Sovereign debt crisis: the benefits and risks to investors
It is no secret that governments get into debt from time to time. Sometimes the fear that a government will not pay back its debt can lead to what is known as a sovereign debt crisis, caused by a dramatic rise in the interest rate. Governments can fall victim to such a syndrome if they rely on short-term bonds, which can have different maturity dates to the long-term asset value of the nation’s tax base. Another cause of sovereign debt crisis can be when the nation’s currency falls in value so much that it makes it too expensive to pay back foreign-denominated bonds. Spotting currencies that may be about to change in value dramatically has potential for investors.
Say if the currency you bought was the USD and you agreed to do this on a $10 per point basis, every time the dollar increased in value against the currency you bought it with, you would gain $10 per point increase. However, every time it fell in value you would lose $10 in currency trading.
A sovereign debt crisis can therefore provide options for an informed investor, however not without risk. More common than sovereign debt crises are debt restructurings, but these also can indicate fluctuating currencies. The political pressure from other countries and from domestic bondholders to repay debts leads many governments form agreements with bondholders. They usually opt to pay back the full amount at a delayed date, or partially reduce their debt payments. This is what is meant by a sovereign debt restructuring. The International Monetary Fund often intervenes in such cases. It may make loans on the condition the government in question implements austerity measures to allow part of the debt to paid off. Such action still leads to political and economic instability, and again investors can spot an opportunity to trade on currencies as some may be about to fall in value
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