Term Paper on "International Financial Management Report"
Term Paper 7 pages (2451 words) Sources: 14
[EXCERPT] . . . .
International Financial ManagementThe sovereign debt crisis in the Eurozone -- focused on Greece, Spain, Portugal and Ireland but threatening to spread to other countries as well -- has been caused be a number of different factors. Of the nations involved, Greece has long been in an unstable financial position, while countries like Ireland and Spain has strong financial positions prior to the bursting of the housing bubble and the global financial crisis. Aside from Greece, therefore, the financial crisis precipitated much of the crisis. Observers from outside of Europe have noted that the Euro currency itself is a major contributor to the crisis. Where devaluation is not an option, recovery is inherently slower and more painful, which in turn has an impact on the ability of countries to deal with their debt burdens, relative to similarly-stricken countries like Iceland that can devalue (Krugman, 2011).
Some blame has also been laid at the feet of international credit rating agencies. These agencies -- Moody's, Fitch, S&P to name a few -- are viewed by some as contributing to the crisis. This paper will analyze the Eurozone debt crisis largely with respect to the role that credit rating agencies have played, if any. The nature of the agencies and their role in sovereign debt markets will be considered. Based on this analysis, an investment strategy will be provided for the sovereign bonds market.
Credit Rating Agencies
The major international credit rating agencies are independent companies that evaluate credit instruments and based on those evaluations assigned a credit rating to a debt instrument. While each agency utilizes
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The ratings agencies were tangentially related to the sovereign debt crisis in their AAA ratings of mortgage-backed securities, which helped fuel the real estate boom that contributed to the crises globally, and especially in countries like Portugal and Spain that became dependent on new construction for their economies (Voigt, 2010). The more important aspect of the agencies' role in the Eurozone crisis has been their treatment of sovereign debt of nations within the zone and the market response to this treatment. An example of an action by a ratings agency was the recent downgrade of Greek debt by Moody's, which based its decision on endemic tax evasion, austerity plans that will cripple the economic recovery and the possibility of a forced debt restructuring by the EU in 2013. The first two factors largely affect the revenue side of Greece's budget and the latter represents a specific risk to holders of Greek sovereign debt. The market's reaction to the downgrade was to lower the price and increase the yield on Greek bonds (BBC, 2011). The rating given by a rating agency is intended to reflect the risk associated with the debt, so a rating downgrade implies that the debt is riskier than previously thought.
Critics point out two key things about the ratings agencies and their impact on sovereign debt markets. The first is that the agencies typically lag market knowledge. This fits with the rational investor theory, which holds that the market already prices in all known information. The second is that too many players in the market overreact to moves by the ratings agencies (Voigt, 2010). This is reasonable, given that the market should already have the knowledge that is built into the ratings agency's assessment of the debt. This implies that market reaction to moves by ratings agencies is somewhat irrational. Indeed, what has been seen during the Eurozone sovereign debt crisis is that an agency downgrade on one nation's debt sets off a chain reaction that lowers the price of debt on other nations in the Eurozone as well -- this reaction is irrational and purely speculative (Arezki, Amadou & Candelon, 2010). German debt is considered the safe haven in the Eurozone, so speculation tends to affect the cost of the debt of all other European nations vs. The cost of German debt; for example France saw its cost of debt increase as the result of a rate cut on Greece in 2010 (the Telegraph, 2010).
Causes of the Sovereign Debt Crisis
It is important when analyzing the Eurozone sovereign debt crisis to consider the individual nations separately. Greece is the nation with the most significant sovereign debt problem, having been downgraded to junk status and having the most significant long-run structural problems. Featherstone (2011) outlines the myriad problems that contributed to the Greek crisis: low competitiveness, trade and investment imbalances and fiscal mismanagement. The structure of the Greek economy, the inability of its government to collects its revenues and debt-to-GDP ratio of 144% - fifth highest in the world -- all contribute to the depth of the Greek crisis (CIA World Factbook, 2011). The intensity of these problems -- all deeply structural in nature - combined with the inability to spur economic growth through currency devaluation make the Greek crisis the deepest and the most intractable of all the sovereign debt issues in the Eurozone.
