Reading 62: Overview of Bond Sectors and Instruments LOS a习 2010, government, statements, following

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LOS a: Describe the features, credit risk characteristics, and distribution methods for government securities.

Which of the following statements regarding sovereign bonds is least accurate?

A) A central government can issue sovereign bonds in its national bond market, in another country’s foreign bond market, or in the Eurobond market.

B) When a central government issues securities, those securities can only be denominated in the local currency regardless of where the bonds are issued.

C) Sovereign bonds denominated in domestic currency are subject to default risk.

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When a central government issues securities, those securities are generally denominated in the currency of the issuing country, but a government can issue bonds denominated in any currency. Sovereign bonds are not necessarily free from default risk.

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Fernando Golpas and Javier Solada were reviewing the financial reports of several Latin American governments. They noticed that the central governments of many Latin American countries such as Argentina, Chile, Peru, and Ecuador had recently been issuing sovereign debt. This sparked a discussion between the two analysts about sovereign debt ratings. During their discussion they made the following statements:

Golpas: The rating agencies, such as Moody's, generally assign two ratings to sovereign debt. One is a local currency debt rating and the other is a foreign currency debt rating. The reason for the two ratings is that the default frequency has been greater on local currency denominated debt.

Solada: If a central government is willing to raise taxes and control its internal financial system, it should be able to generate sufficient local currency to meet its local currency obligation. That is why the rating on local currency denominated debt is generally higher than the rating on foreign currency denominated debt.

With regards to the statements made by Golpas and Solada:

A) both are correct.

B) only one is correct.

C) both are incorrect.

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Golpas’ statement is incorrect because the reason for the two ratings (the local currency and the foreign currency debt ratings) is that the default frequency has been greater on foreign currency denominated debt. It is often easier for a central government to print local currency to meet its obligations in the home currency than to exchange the local currency in the foreign exchange markets for a given amount of foreign currency.

honeycfa

Often central governments will announce auctions to issue new bonds when they believe prevailing market conditions appear most suitable. At the time of the auction, the amount to be auctioned and the maturity of the security to be offered are announced. This method of distributing new government securities is called:

A) an ad hoc auction method.

B) a regular auction cycle / single-price method.

C) the tap method.

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An ad hoc auction system is a method in which a central government distributes new government securities via auction when it determines that market conditions are advantageous.