Question 1

The GDPs of two emerging economies (A andB) are equal, but GDP in country B is less volatile than GDP in country A. Both have borrowed $25 billion that must be repaid next year. Which of the following is correct in terms of the probabilities of default?
A) Both A and B have the same probability of default.
B) A's probability of default is higher than B's probability of default.
C) B's probability of default is higher than A's probability of default.
D) Based on probability, B will default.

Accepted Answer

The fact that country B's GDP is less volatile suggests that it has a more stable economy and is better able to handle debt repayment. Therefore, B's probability of default is lower than A's probability of default.

Question 2

Evidence on developing countries' debt suggests that lenders have:
A) consistently made huge profits by lending money to these countries.
B) engaged in predatory lending practices.
C) at best broken even by lending to these countries.
D) done much worse on their investments to advanced countries.

Accepted Answer

Lenders have often faced challenges in recovering loans from developing countries, leading to situations where they have at best broken even, rather than making huge profits or consistently outperforming investments in advanced countries.

Question 3

When GDP volatility increases, it changes the equilibrium in the credit market for sovereign borrowers. How?
A) Volatility increases the probability that a nation will repay and decreases the need to borrow, so the equilibrium debt level and interest rates drop.
B) Volatility decreases the probability that a nation will repay and increases the need to borrow, so the equilibrium debt level is indeterminate and interest rates rise.
C) Volatility decreases the probability that a nation will repay and decreases the need to borrow, so the amount of debt level will fall and interest rates drop.
D) Volatility increases the probability that a nation will repay and increases the need to borrow, so the amount of debt level and interest rates rise.

Accepted Answer

When GDP volatility increases, it creates uncertainty about a nation's ability to repay its debt, causing lenders to demand higher interest rates to compensate for the increased risk. This increases the cost of borrowing, which in turn increases the need to borrow to cover the interest payments. As a result, the equilibrium debt level becomes indeterminate, as lenders try to balance the risk of default against the need for higher returns.

Question 4

Suppose that an emerging market economy was paying the world interest rate on risk-free debt (5%) plus a risk premium of 2% on its international debt. For some reason, the volatility of its GDP increases. Ceteris paribus, how will the increased GDP volatility affect the interest rate it will pay on future borrowing?
A) The interest rate will fall.
B) The interest rate will rise.
C) The interest rate will be unaffected.
D) The interest rate will first fall, then rise as it repays its debt.

Accepted Answer

The increased GDP volatility will increase the perceived risk of the emerging market economy and therefore increase the risk premium that lenders will demand. This will result in a higher interest rate on future borrowing.

Question 5

Which of the combinations of default, exchange rate, and banking crises occurred most frequently between 1970 and 2000?
A) default crisis only
B) default and exchange rate crises
C) default and banking crises
D) default, exchange rate, and banking crises

Accepted Answer

According to studies, the combination of default, exchange rate, and banking crises occurred most frequently between 1970 and 2000. This is often referred to as a "perfect storm" of economic crises, as it involves a significant reduction in the value of a country's currency, a banking system in distress, and the inability of the government to service its debts.

Question 6

A nation will borrow as long as:
A) the benefit of consumption smoothing insurance derived from borrowing is greater than the cost of borrowing those funds.
B) the supply of domestic credit is equal to the demand for domestic credit.
C) international creditors will lend to it at lower-than-market rates.
D) the nation still has foreign currency reserves to calm anxious creditors.

Accepted Answer

A nation will borrow as long as the benefit of consumption smoothing insurance derived from borrowing is greater than the cost of borrowing those funds. This means that the nation sees borrowing as a way to smooth consumption over time, and as long as the cost of borrowing is not too high, they will continue to borrow. The other options are not necessarily true - the supply and demand for domestic credit may not be equal, international creditors may not be willing to lend at lower rates, and foreign currency reserves may not be enough to calm anxious creditors.

Question 7

Prior to the 2007-09 financial crisis, the world saw:
A) an increase in investment demand.
B) a decrease in savings.
C) an increase in real interest rates.
D) an increase in savings.

Accepted Answer

Prior to the financial crisis, the world saw an increase in savings, as households and governments had a higher propensity to save. This contributed to a global savings glut, which in turn put downward pressure on interest rates.

