Question

1. List and explain the two dominant factors as to why there are country differences in the cost of debt. For example, why is the cost of debt different in Brazil than Japan? (If a Brazilian subsidiary was to borrow money locally, they would pay a different interest rate than if a Japanese subsidiary was to borrow money locally.)

Answer 1

Two dominant factors as to why there are country differences in the cost of debt are:

· Risk free rate – Different countries will have different risk free rates. Even if the borrowing is done in local currency not all governments are free from risk of default. In some countries the investors can be of the perception that the government is at risk of default even when the borrowing is done in local currency. Moreover real risk free rate is adjusted for inflation and different countries have different inflation rates.

· Economic conditions of a country – Cost of debt in a country are also determined by the economic conditions prevailing in that country. Factors like perceived level of country risk and exchange rate risk also impacts the cost of debt of a country. Japan will have a lower cost of debt than Brazil because Japan has a lower level of country risk than Brazil.