 0.03 INVRi + 0.84VAREXi + 0.93 MGi
Where Pi is the probability of rescheduling country I's debt; DSR is the country's total debt service ratio; IR is the country's import ratio; INVR is the country's investment ratio; VAREX is the country's variance of export revenue; and MG is the country's rate of growth of the domestic money supply.
Two countries are identical in all respects except that country A's rate of growth of the domestic money supply (MG) is 33 percent, while country B's MG is 25 percent, and country A's variance of export revenue (VAREX) is 3.75 percent, while country B's VAREX is 10 percent. Based only on these two variables, compare the prices of debt issued by country A to the price of debt issued by country B if both issues have the same maturity and coupon payments. Both debt issues are trading in the secondary market.
A. Country B's debt is priced higher because the probability of rescheduling is lower for country A than for B.
B. Country A's debt is priced higher because the probability of rescheduling is lower for country A than does country B.
C. Country B's debt is priced lower because country B has a lower probability of rescheduling than does country A.
D. Country A's debt is priced lower because country A has a higher probability of rescheduling than does country B.
E. Both debt issues have the same price.
Feedback: Pi = 0.25DSRi + 0.17IR - 0.03 INVR + 0.84VAREX + 0.93 MG
Country A: Pi = 0.84(0.0375) + 0.93(0.33) = 0.0315 + 0.3069 = 0.3384
Country B: Pi = 0.84(0.10) + 0.93(0.25) = 0.084 + 0.2325 = 0.3165