Sovereign Default – When Government Defaults on Sovereign Bonds

Stock markets all over the world are going down on the fears of sovereign default by countries in euro zone like Greece, Spain, and Portugal, recently Dubai also was faced with the same problem. So what exactly is sovereign default, well in simple terms it can be defined as inability of the country to honor its obligations on the sovereign bonds which it has issued.

Sovereign bonds are those bonds which are issued by the government of a country but they are denominated in foreign currency, so sovereign default occur when the government of the country is unable to repurchase the foreign currency which is required at bond repayment time and which results in sovereign default by the government of the country. It is quite different from a company which is unable to hour its obligations on debt it has issued because company can be declared bankrupt but country as a whole cannot be declared bankrupt. Sovereign bonds are high yield bonds so investors from other countries where the rate of borrowing is low tend to invest in such bonds so as to earn higher rate of return on their investments (similar to dollar carry trade).

The fear among investors all over the world that this default may spill over to other countries as well as other asset classes leading to another major crisis like that of sub-prime which happened in 2008.

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