1. 1 (of 26) IBUS 302: International Finance Topic 13-International Bonds Lawrence Schrenk, Instructor.

2. 2 (of 26) Learning Objectives 1. Describe the general characteristics of international bond markets. 2. Explain the classification of international bonds. 3. Explain the types of instruments available in the international bond market.

3. 3 (of 26) International Bond Markets International bond markets are NOT unified into a single market (like FX and Eurocurrency market). International Bonds are viewed as substitutes to Domestic bonds.

4. 4 (of 26) Market Demographics Bond Market Segments: Domestic Bonds, Foreign Bonds, Eurobond Total market value of the worlds bond markets are about 50% larger than the worlds equity markets. Denominations: 1. U.S. $ = 47% (46% of international) 2. Euro = 18% (23% of international) 3. Yen = 19% (4.0% of international)

5. 5 (of 26) Domestic Bond Market Foreign Bond Market Global Bond Market EuroBond Market International Internal External / Offshore Classification

6. 6 (of 26) Domestic Bonds Issued by domestic entity Denominated in that countrys currency Corporate IBM issues $ denominated bonds in USA Governments: Treasury Bonds (USA) Gilts (UK) Bunds (Germany)

7. 7 (of 26) Domestic Bonds: Review Key Variables Principal, Par Value, Face Value Coupon, Coupon Rate Maturity (t) Discount Rate (r) Periods (per year), (m)

8. 8 (of 26) Domestic Bonds: Review Premium versus Discount Bonds Features Callable Bonds Convertible Bonds Sinking Funds Debt Covenant Financial Ratios Technical Default

9. 9 (of 26) Foreign Bonds–Type I Issued by foreign entity Outside the country where the entity resides Denominated IN THE currency of the country where issued Example: Toyota issues $ denominated bonds in USA.

10. 10 (of 26) Foreign Bonds–Type II Issued by foreign entity Outside the country where the entity resides Denominated in currency OTHER THAN THAT of the country where issued Example: Toyota issues Yen denominated bonds in USA

11. 11 (of 26) Foreign Bonds–Type II Who are the potential investors for such a bond? Toyota issues Yen denominated bonds in USA Hedger: Your Firm imports from Japan and has Yen A/P Yen bond interest you receive is used to pay Yen A/P on your imports. Like a forward contract Speculator: Speculate that Yen will appreciate (buy more $)

12. 12 (of 26) Global Bonds Similar to Foreign bonds, but Simultaneously issued in many different countries. Denominated in 1 or many currencies. Registered in each market where issued.

13. 13 (of 26) EuroBonds Issued outside the country in bond is denominated (same as second type of foreign bond) OR, issued in same country, but only to non- residents Not Registered, i.e., Bearer Bonds Example: Toyota issues Yen-denominated bonds in offshore market. EUROYEN Bond

14. 14 (of 26) Bond Return of Foreign Currency Bonds RETURN = local currency return + foreign exchange return = YTM + %change in spot exchange rate

15. 15 (of 26) Comparing Yields on US Bonds and Eurodollar Bonds U.S. Bonds pay semiannual coupons Eurobonds pay annual coupons Bond Equivalent Yield (BEY) of Eurobond = 2[(1 + YTM on eurobond) 1/2 - 1] Example: YTM on Eurobond = 10%. BEY = 2[(1.1).5 -1] = 0.09762 = 9.762% Thus, Eurobonds must offer higher yields (all else is equal).

16. 16 (of 26) Summary of Features Affecting Eurobond Yields Yield impactEurobond Feature – Tax Free Interest + Registration and Regulation + Annual Coupons – Quality of Issuer

17. 17 (of 26) Types of Instruments Straight Fixed Rate Debt Floating-Rate Notes Zero Coupon Bonds Equity-Related Bonds Dual-Currency Bonds

18. 18 (of 26) Straight Fixed Rate Debt Plain Vanilla Bonds Typically have annual coupons. Since most Eurobonds are bearer bonds, coupon dates tend to be annual rather than semi-annual, less costly for issuer. The vast majority (71% in 2002) of new international bond offerings are straight fixed- rate issues.

19. 19 (of 26) Floating-Rate Notes Coupon rate reset every 6 or 12 months Eurobonds commonly use LIBOR as reference rates LIBOR = London Interbank Offer Rate Usually pay quarterly or semiannual coupons

20. 20 (of 26) Zero Coupon Bonds No Explicit Interest Paid Issued in one of two ways: At a discount to face value Issued as a zero at a 50% discount to $100 face value in 4 years Yield = 18.9% At face value, but pay a premium at maturity Issue at $100 (Face Value), Pay $200 in 4 years yield = 18.9%

21. 21 (of 26) Equity-Related Bonds Convertibles Allow the holder to convert bond in exchange for a specified number of shares in the firm of the issuer (or for some other specified commodity). Bonds with Equity Warrants 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.

22. 22 (of 26) Dual-Currency Bonds Fixed-rate bond Price and interest in one currency. Principal in another currency. Japanese firms have been big issuers with coupons in yen and principal in dollars. Good option for a MNC financing a foreign subsidiary. Straight Bond + Forward Contract on FV

23. 23 (of 26) Credit Ratings Corporate Debt Fitch IBCA, Moodys and Standard & Poors sell credit rating analysis. Focus on default risk, not exchange rate risk. Sovereign Debt Assessing sovereign debt focuses on political risk and economic risk. Sovereign debt is the obligation of a countrys central government.

24. 24 (of 26) 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