When a country’s central government is at risk of defaulting on its debt, lenders perceive higher risks and demand higher interest rates as compensation. This results in:
Anincrease in interest ratesfor borrowing by all entities in the country.
OptionsA and Bare incorrect because exchange rates usually decline (currency devalues) when default risk rises.
D. Decrease in interest ratesis the opposite of what happens in such scenarios.
References:Volume 1, Chapter 4 ("Sovereign Risk and Interest Rates").
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