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As I understand it, foreign currency indexation (FCI) is when a government pegs its currency to another (usually the dollar), and their central bank buys or sells dollars to maintain a stable exchange rate between the two.

The material I have to read for my class mentions FCI in the context of the Mexican tesobonos and other domestic debt that was issued linked to another currency.

I am unable to find a resource online or otherwise that can distinguish between the two possible answers I'm given to the question "What is FCI": 1. When a country issues debt in another country's currency 2. When a country buys foreign currency to lower the value of its currency

One seems incorrect because I don't see how the option hits at the fact that the currency is being pegged to the dollar (or another stable currency), and two seems wrong because it does not account for the other side of the equation (selling to increase which I would assume is functionally correct).

Any input or suggestions?

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1 Answer 1

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A currency can be indexed but so can a bond. An indexed bond is one where the coupons and principal are indexed to another currency (the U.S dollar in the case of Tesobonos) at the spot rate in effect at the time of issuance. So you actually pay in the local currency but how much you pay depends on the prevailing exchange rates when payment is due.

A bond can be indexed without a currency being indexed. It is typically a way, much like a foreign currency denominated debt issuance, to remove local inflation and exchange risk from debt issuance.

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