Chapter+10+Answers+to+end-of-chapter+questions - CHAPTER 10...

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CHAPTER 10 SOVEREIGN RISK Chapter outline Credit Risk versus Sovereign Risk Debt Repudiation versus Debt Rescheduling Country Risk Evaluation Outside Evaluation Models Internal Evaluation Models The Debt Service Ratio (DSR) The Import Ratio (IR) Investment Ratio (INVR) Variance of Export Revenue (VAREX) Domestic Money Supply Growth (MG) Using Market Data to Measure Risk: The Secondary Market for LDC Debt Appendix 10A: Mechanisms for Dealing with Sovereign Risk Exposure Debt-for-Equity Swaps Multi-year Restructuring Agreements Loan Sales Bond-for-Loan Swaps (Brady Bonds) Instructor’s Resource Manual t/a Financial Institutions Management 2e by Lange, Saunders, Anderson, Thomson and Cornett 1
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Solutions for end-of-chapter questions QUESTIONS AND PROBLEMS 1. What risks are incurred when making loans to borrowers based in foreign countries? Explain. When making loans to borrowers in foreign countries, two risks need to be considered. First, the credit risk of the project needs to be examined to determine the ability of the borrower to repay the money. This analysis is based strictly on the economic viability of the project and is similar in all countries. Second, unlike domestic loans, creditors are exposed to sovereign risk. Sovereign risk is defined as the uncertainty associated with the likelihood that the host government may not make foreign exchange available to the borrowing firm to fulfil its payment obligations. Thus, even though the borrowing firm has the resources to repay, it may not be able to do so because of actions beyond its control. Thus, creditors need to account for sovereign risk in their decision process when choosing to invest abroad. 2. What is the difference between debt rescheduling and debt repudiation? Loan repudiation refers to a situation of outright default where the borrower refuses to make any further payments of interest and principal. In contrast, loan rescheduling refers to temporary postponement of payments during which time new terms and conditions are agreed upon between the borrower and lenders. In most cases, these new terms are structured to make it easier for the borrower to repay. 3. Identify and explain at least four reasons why rescheduling debt in the form of loans is easier than debt in the form of bonds. The reasons why it is easier to reschedule debt in the form of bank loans than bonds, especially in the context of post-war lending in international financial markets, include: (i) Loans are usually made by a small group (syndicate) of banks as opposed to bonds that are held by individuals and institutions that are geographically dispersed. Even though bondholders usually appoint trustees to look after their interests, it has proven to be much more difficult to approve renegotiation agreements with bondholders in contrast to bank syndicates.
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This note was uploaded on 08/21/2009 for the course FINS 3630 taught by Professor Yip during the Three '09 term at University of New South Wales.

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Chapter+10+Answers+to+end-of-chapter+questions - CHAPTER 10...

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