The Eurozone and the Sovereign Debt Crisis Research Assignment (Essay Sample)

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The Eurozone and the Sovereign Debt Crisis
Question 1: How will/has the role of financial institutions affect negotiations among European leaders about potential solutions?
The role of financial institutions affected the negotiations among European leaders with regard to the potential solutions to the Sovereign Debt Crisis. It had been established that European banks had relaxed and was not bothered withholding cross-border debt. Therefore, it was difficult for leaders to accept the formulation of a monetary union. In the affected countries, financial institutions had adopted different approaches to establishing the remedy to the debt crisis. Some aimed at stimulating economic growth, while other focused on reducing spending. In real sense, potential solution to the debt crisis required an integration of both approaches.
The European leaders faced resistance and hostility from each other, and this made it difficult to reach a long-lasting solution to solve a Sovereign Debt Crisis. The strategies that were adopted without many disagreements included increasing imports, taxes, and issuing debts. Leaders from nations that experienced difficulties to afford their current debt disagreed with issuing debt. Moreover, most leaders protested the increase in tax revenue because financial institutions did not have a formal structure that would support an efficient tax collection. Financial institutions from the Club Med Countries raised the need to implement deflationary policies since they could not produce the goods required by other nations and they aimed at recovering price competitiveness.
Financial institutions that faced debt crisis faced hard times as they could not offer help in saving the situation (Risell, and Allayannis 20). Leaders from this countries wanted to formulate deflationary policies to stop the explosion of the debt that would result in insolvency. The objectives of financial institutions in the European countries were different, thus, leaders faced it rough to form a consensus since country-specific solutions could not be implemented.
What is the range of market-implied probabilities of default for the PIIGS countries and what does this imply about market views?
In exhibit 8, the market-implied probability default (PD) for a sovereign bond is realized from the yield on the bond (i), the yield on a safe benchmark bond (German 10-year bond) and 2.91% constant recovery rate assumption (Risell, and Allayannis 20). The formulae for obtaining the range of market-implied probabilities of default for the PIIGS countries is:
PD= (i-I*)/(1-RR+i)
Market-implied default for Portugal
= (365-10)/ (1-0.291+365)
=0.2907
Market-implied default for Italy
= (185-10)/ (1-0.291+185)
=0.9423
Market-implied default for Greece
= (951-10)/ (1-0.291+951)