Question 8

Argentina defaulted on its international debt and the Argentine peso depreciated by more than two-thirds in 2001. Why would you expect that, in 2007, most lenders will only make loans to Argentina that are denominated in dollars, euros, or a currency other than the Argentine peso?
A) Lenders fear that another default will be accompanied by a significant depreciation of the Argentine peso.
B) Lenders fear that another default will be accompanied by a significant appreciation of the Argentine peso.
C) In case of a default, lenders will always be repaid if the loans are dollar-denominated than peso-denominated.
D) In the case of a default, lenders are less likely to be repaid if the loans are Argentine peso-denominated.

Accepted Answer

Lenders fear that another default will lead to a significant depreciation of the Argentine peso, which would reduce the value of their repayments if loans were peso-denominated.

Question 9

To determine the supply of lending to low-income nations, we calculate expected returns, which depend on the probability of repayment. The probability is related in the following way to various factors.
A) The probability is positively correlated to the size of total debt and to the volatility of GDP.
B) The probability is positively correlated to the size of total debt and negatively to the volatility of GDP.
C) The probability is negatively correlated to the size of total debt and positively to the volatility of GDP.
D) The probability is negatively correlated to the size of total debt and to the volatility of GDP.

Accepted Answer

The probability of repayment is generally negatively correlated to both the size of total debt and the volatility of GDP. A larger total debt increases the risk of default, and higher GDP volatility indicates economic instability, which also increases the risk of default.

Question 10

A study done on the average return (after all costs and defaults were figured in) revealed that creditors lending to low-income nations:
A) on average earned substantially higher returns.
B) on average earned less than the return on less risky lending.
C) on average earned only a slight risk premium, overall just breaking even.
D) had on average negative returns.

Accepted Answer

Creditors lending to low-income nations typically face higher risks, and the study suggests that they only earned a slight risk premium, which means they just broke even after accounting for costs and defaults.

Question 11

A higher lending rate or an increase in debt principal increases the probability of default because:
A) creditors get more anxious to get repaid and therefore drive debtors into bankruptcy.
B) the nation's repayment/default threshold is higher because the consumption level after repayment of principal and interest falls, whereas the default cost did not change.
C) the bankers of the nation will not help because they can make more profitable loans to third-party borrowers.
D) the government is adverse to repaying a debt that has existed for more than five years.

Accepted Answer

An increase in the lending rate or debt principal raises the repayment/default threshold because it reduces the level of consumption after repaying principal and interest, without altering the cost of default. This makes default more likely as the economic burden of repayment becomes heavier relative to the consequences of defaulting.

Question 12

If an emerging market economy has a low level of international debt, it can expect to borrow at the world interest rate:
A) on risk-free debt.
B) plus a risk premium.
C) minus a risk premium.
D) plus a risk and inflation premium.

Accepted Answer

If an emerging market economy has a low level of international debt, it signifies its creditworthiness and lowers the risk of default. As a result, it can borrow at the world interest rate on risk-free debt.

Question 13

All but one of the following are international financial market penalties that defaulters must face. Which is NOT a financial market penalty?
A) denial of access to international credit markets for some time
B) increases in risk premiums on their future international borrowing
C) increases in the domestic money supply while inflation is occurring
D) an inability to borrow internationally in their own currencies

Accepted Answer

The increase in the domestic money supply while inflation is occurring is not a financial market penalty, but rather a consequence of inflationary monetary policy. The other options represent penalties that defaulters typically face in international financial markets.

Question 14

What was the approximate average annual cost for a country suffering from default, banking, and exchange rate crises simultaneously during the period 1970 to 2000?
A) 2% of GDP per year
B) 12% of GDP per year
C) 22% of GDP per year
D) 92% of GDP per year

Accepted Answer

According to research, countries experiencing default, banking, and exchange rate crises simultaneously during the period of 1970-2000 incurred an average cost of 22% of GDP per year. This highlights the severe economic consequences of such crises and the importance of preventing them.

Question 15

At some level of lending, the interest rate at which lenders are willing to supply loans to an emerging market economy will begin to increase as the:
A) economy's total loans increase.
B) economy's GDP increases.
C) economy's default risk decreases.
D) volatility of the economy's GDP decreases.

Accepted Answer

As the total amount of loans to an emerging market economy increases, lenders perceive a higher risk of default due to the increased debt burden on the economy. This leads to an increase in the interest rate to compensate for the higher perceived risk.

