Can Panama issue a bond denominated in dollars at the same terms (that is, at the same yield) as the U.S. government? Why or why not?
What will be an ideal response?
When a sovereign borrower issues bonds in its own currency, there is technically no default risk because the government can typically simply print money to pay back the debt holders. When a sovereign borrower issues bonds in a different currency, though, a default is possible because the government must earn foreign exchange to pay off the bondholders. This possibility of default will be priced into the yield on the bond. Hence, Panama will face a higher yield on its dollar borrowings than the U.S. government does. The difference between the two yields is called the country credit spread. For example, if the yield on a 5-year U.S. Treasury bond is 5%, and the yield on a 5-year dollar bond issued by the Panama government is 10%, the Panama country credit spread is 5%. These spreads, which vary over time as the bonds trade in secondary markets, are, of course, an indication of country risk.
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