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Restructuring Sovereign Debt

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Suppose a country plans to restructure its sovereign debt by swapping its existing government bonds for bonds that have (i) half the face value, (ii) half the coupon rate, and (iii) double the remaining time to maturity. Assuming that the relevant opportunity cost remains the same, explain how each of these three measures would affect the present value of the countries' sovereign debt. Would the combined effect of the first two measures reduce the present value of the sovereign debt by more or by less than 50%?

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Solution Summary

The solution explains the impact of coupon payment, face value and time to maturity on the price of a bond or the present value of future cash flows. The answer is brief and to the point. Clear examples are also provided.

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For this question I am assuming that you are doing a 1-1 swap for each bond.

(i) If you half the face value of the bond, the coupon payments will reduce in half and so would be the final payment. So all cash flows would reduce in half. This would lower the sovereign debt by half as well as the present value of all ...

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