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.
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