The other nations faced different problems. Spain and Ireland did not have debt crises prior to the economic downturn. Spain's troubles were related to a massive real estate bubble that burst, causing massive employment and therefore a sharp downturn in government revenues. In Ireland, the government bailed out its irresponsible banking sector to the detriment of essentially everything else in the economy, not only devastating the country's balance sheet but also its prospects for economic recovery. Investors saw similarities in the struggles of these nations and Greece. The prevailing view is not that these countries are in the same situation as Greece, but that if Greece could fall, other countries within the Eurozone could as well, and these peripheral countries were in the most precarious positions.
Arezki, Amadou & Candelon (2010) highlight the impact that ratings agencies play in the crisis. The markets, acting more or less irrationally, tend to sell off most Eurozone sovereign debt in response to moves by the ratings agencies. They identified that'd&P outlook revisions tend to spill across other countries, while Moody's and Fitch downgrades are more likely to spill across other countries. These effects are likely related to the market's understanding of the methodology of each agency. The complexity of the transmission of these agency moves throughout Eurozone sovereign debt markets is not fully understood by markets, regulators or scholars, but the impact is clear in that problems in one nation tend to have a spillover effect on the debt of other nations within the Eurozone.
In part, this is related to the common currency. Maurer (2010) argues that the crisis is the result of self-reinforcing debt-spirals, caused by different inflation rates throughout the Eurozone. That the problem in Greece spread to Spain, Portugal and Ireland is less a result of the long-run budget situations in those countries than is attributable to faulty design by the EMU. Maurer argues that the EMU needs to have instruments within its structure to deal with business cycle shocks in its member nations -- something that would effectively replace currency devaluation as a means of evening out the differences in inflation rates across the Eurozone. That there are no such mechanisms available has resulted in the crisis becoming a Eurozone crisis, putting the common currency at risk based on what essentially was a sovereign debt crisis in Greece (De Grauwe, 2010).
What is evident about the crisis is that the most significant elements of the crisis are structural, or related to the business cycle downturn. The ratings agencies are a contributor in that they reflect negatively on the debt of specific countries. However, some of the blame ascribed to the ratings agencies would be better ascribed to the market players who react to ratings agency moves irrationally. While it is the responsibility of the ratings agencies to be accurate with their information and objective in their assessments, they cannot be held responsible for markets that react to a change in the status of one sovereign entity's debt rating by selling off the debt of a dozen other nations on pure speculation.
The Current Situation
The Eurozone sovereign debt crisis remains unresolved. Moody's has cut the debt rating for Greece again this month (BBC, 2011), setting off another round of speculative selling in debt markets.… READ MORE
Quoted Instructions for "International Financial Management Report" Assignment:
Topic and requirement
In recent months we receive news that claim there is a link between international credit rating agencies, such as Moody*****s, S&P and Fitch, and the sovereign debt crisis in the euro-area (see *****"Are the ratings agencies credit worthy?*****" CNN). In fact, international credit rating agencies have been accused of having a detrimental impact on the current sovereign debt crisis.
Required:
I am an investment banker. Prepare a report for me providing a detailed rationale of the sovereign debt crisis in the euro-area in relation with the role of international credit rating agencies. Please, also given your analysis provide an investment strategy for sovereign bonds market. In researching this assignment, you should carry out your own research. This assignment is to be done in groups of three. The essay should be round 2,000 words
This report is testing learning outcome 2:
Having completed this unit the student is expected to demonstrate:
a critical evaluation of the complexities associated with corporate capital structure and the relationship between risk and return
The essay should follow the following outline
Outline
Introduction
A brief introduction of credit rating agencies , the sovereign debt crisis in the euro-area and the relationship between the two
Main Body
Firstly review of the Reasons and Implications of Sovereign Debt Crisis in The Euro-area
Secondly evaluating of the situation with chart and data
Finally risk appraisal and investment strategy for sovereign bonds market
Conclusion
References
please use simple English because I am an ESL student. I will also upload some materials to the resource files and hope they can help.
Please only use academic published books, journals and other reliable sources. No unreliable web source is allowed, except the well-established academic organization or government websites(no more than 3)
The style should be formal. clear sections with headings.
How to Reference "International Financial Management Report" Term Paper in a Bibliography
“International Financial Management Report.” A1-TermPaper.com, 2011, https://www.a1-termpaper.com/topics/essay/international-financial-management/3917908. Accessed 5 Oct 2024.
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