Question 16

An increase in the volatility of GDP increases the probability of default because:
A) it increases political tension and there is a big turnover in government officials who don't know how to run the financial system.
B) automatic stabilizers kick in and increase spending when GDP is lower, taking money away from repaying debt.
C) tax receipts are erratic and government is not good at coming up with payments when they are due.
D) there is still only one potential real GDP level but many more possibilities below potential real GDP, thus a higher likelihood of default.

Accepted Answer

An increase in the volatility of GDP means that there is a greater likelihood that GDP will deviate from its potential real GDP level. This means that there are many more possibilities for GDP to be below potential real GDP, and thus a higher likelihood of default.

Question 17

The factors that affect the probability of a nation's repayment versus default include the:
A) exchange rate of its currency with that of the lender and whether the lender is private or official.
B) conditions set out in the original loan agreement plus the percent of the population in the workforce.
C) ability to earn export revenues and the nation's past credit history.
D) volatility of its output and how burdensome the debt repayment is.

Accepted Answer

The answer of The factors that affect the probability of...

Question 18

The breakeven condition for a lender to an emerging market economy where the risk of default is positive cannot exceed the:
A) probability of repayment minus the probability of default times the rate of interest (r × [pR - pD]).
B) probability of default times the probability of repayment (pD × pR).
C) lender's cost, which is the probability of repayment, times the lender's interest earnings (p × [1 + RL]).
D) market rate of interest for the most default-prone borrowers.

Accepted Answer

The breakeven condition for a lender is when the expected return equals the cost. This is achieved when the probability of repayment times the lender's interest earnings equals the lender's cost.

Question 19

The GDPs of two emerging economies (A and
A) $X is greater than $Y.
B) $X = $Y.
C) $X is less than $Y.
D) $X is significantly greater than $Y.

Accepted Answer

The statement indicates that one of the GDPs is greater than the other, but does not provide any information on the magnitude of the difference. Therefore, it cannot be assumed that the difference is significant, and option D cannot be selected. As there is no possibility of the two GDPs being equal (since it is stated that one is greater than the other), option B can also be ruled out. Therefore, the correct answer is option C, which indicates that $X is less than $Y.

Question 20

Ceteris paribus, if the volatility of an emerging market economy's GDP increases:
A) it will not be able to borrow as much as before at the world interest rate on risk-free debt.
B) it will be able to borrow more than before at the world interest rate on risk-free debt.
C) it can borrow the same amount as before at the world interest rate on risk-free debt.
D) its risk premium falls.

Accepted Answer

If the volatility of an emerging market economy's GDP increases, investors will see it as a riskier investment and demand a higher interest rate in return for lending to them. As a result, the country will not be able to borrow as much as before at the world interest rate on risk-free debt.

Quiz 22: Topics in International Macroeconomics

The GDPs of two emerging economies (A andB) are equal, but GDP in country B is less volatile than GDP in country A. Both have borrowed $25 billion that must be repaid next year. Which of the following is correct in terms of the probabilities of default?

Evidence on developing countries' debt suggests that lenders have:

When GDP volatility increases, it changes the equilibrium in the credit market for sovereign borrowers. How?

Which of the combinations of default, exchange rate, and banking crises occurred most frequently between 1970 and 2000?

A nation will borrow as long as:

Prior to the 2007-09 financial crisis, the world saw:

Argentina defaulted on its international debt and the Argentine peso depreciated by more than two-thirds in 2001. Why would you expect that, in 2007, most lenders will only make loans to Argentina that are denominated in dollars, euros, or a currency other than the Argentine peso?

To determine the supply of lending to low-income nations, we calculate expected returns, which depend on the probability of repayment. The probability is related in the following way to various factors.

A study done on the average return (after all costs and defaults were figured in) revealed that creditors lending to low-income nations:

A higher lending rate or an increase in debt principal increases the probability of default because:

If an emerging market economy has a low level of international debt, it can expect to borrow at the world interest rate:

All but one of the following are international financial market penalties that defaulters must face. Which is NOT a financial market penalty?

What was the approximate average annual cost for a country suffering from default, banking, and exchange rate crises simultaneously during the period 1970 to 2000?

At some level of lending, the interest rate at which lenders are willing to supply loans to an emerging market economy will begin to increase as the:

An increase in the volatility of GDP increases the probability of default because:

The factors that affect the probability of a nation's repayment versus default include the:

The breakeven condition for a lender to an emerging market economy where the risk of default is positive cannot exceed the:

The GDPs of two emerging economies (A and

Ceteris paribus, if the volatility of an emerging market economy's GDP increases: