Cogito

How Central Governments Issue Sovereign Debt?

Posted in CFA by qmarks on March 22, 2010

Bonds issued by a country’s central government are referred to as sovereign bonds or sovereign debt.

Sovereign debt is typically issued in the currency of the issuing country, but it can also be issued in other currencies as well. Bond rating agencies, such as Standard and Poor’s rate sovereign debt based on its perceived credit risk, often giving different ratings to sovereign debt denominated in the home currency and to the sovereign debt of the same country denominated in foreign currency. But it is often easier for a country to print currency in order to meet obligations denominated in the home currency than it is to exchange the local currency for a fixed amount of foreign currency. Thus local currency sovereign debt often receives a higher rating than the foreign currency denominated of the same country. Because first and foremost you have to import foreign currency to be indebted in the issuing one which is harder than just printing your own. Also don’t forget that printing your own currency may also causes inflation as we remember from Zimbabwe where the cost of fiat money was cheaper than toilet paper.

there are four primary methods used by central governments to issue sovereign debt

1. Regular cycle auction-single price: Under this method the debt is auctioned periodically according to a cycle and the highest price (lowest yield) at which the entire issue to be auctioned can be sod is awarded to all bidders. This system is currently used by the US Treasury

2. Regular cycle auction-multiple price. Under this method winning bidders receive the bonds at the price(s) that they bid

3. Ad-hoc auction system refers to a method where the central government auctions new securities when it determines market conditions are advantageous.

4. A tap system refers to the issuance and auction of bonds identical to previously issued bonds. Under this system bonds are sold periodically not according to a regular cycle.

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