Key sources of country risk include:
The key sources of country risk affect a country’s risk exposure in the following ways:
There are numerous services that attempt to evaluate country risk in its entirety, including:
Sovereign default risk refers to the risk that holders of government-issued debt fail to receive the full amount of promised interest and principal payments during the specified time period. Sovereign default categories include foreign currency defaults and local currency defaults.
An examination of research on sovereign defaults leads to the following conclusions:
RATING AGENCIES & DEFAULT RISK
The market for sovereign bonds has increased dramatically since 1994. Moody’s, S&P, and Fitch currently rate more than 100 countries each. Moody’s and S&P have improved the ratings, currently providing two ratings for each country, a local currency rating for domestic currency bonds and a foreign currency rating for borrowings in a foreign currency. Generally, the local currency rating is at least as high as the foreign currency rating, because, as noted, countries can print money in local currency to repay debt.
HOW RATING AGENCIES MEASURE RISK
The ratings process includes:
DO RATINGS MEASURE RISK?
Rating agencies have been criticized on a number of counts. These include:
There has been significant growth in the sovereign bond market, beginning in the 1980s. More countries are deliberately avoiding bank debt and issuing bonds instead. As a result, there is another measure of sovereign default risk that may be used, the sovereign default spread. This measure is generated by the market and is continuously updated as sovereign bonds are traded.
ADVANTAGES OF DEFAULT RISK SPREADS:
DISADVANTAGES OF DEFAULT RISK SPREADS:
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