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Answer: Countries that have larger commitments to provide health care and pay pensions to their citizens will have higher default risk than equivalent countries that do not.
B is correct. As the size of a government's commitments to pay pensions and provide health care increases, the government has less free cash to service debt. A is incorrect. During economic downturns, for example, developing countries often see larger declines in GDP than their developed counterparts. This is because developing economies tend to rely more heavily on commodities. This means that they get squeezed by lower prices and demand during global recessions. C is incorrect. Government debt-to-GDP ratio is not a complete measure of sovereign default risk. For instance, Japan has a much higher government debt-to-GDP ratio than most countries of the world. However, The Japanese government, to a much greater extent than other governments, holds assets. When the figures are adjusted for those asset holdings, the debt-to-GDP ratio becomes much more reasonable. D is incorrect. When a country defaults, the old debt is usually replaced by new debt or restructured in some other way (e.g., by lowering the principal, lowering the interest payments, or extending the life of the debt). It is not typical for investors to lose the entirety of their investment.
Author: LeetQuiz Editorial Team
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A sovereign wealth fund manager is tasked with assessing the risks associated with bonds issued by bodies in emerging and developed economies. The evaluation takes into account the default risk on sovereign bonds and the specific risks inherent in corporate bonds from these countries. Presuming that all other variables remain the same, which of the following statements is the manager most likely to find accurate in forming a conclusion?
A
A global economic downturn will generally have less impact on developing countries than on developed countries.
B
Countries that have larger commitments to provide health care and pay pensions to their citizens will have higher default risk than equivalent countries that do not.
C
Countries with a much higher government debt-to-GDP ratio will always have a higher default risk than countries with a lower debt-to-GDP ratio.
D
Sovereign defaults by developing countries will typically result in no recovery for investors holding bonds issued by that country.
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