Global Journal of Management and Business Research, D: Accounting and Auditing, Volume 22 Issue 2

III. I mpact on the B ond M arket and its I mplications on O ther M arkets The European debt crisis reached its first peak in the first half of 2011 after Greece, Ireland and Portugal officially requested financial assistance. According to Bernoth and Von Hagen (2012), “government bond yields include risk premiums; increasing indebtedness may cause bond yields to go up, thus raising the cost of borrowing and imposing discipline on governments.” Governments issue debt almost every week to roll their outstanding bonds. Therefore, the risk of not being able to borrow rose (Bernoth and Von Hagen et al., 2012, pp. 975-995). Source: Bloomberg, 2014 Figure 3: PIIGS 10-year Government Spread to Germany Figure 3 emphasises the deteriorating situation of bond markets by observing the widening spreads of ten-year bond yields of the PIIGS countries. The second peak of the yield can be examined in May 2012 when Greece faced default risk once again. However this time, the second rescue package of €130 billion from the IMF and the EU was granted under the condition that a debt swap be concluded. Private investors such as banks, insurance companies and investment funds had to accept a haircut on their Greek bonds’ face value. Due to the financial restructuring of Greece, the fear about contagion effect on other Eurozone countries increased (DW.de , 2014). Consequently, credit rating agencies had to adjust their ratings of the PIIGS’ sovereign debt (Table 1). Table 1: Sovereign Debt Ratings Germany Italy Spain Ireland Greece Portugal Moody's Aaa Baa2 Baa2 Baa3 Caa3 Ba3 S&P AAAu BBBu BBB- BBB+ B- BBu Fitch AAA BBB+ BBB BBB+ B- BB+ Source: Bloomberg, 2014 In parallel, prices for derivative instruments used by financial institutions to hedge against sovereign default risk soared. Credit default swap (CDS) spreads are valuable indicators to measure sovereign risk as they are usually traded as an insurance against sovereign bond default (Alloway, 2013). Hence, tighter spreads represent lower risk and wider spreads such as shown by Figure 4 suggest a higher event-risk. Figure 4 depicts a dramatic increase in March 2012 which indicates a high default probability of Greece. Additionally, at a spread of 2500 bps, Greece’s CDS contracts were too expensive to be traded (Arghyrou, Kontonikas et al., 2012, pp. 658-677; Lucas and Schwaab et al., 2013). Figure 5 emphasises the uncertainty and the contagion risk to other peripheral countries. Lessons Learned from European Sovereign Debt Crisis 57 Global Journal of Management and Business Research Volume XXII Issue II Version I Year 2022 ( )D © 2022 Global Journals