International Bond Market 7 Chapter Seven International Bond Market Chapter Objective: This chapter continues discussion of international capital markets with a discussion of the structure of the international bond market. Chapter Outline The World’s Bond Markets: A Statistical Perspective Foreign Bonds and Eurobonds Types of Instruments Internat. Bonds and Notes: Currency, Nationality, Type of Issuer International Bond Market Credit Ratings Eurobond Market Structure & Practices International Bond Market Indices

7.1 The World’s Bond Markets A statistical perspective: The total market value of the world’s bond markets was over $68 trillion in 2006, $18 trillion of this was classified international debt. Most issues are denominated in US$, Yen and Euro. Domestic and international debt outstanding $bn 2

International Bonds Foreign Bond: - Issued by a foreign borrower to investors in another country and denominated in the currency of that country. Yankee, Samurai, Bulldog, Kangaroo, Maple bonds Investors view it as a debt instrument issued by a foreign instead of a domestic borrower. Ford issues offers a bond denominated in SFs to Swiss investors. Eurobond: - Denominated in a specific currency, but sold to investors in a national capital market other than the country of the denominated currency. Swiss borrower issues $-denominated bonds to investors in UK, India,and Japan. Bearer Bonds are bonds with no registered owner. They offer anonymity but they also offer the same risk of loss as currency. Registered Bonds: the owner’s name is registered with the issuer. U.S. security laws require Yankee bonds sold to U.S. citizens to be registered.

7.3 Types of Instruments Straight Fixed Rate Debt Euro-medium term notes Floating-Rate Notes Equity-Related Bonds Zero Coupon Bonds Dual-Currency Bonds 4

Types of Instruments 1. Straight Fixed Rate Debt These are “plain vanilla” bonds with a specified coupon rate and maturity, and no options attached. Since most Eurobonds are bearer bonds, coupon dates tend to be annual rather than semi-annual, less costly for issuer. The vast majority of new international bond offerings are straight fixed-rate issues. 2. Euro-Medium-Term Notes (Euro MTNs) 1 to 10 year notes (medium term) fixed coupon rate Issued on a continual basis (not all at once like bonds) as MNC needs credit.  Very popular for issuers due to flexibility. 

Types of Instruments 3. Floating-Rate Notes FRNs are typically medium term bonds with coupon payments indexed to some reference rate. Common reference rates are 3-month and 6-month U.S. dollar LIBOR Coupon Payment (6mo.) = 0.5 x (LIBOR + X) X = default risk premium(%); LIBOR resets. Since FRN reset every 6 or 12 months, the premium or discount is usually quite small…as long as there is no change in the default risk.

Types of Instruments 4. Equity-Related Bonds Convertibles: Convertible bonds allow the holder to surrender his bond in exchange for a specified number of shares in the firm of the issuer. Bonds with equity warrants: These bonds allow the holder to keep his bond but still buy a specified number of shares in the firm of the issuer at a specified price. These are straight fixed rate bonds with a call option for a number of shares at a strike price over a period of time.

Types of Instruments 5. Zero Coupon Bonds Zeros are sold at a large discount from face value because there is no cash flow until maturity, primarily US $ and Swiss Francs. Pricing is straightforward: Stripped Bonds - Making a series of zero coupon bonds from a coupon bonds.  The coupons and the maturity value are stripped and sold separately as zero coupon bonds.     

Types of Instruments 6. Dual-Currency Bonds Became popular in the mid-1980s A straight fixed-rate bond, with interest paid in one currency, and principal in another currency. Investor’s perspective: a long-term forward contract. Japanese firms have been big issuers with coupons in yen and principal in dollars. Good option for a MNC financing a foreign subsidiary.

International Bond Market Instruments Frequency of Payment Size of Coupon Payoff at Maturity Straight Fixed-Rate Annual Fixed Currency of issue Floating Rate Note Every 3 or 6 months Variable Currency of issue Convertible Bond Annual Fixed Currency of issue or conversion to equity shares. Straight fixed rate with equity warrants Annual Fixed Currency of issue plus conversion to equity shares. Zero none zero Currency of issue Dual Currency Bond Annual Fixed Dual currency

7.4 International Bonds and Notes: Currency, Nationality, Issuers Bonds issued in Canadian dollars represent about 1% of world total   11

Distribution of International Bond Offerings by Nationality   Distribution of International Bond Offerings by Nationality     12

International Bond Market Credit Ratings Fitch IBCA, Moody’s , Standard & Poor’s and DBRS sell credit rating analysis. Focus on default risk, not exchange rate risk. Assessing sovereign government debt focuses on political risk and economic risk. Economic risk: external debt, BOP flexibility, economic structure & growth, management of the economy, and economic prospects.

Eurobond Market Structure Primary Market: new issues Similar to domestic underwriting. - Investment Banks Underwriters use own funds to buy new issue at a discount from the issue price (2-2.5%) [1% domestic] Secondary Market: “used” issues = resale OTC market centered in London. Bid and ask prices. Comprised of market makers and brokers. Members of the International Securities Market Association (ISMA), Zurich, Switzerland, self-regulatory organization. Clearing Procedures Euroclear and Clearstream International handle most Eurobond trades.

International Bond Market Indices There are several international bond market indices. J.P. Morgan and Company Domestic Bond Indices International Government bond index for 18 countries. Widely referenced and often used as a benchmark. Appears daily in The Wall Street Journal

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