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Quick Economics Question

For some reason, I think panic of the exam has set in and the simplest things are starting to not make sense - please could someone help in understanding the following statement: 

“Most emerging market debt is denominated in a non-domestic currency, which increases its default risk.”

I understand that EM debt has more default risk, but I thought the point of denominating it in a non-dom currency was to reduce its riskiness (so for example, the EM country doesn’t have the power to inflate its currency to reduce the value of the debt). 

Thanks! 

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Most of the EM countries do not have enough USD reserve. Thus, increase the defaut risk when the Bond is demoniated in USD.

Thanks! 

NCL32018 wrote:
For some reason, I think panic of the exam has set in and the simplest things are starting to not make sense - please could someone help in understanding the following statement: 

“Most emerging market debt is denominated in a non-domestic currency, which increases its default risk.”

I understand that EM debt has more default risk, but I thought the point of denominating it in a non-dom currency was to reduce its riskiness (so for example, the EM country doesn’t have the power to inflate its currency to reduce the value of the debt). 

Thanks!

First, to reduce the value of its debt, a country would deflate its currency (e.g., by printing more), not inflate its currency.

Second, that’s exactly the point: if a country’s debt is denominated in another country’s currency, it cannot print its way out of default, so it’s more likely to default.

Simplify the complicated side; don't complify the simplicated side.

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Hi S2000magician, 

Thanks for your response. Could you please further explain why it would be deflation not inflation? I thought it the currency value inflation reduces the value of the currency (e.g. hyperinflation in Zim)? I am sure you are right, but I’m missing a piece of the puzzle here. Or I’m just being stupid! 

You’re correct, just from the opposite perspective: The currency deflates, and thus inflation of goods & services occurs. (Hyperinflation in Zimbabwe occured because the currency was becoming worthless)

What Louter said.

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/