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Answer: Rating agencies use a country's government debt-to-GDP ratio as the primary debt ratio for assessing the country's sovereign default risk.
## Explanation **A is correct** because rating agencies primarily use the government debt-to-GDP ratio when assessing sovereign default risk. This ratio focuses specifically on the debt obligations of the government itself, which is the relevant measure for sovereign credit ratings. **B is incorrect** because rating agencies do not use total debt-to-GDP ratio as the primary measure. Total debt includes private sector debt, which is not directly relevant to the government's ability to service its sovereign obligations. **C is incorrect** because a higher government debt-to-GDP ratio does not automatically result in a lower rating. Rating agencies consider multiple factors, including: - Government assets that can offset debt - Economic diversification - Political stability - Inflation risks - Other country-specific factors For example, Japan has a high government debt-to-GDP ratio (>200%) but maintains relatively good ratings due to its substantial government assets and other economic strengths. **D is incorrect** because countries with concentrated economies in a few industries tend to have less stable tax bases, not more stable ones. Economic diversification provides more stable tax revenues across different economic cycles. **Learning Objective:** Describe factors that influence the level of sovereign default risk; explain and assess how rating agencies measure sovereign default risks. **Reference:** Global Association of Risk Professionals, Valuation and Risk Models (New York, NY: Pearson). Chapter 5. Country Risk: Determinants, Measures, and Implications [VRM-5]
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A credit risk manager at an insurance company is examining the credit ratings on sovereign bonds held in the company's investment portfolio. The manager researches the factors that rating agencies consider when determining sovereign credit ratings. Which of the following statements is correct regarding the process used by rating agencies to rate countries?
A
Rating agencies use a country's government debt-to-GDP ratio as the primary debt ratio for assessing the country's sovereign default risk.
B
Rating agencies use a country's total debt-to-GDP ratio as the primary debt ratio for assessing the country's sovereign default risk.
C
A country with a higher government debt-to-GDP ratio will always receive a lower rating than a country with a lower ratio.
D
A country with an economy concentrated in a few industries will tend to have a more stable tax base, which has a positive impact on its total debt-to-GDP ratio and its rating.
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