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A valuation formula for LDC debt

  • Cohen, Daniel

A large gap may lie between the amount of debt relief that is nominally granted to a debtor and that which is actually given up by the creditors. To help put that gap in perspective, the author proposes a valuation formula that provides: (i) the price at which a buy-back of the debt, on the secondary market, is advantageous to the country; (ii) the value to creditors of having the flows of payment guaranteed against factors that hinder a country in servicing its debt; and (iii) the degree of tradeoff between growth of payments and levels of payments. The author argues that it is not good business for a country to announce its intention to buy back debt, because doing so immediately raises the price. The value of guarantees, the author argues, cannot exceed 25 percent of the market price of the debt. Typically they're worth only about 10 percent. As for the degree of tradeoff, the author's formula finds that 1 percent additional growth rate is worth a 15 percent increase in the flows of payments. An assessment of the Mexican debt-relief agreement reached in 1990 is also offered.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 763.

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Date of creation: 30 Sep 1991
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Handle: RePEc:wbk:wbrwps:763
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  1. Claessens, Stijn & van Wijnbergen, Sweder, 1990. "Secondary Market Prices Under Alternative Debt Reduction Schemes: An Option Pricing Approach with an Application to Mexico," CEPR Discussion Papers 415, C.E.P.R. Discussion Papers.
  2. Michael P. Dooley, 1988. "Buy-Backs and Market Valuation of External Debt," IMF Staff Papers, Palgrave Macmillan, vol. 35(2), pages 215-229, June.
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