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Explain how issuers that are sovereign, non-sovereign, quasi-government or supranational raise funds

CFA® Level I · Fixed Income · Fixed-Income Markets for Government Issuers · FI.9.a

The idea

Governments fund spending from taxes and, when revenue falls short, borrowing. Sovereign issuers sell bills, notes and bonds, usually by regular auction to build a liquid benchmark yield curve. Debt in the sovereign's own currency is backed by the power to tax and, ultimately, to create money, so it carries less default risk than foreign-currency debt, which must be serviced from export earnings or reserves. Non-sovereign governments such as states, provinces and cities issue general obligation bonds backed by their taxing power and revenue bonds serviced only from a specific project's income. Quasi-government entities, such as government-sponsored agencies, borrow to fund public-policy activities and often benefit from an implicit or explicit government guarantee, so they trade a little above the sovereign. Supranational issuers such as multilateral development banks are owned by member countries, backed by their capital, and typically borrow at very high credit ratings.

A practice question

From the question bank, with the reason each wrong option is wrong.

A supranational issuer, such as a multilateral development bank, is best described as:

  1. owned and backed by member countries — correct
  2. a regional government within one countryWhy not: That is a non-sovereign government, such as a state or city.
  3. a state-owned company in one countryWhy not: That is a quasi-government entity, owned by a single sovereign.

Supranationals are owned by several member countries and backed by their capital, which typically allows them to borrow at very high credit ratings.

A harder one

A city issues bonds serviced only by tolls from a new bridge. These are most likely:

  1. general obligation bondsWhy not: Those are backed by the issuer's full taxing power, not one project.
  2. supranational bondsWhy not: Supranationals are multi-country issuers, not local governments.
  3. revenue bonds — correct

Revenue bonds depend on the income of a specific project, so they generally carry more credit risk than general obligation bonds of the same issuer.

The hardest tier

A sovereign's local-currency bonds are rated several notches higher than its foreign-currency bonds. The best explanation is that:

  1. foreign investors are always repaid firstWhy not: Priority in repayment does not favour foreign-currency holders in this way.
  2. it can tax and create its own currency — correct
  3. local bonds are secured by specific assetsWhy not: Sovereign bonds are backed by the government's general credit, not collateral.

Local-currency debt can be serviced from taxes and, ultimately, by creating money. Foreign-currency debt must be met from reserves or export earnings the government does not control.

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