READING 61 CREDIT ANALYSIS FOR GOVERNMENT ISSUERS

Question 1

Which of the following best describes the primary source of a sovereign government’s ability to repay its debt?
A. Monetary policy tools
B. Foreign exchange reserves
C. The ability to tax domestic economic activity

Answer 1

Correct Answer: C

Explanation:

The government’s main ability to service debt comes from collecting taxes within its jurisdiction.

A is incorrect because monetary policy tools can affect inflation and growth, but they don’t directly generate revenue.

B is incorrect because reserves help with external obligations but are not the primary source of repayment.

Question 2

Which of the following is least likely a qualitative factor used to assess sovereign credit risk?
A. Economic flexibility
B. Fiscal strength
C. Monetary effectiveness

Answer 2

Correct Answer: B

Explanation:

B is a quantitative factor — it involves measurable data like debt-to-GDP.

A and C are qualitative because they assess conditions such as diversity of growth and credibility of monetary policy.

Question 3

Which of the following would most likely enhance a country’s institutional and policy credibility?
A. Reducing near-term external debt obligations
B. Transparent legal enforcement and property rights
C. Strong export growth in a single commodity

Answer 3

Correct Answer: B

Explanation:

Strong legal systems and property rights promote business activity and investor confidence.

A relates to external stability, not institutional strength.

C may increase risk if exports are not diversified.

Question 4

Why is a government’s willingness to repay debt an essential part of sovereign credit analysis?
A. Governments cannot default on their obligations
B. Sovereign immunity limits legal enforcement for non-payment
C. Bondholders can legally seize sovereign assets in case of default

Answer 4

Explanation:

Because of sovereign immunity, investors have little legal recourse if a government chooses not to repay.

A is incorrect — governments can default.

C is incorrect — sovereign assets are typically protected from legal seizure.

Question 5

A government’s fiscal flexibility is best described as its ability to:
A. Adjust monetary supply and interest rates
B. Increase taxes or reduce spending to maintain debt payments
C. Maintain a balanced budget across election cycles

Answer 5

Correct Answer: B

Explanation:

Fiscal flexibility involves changing tax policy or reducing expenditures to ensure continued debt servicing.

A relates to monetary policy.

C is a good practice but not the definition of fiscal flexibility.

Question 6

Which condition is most likely to support a country’s monetary effectiveness?
A. A central bank that frequently prints money to fund government deficits
B. A central bank that is independent and policy-credible
C. A central bank that pegs its currency to a foreign reserve currency

Answer 6

Correct Answer: B

Explanation:

Independent central banks are more trusted, less likely to cause inflation, and maintain policy credibility.

A leads to inflation and weakens credibility.

C may help stability but does not ensure monetary policy effectiveness on its own.

Question 7

A country where the central bank is under political control is more likely to experience:
A. High foreign reserves
B. Persistent budget surpluses
C. Inflation and currency depreciation

Answer 7

Correct Answer: C

Explanation:

Politically influenced central banks may print money, leading to inflation and a weaker currency.

A and B are not direct outcomes of central bank dependence.

Question 8

Which of the following best describes economic flexibility?
A. A country’s ability to produce goods with a fixed currency exchange rate
B. Trends in income per capita and diversity of economic sectors
C. Government capacity to negotiate trade agreements

Answer 8

Correct Answer: B

Explanation:

Economic flexibility involves how diversified and resilient an economy is in terms of growth sources and income levels.

A is unrelated.

C may influence trade but is not a measure of economic flexibility.

Question 9

Which country is likely to be considered more creditworthy, based on external status?
A. A country with a widely used reserve currency
B. A country that exports only agricultural products
C. A country with no fiscal surplus but strong political ties

Answer 9

Correct Answer: A

Explanation:

Countries with reserve currencies can borrow more easily and in their own currency, enhancing creditworthiness.

B implies concentration risk.

C might offer political support but not financial strength.

