Consider the following statements : Statement-I : If the United States of America (USA) were to default on its debt, holders of US Treasury Bonds will not be able to exercise their claims to receive payment. Statement-II : The USA Government debt is not backed by any hard assets, but only by the faith of the Government. Which one of the following is correct in respect of the above statements ?
A
Both Statement-I and Statement-II are correct and Statement-II explains Statement-I
Correct Answer
B
Both Statement-I and Statement-II are correct, but Statement-II does not explain Statement-I
C
Statement-I is correct, but Statement-II is incorrect
D
Statement-I is incorrect, but Statement-II is correct
Explanation
Option (a) is correct because a sovereign default signifies a failure to meet legal payment obligations, and this risk is inherent because US Treasury bonds are backed only by the "full faith and credit" of the government rather than physical collateral. Option (b) is the most tempting wrong choice, but it fails to recognize that the lack of underlying hard assets (Statement-II) is the direct reason why bondholders have no recourse to seize property or enforce claims if the government stops paying (Statement-I). The core concept tested is the nature of sovereign debt and the credit risk associated with fiat-backed government securities.
MacroeconomicsSovereign Debt & Bond MarketsUS Treasury BondsSovereign defaultHard assetsGovernment debtFiat currency