Government, Sovereign Debt

Lesson

Foreign-issued bonds are debt securities issued by foreign governments, also known as sovereign debt. These bonds are used to finance a country's spending and are typically denominated in the issuing country's currency. Investors in foreign-issued bonds face risks such as currency risk, political risk, and default risk.

Practice Question #1

Which of the following risks is unique to investing in foreign-issued bonds?

A) Interest rate risk

B) Currency risk

C) Default risk

D) Inflation risk

Select an option above to see an explanation here.

A) Interest rate risk is associated with all bonds, not just foreign-issued bonds. B) Currency risk is unique to foreign-issued bonds, as exchange rate changes can impact the investment's value. C) Default risk is associated with all bonds, not just foreign-issued bonds. D) Inflation risk is associated with all bonds, not just foreign-issued bonds.

Terms

Sovereign debt:: Debt issued by a national government in a foreign currency to finance the issuing country's growth and development.

Practice Question #2

What is the primary purpose of a government issuing sovereign debt?

A) To finance corporate growth

B) To finance the issuing country's growth and development

C) To provide tax advantages for investors

D) To create a secondary market for bonds

Select an option above to see an explanation here.

A) Governments, not corporations, issue sovereign debt. B) The primary purpose of issuing sovereign debt is to finance the issuing country's growth and development. C) Tax advantages are typically associated with municipal bonds, not sovereign debt. D) Creating a secondary market for bonds is not the primary purpose of issuing sovereign debt.

Historical Example

In the early 2000s, a major South American country defaulted on its sovereign debt, causing a significant decline in the value of its currency and leading to a severe economic crisis. This event highlighted the risks of investing in foreign-issued bonds, particularly those issued by countries with unstable political or economic environments.

Practice Question #3

Which of the following is a key difference between foreign-issued bonds and U.S. Treasury bonds?

A) Foreign-issued bonds have higher default risk.

B) U.S. Treasury bonds have higher yields.

C) Foreign-issued bonds have shorter maturities.

D) U.S. Treasury bonds have higher currency risk.

Select an option above to see an explanation here.

A) Foreign-issued bonds typically have higher default risk than U.S. Treasury bonds, considered among the safest investments available. B) U.S. Treasury bonds typically have lower yields than foreign-issued bonds. C) Maturities for both foreign-issued bonds and U.S. Treasury bonds can vary widely. D) U.S. Treasury bonds do not have currency risk for U.S. investors, as they are denominated in U.S. dollars.

Real-World Example

An investor considering adding foreign-issued bonds to their portfolio might look at bonds issued by a European country with a strong economy and stable political environment. By investing in these bonds, the investor could potentially benefit from higher yields than those offered by domestic bonds while also diversifying their portfolio.