Question 10

What is the primary credit risk when a country relies heavily on a single exported commodity?
A. Trade barriers
B. Geopolitical uncertainty
C. Exposure to price volatility of that commodity

Answer 10

Correct Answer: C

Explanation:

If export earnings depend on one commodity, a price crash can threaten the country’s ability to repay debt.

A and B can be risks, but C is directly tied to export concentration.

Question 11

Which metric is best used to assess a sovereign’s fiscal strength?
A. Debt-to-GDP ratio
B. Number of export partners
C. Independence of central bank

Answer 11

Correct Answer: A

Explanation:

Debt-to-GDP is a standard measure of fiscal burden.

B relates to trade, not fiscal metrics.

C relates to monetary, not fiscal, policy.

Question 12

A country with low interest payments relative to GDP likely has:
A. Poor fiscal strength
B. Strong debt affordability
C. High risk of default

Answer 12

Correct Answer: B

Explanation:

If interest payments are a small portion of GDP, the country can manage its debt more easily.

A and C are inconsistent with low interest burdens.

Question 13

Which condition reflects strong economic growth and stability?
A. Low and volatile GDP
B. High real GDP growth and low volatility
C. Consistent trade deficits

Answer 13

Correct Answer: B

Explanation:

Strong economies show consistent, high real GDP growth with minimal swings.

A implies instability.

C signals external imbalance.

Question 14

Which of the following indicates strong external stability?
A. High short-term external debt due within a year
B. High foreign exchange reserves compared to external debt
C. Heavy reliance on foreign loans for infrastructure

Answer 14

Correct Answer: B

Explanation:

A country with more reserves than debt is safer and more resilient to external shocks.

A increases repayment risk.

C may be common, but it adds to external debt pressure.

Question 15

Countries with a current account surplus typically:
A. Import more than they export
B. Accumulate foreign exchange reserves
C. Face high inflation and weak currencies

Answer 15

Correct Answer: B

Explanation:

A surplus means more exports, which brings in foreign currency — often saved as reserves.

A is the opposite.

C may happen with deficits, not surpluses.

Question 16

Which of the following is most likely an issuer of non-sovereign government debt?
A. The Ministry of Finance of a national government
B. The World Bank
C. The International Monetary Fund (IMF)

Answer 16

Correct Answer: B

Explanation:

The World Bank is a supranational issuer, which is a type of non-sovereign debt issuer.

A is a sovereign debt issuer.

C (IMF) does not issue debt in the same context; it lends to countries, not via public bond issuance.

Question 17

Which of the following entities is most likely to issue bonds with credit ratings close to the sovereign due to implicit government support?
A. Private sector infrastructure firm
B. Government sector bank
C. Foreign central bank

Answer 17

Correct Answer: B

Explanation:

Government sector banks have implied backing from the state, often resulting in credit ratings close to sovereigns.

A is not government-backed.

C may issue debt but not under the classification of non-sovereign debt for a domestic analysis.

Question 18

Which characteristic most accurately applies to agencies as non-sovereign debt issuers?
A. They are fully independent of government policy.
B. They typically issue bonds without credit ratings.
C. They operate under a government mandate and are backed by law.

Answer 18

Correct Answer: C

Explanation:

Agencies are quasi-governmental and operate under legal mandates.

A is incorrect—they are not fully independent.

B is false—most agency bonds do have ratings.

Question 19

Which of the following bonds is most likely backed by the taxing power of a regional government?
A. Green bond
B. Revenue bond
C. General obligation bond

Answer 19

Correct Answer: C

Explanation:

General obligation (GO) bonds are backed by the taxing power of the local government.

A may or may not be tax-backed.

B is backed by project revenue, not taxes.

Question 20

A toll road authority is issuing a bond backed solely by toll collections. This is an example of:
A. General obligation bond
B. Revenue bond
C. Supranational bond

Answer 20

Correct Answer: B

Explanation:

Revenue bonds are repaid using cash flows from specific projects, like tolls.

A would be backed by taxes.

C is not project-specific.

Question 21

Which of the following is a key limitation faced by regional governments compared to sovereigns in servicing debt?
A. Limited access to capital markets
B. Inability to control monetary policy
C. Prohibition from collecting taxes

Answer 21

Correct Answer: B

Explanation:

Regional governments cannot print money or set interest rates—they lack monetary policy control.

A is often not true; many access markets.

C is incorrect—they often can collect taxes.

Question 22

Which of the following entities issues municipal bonds in the United States?
A. Federal Reserve
B. Local governments
C. Private utilities

Answer 22

Correct Answer: B

Explanation:

Municipal bonds are issued by states, cities, and counties in the U.S.

A is the central bank.

C are private and not “municipal” entities.

Question 23

Revenue bonds are typically considered riskier than general obligation bonds because:
A. They have no repayment schedule.
B. Their repayment depends on a specific project’s success.
C. They are usually denominated in foreign currencies.

Answer 23

Correct Answer: B

Explanation:

Revenue bonds are repaid only from the cash flows of the funded project.

A is false — they have schedules.

C is not a general characteristic.

Question 24

Which measure is most appropriate when analyzing a revenue bond’s ability to service its debt?
A. Debt-to-GDP ratio
B. Inflation rate
C. Debt-service coverage ratio

Answer 24

Correct Answer: C

Explanation:

Debt-service coverage ratio (DSCR) compares project revenue to required payments — key for revenue bonds.

A is for sovereign debt.

B is macroeconomic, not project-specific.

Question 25

Which of the following best describes the support for bonds issued by a supranational issuer? A. Backed by national taxation authority B. Backed by the credit strength of several member countries C. Guaranteed by the U.S. Treasury

Answer 25

Correct Answer: B Explanation: Supranationals, like the World Bank, are supported by multiple countries. A is for sovereigns. C is inaccurate — supranationals aren't U.S.-guaranteed.

Question 26

A key feature of general obligation bonds is that they are: A. Secured by specific assets B. Unsecured but backed by the issuer’s full faith and credit C. Tied to the issuer's currency reserves

Answer 26

Correct Answer: B Explanation: GO bonds are not backed by assets, but by the taxing power and creditworthiness of the issuer. A describes secured bonds. C is irrelevant to municipal bonds.

Question 27

Government sector financial institutions most often receive credit ratings similar to the sovereign due to: A. Direct fiscal bailouts B. Ownership of national defense assets C. Implied government support

Answer 27

Correct Answer: C Explanation: These institutions often enjoy assumed government backing, which lifts their ratings. A may occur, but isn’t the basis for the rating. B is unrelated.

Question 28

A municipal government operates under a balanced budget requirement. Which of the following does this most directly impact? A. Its ability to print money B. Its ability to roll over short-term debt C. Its flexibility to increase debt-financed spending

Answer 28

Correct Answer: C Explanation: Balanced budget rules limit borrowing for spending purposes. A is already restricted for non-sovereigns. B is not directly constrained unless related to budget balance.

Question 29

Which of the following best explains the difference in credit analysis for revenue bonds versus general obligation bonds? A. Revenue bonds rely on asset-backed structures B. Revenue bonds require a focus on project cash flows C. General obligation bonds require forecasting market interest rates

Answer 29

Correct Answer: B Explanation: Revenue bonds are project-financed, so the project’s income is critical in analysis. A is misleading — they aren't always asset-backed. C is part of broader bond valuation, not a main difference here.

Question 30

Which of the following is least likely to affect the creditworthiness of a general obligation bond? A. Local economic strength B. Interest coverage from toll revenues C. Tax collection capacity of the issuer

Answer 30

Correct Answer: B Explanation: Toll revenues apply to revenue bonds, not GO bonds. A and C are key for assessing GO bond strength.