Pprice of debt security0.5

1
Pprice of debt security0.5 Pnew price of
debt security0.56 Gain to creditors (sellers
holders)
Debt relief50-428 The externally funded costs
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Cross Section
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(No Transcript)
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Gain to sellers
Gain to holdout creditors
Total gain to creditors
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Emerging Markets 1997

• Korean Crisis (1997)
• Liberalization of capital account was associated
  with 120 billions of capital inflows, 1992-1997.
  Reversals of flows in second half of 1997 thru
  1998 generated a downturn in the economy and debt
  problem but this time mostly to private sector
  and financial intermediaries- although there was
  a substantial Intl bail out.

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Brady Bonds Deal

• A country issues new bonds (Brady Bonds) with a
  reduced rate of interest, and with Industrial
  Country Coovts guarantees. Thus the market will
  purchase these bonds since they are credit
  worthy.
• Resources obtained from the Brady Bonds issue
  will be used to buy back the country old debt.
  (on which the country was not credit worthy)
• Thus, the real amount to a combination of
  external funding (not thru grants but through
  good credit) that finances a buy back of old debt.

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Price
1
New price
0.56
Old price
AV
0.5
MV
Nominal debt
100
75
25
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Knocked DownSecondary-market debt
prices,September, 1991, of face value
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International Cross-Section Regression

• Pprice
• DNominal Debt
• XExports
• GGrowth rate

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At D
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Debt Reduction and Expected Repayments Effect on
probabilities.
Dface value VpD(1-p)d
Marginal change in probability of good state when
face value increases by 1 unit

• Thus the debt reduction raises AV for 2 reasons
• Relative payments d/D, rise
• P rises.

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AV Average of debt 0.5 (price) MVMarginal
value of debt0.33 (1/3)
MV
Mv is the change in the market value of debt
(Expected repayment to creditors) if the
NOMINAL debt is increased by 1 unit.
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PDV
Debt relief Laffer Curve
D
D
1
P
AV
D
D
MV