FNCE 4070Financial Markets andInstitutions

Lecture10The Global Bond Markets

Changing Nature of the Global Bond Market Historically, the U.S. bond market dominated the global

bond market, with the U.S. market representing a key source of financing for U.S. and foreign corporations.

However, since the expansion of the European Union and the advent of the Euro-Zone, Europe’s importance in the global bond market as grown. In 2001, the U.S represented 44% of the world’s bond market; the

European Union represented 28% (the Euro-zone countries: 23%). By 2009, the U.S. share of the global bond market had fallen to

34% and the European Union’s share had grown to 36% (the Euro-zone countries: 30%).

While today the U.S. market is dominated by U.S. firms, an increasing of U.S. company bond financing is taking place in the European bond markets.

Trends in Debt Markets

Institutional Arrangements in Corporate Funding The historical institutional patterns of corporate

borrowing in various countries have influenced the development the a country’s bond markets and equity markets. In Japan and Germany, companies have relied less on

equity markets for funds than their counterparts in the U.S. In both of these counties, banking has been a relatively more important source of funds.

In Europe, the close ties between banks and their corporate clients hindered the development of a European corporate bond market. That changed, however, with the launch of the euro in 1999,

which promoted the development of Europe’s bond market.

Importance of Banking Markets for the U.S., Japan and Germany

Importance of Banking Markets for the U.S. and Europe

Growing Importance of Bond Markets in Europe

Bond Market Growth in Europe: Pre and Post the Euro

Bond Market Growth in Europe Since the Introduction of the Euro

Impact of Larger European Bond Market on Bond Spreads High Yield Spread

equals the difference between the Merrill Lynch European High Yield Corporate Bond Issuers and the 10 year German Government benchmark bond yield.

The Rise of the Foreign Bond Market In contrast to the IPO equity financing, where the majority

of U.S. firms exhibit a strong home bias, in bond financing a growing number of U.S. issuers are relying more on foreign bond markets for funding.

For example: The percent of all U.S. firms issuing bond’s domestically fell from 92% in 1995 to 82% in 2006. Additionally, the share of non-financial U.S. firms issuing bonds domestically declined from 95% to 83% over the same period. Thus, U.S. corporates are increasing their funding presence in

the foreign bond markets. At the same time, the share of European issuers borrowing

in the U.S. bond market dropped from more than 20% in 2000 to approximately 9% in 2006. Thus, European firms are increasing turning to their own markets

In addition to issuing more equity in their home markets for debt financing

U.S. Stock Exchanges Share of IPO Offerings

New Listings on Large Stock Exchanges(% of Total Global Listings)

Note: AIM is the Alternative Investment Market segment of the London Stock Exchange; it was launched in 1995 as a market mainly for smaller companies backed by venture capital.

U.S. Bond Markets Share of Bond Offerings

Classifying the World’s Bond Markets The world’s bond market can be divided into two

broad groups: (1) the domestic bond market and (2) the international bond market. (1) The domestic bond market is comprised of all

securities issued in each country by “domestic” government entities and corporates. In this case, issuers are domiciled (i.e., headquartered) in

the country where those bonds are traded. (2) The international bond market is comprised of

non-residents borrowing in another country’s bond markets The international bond market consists of two groups: (1) Foreign Bonds and (2) Eurobonds.

Foreign Bonds: Characteristics Foreign Bonds are bonds issued by a non-resident and

denominated in the currency of the country in which it is being placed (i.e., issued). Example: Ford Motor Corporation issuing a yen denominated

bond in Japan Foreign bonds are subject to the regulations of the

country in which the bond is being offered. The SEC regulates foreign bond offerings in the U.S.

Historically, the most important foreign bond markets have been in Zurich, New York, and Tokyo. Zurich and Tokyo because of low market interest rates; the U.S.

because of its large market. Foreign bonds are often swapped out for another

currency.

History of the Foreign Bond Market 100 years ago, the international bond markets consisted solely

of foreign bonds, that is, bonds issued, placed, and traded in a bond market which was foreign to the issuer's country of incorporation.

Issuers were typically foreign governments or private sector utilities such as railway companies.

After WW I, the world saw a strong U.S. economy and a strong U.S. dollar. During this period, world capital markets served primarily to channel European savings into the U.S. economy.

Issuance activity elsewhere in the international markets remained small.

This dominance of the U.S. foreign bond market became even stronger after WW II. For years the U.S. foreign bond market was the largest and most important foreign bond market.

In recent years, however, it has been surpassed by the Swiss franc (CHF) foreign bond market.

Unique Names for Foreign Bonds The financial markets

have come up with unusual nicknames for foreign bonds. These include: Yankee bonds

Issued in the United States. Matador bonds

Issued in Spain. Rembrandt bonds

Issued in the Netherlands. Samurai bonds

Issued in Japan.

Bulldog bonds Issued in the United

Kingdom. Kiwi bonds

Issued in New Zealand. Kangaroo bonds

Issued in Australia. Maple bonds

Issued in Canada. Panda bonds

Issued in China. Kangaroo or Matilda

bonds Issued in Australia.

Impact of Exchange Rate Changes on Foreign Bond Returns (For U.S. Investors)

Eurobonds Eurobonds are bonds issued by a non-resident

and denominated in other than the currency of the country in which it is being placed. The bond’s currency of denomination is referred to as an

offshore currency. Example: Coca Cola issuing a U.S. dollar denominated

bond in Europe. They are generally issued and sold simultaneously

in more than one market and thus the advantage of the Eurobond market is that issuers can raise large sums of capital from investors all around the world.

Issuers include national governments, supranational organizations (such as the World Bank),“AAA” corporations and global banks.

The U.S. dollar is the dominant currency of denomination for Eurobonds.

History of the EuroBond Market The first Eurobond (which was also a U.S. dollar

denominated bond) was the July 1963 issue by the Italian Autostrade (Italian National Highway Authority), led by SG Warburg & Co and issued in London. $15 million; 5.5% coupon; 15 year bonds; listed on the London

and Luxembourg stock exchanges. By 1972, the market had grown to $5 billion; $42 billion by

1982 and $371 billion by 1995. In the early 1960s, the Eurobond market was mainly a

Eurodollar bond market. Today, the Eurobond market comprises bonds

denominated in all the major currencies and several minor currencies. For example, in 1996, the Eurobond market included issues

denominated in the Egyptian pound, Polish zloty and Croatian kuna.

EuroBond Market by Currency, Early Years (% of Total Volume)

The Main Features of a Eurobond Eurobonds are not regulated by the country of the currency in

which they are denominated. Eurobonds are “bearer bonds”, i.e., they are not registered

anywhere centrally, so whomever holds (or bears) the bond is considered the owner. Bearer status also enables Eurobonds to be held anonymously.

The Eurobond market is largely a wholesale (i.e., institutional market) with bonds held by large institutions. Pension funds, insurance companies, mutual funds

Since they are denominated in an offshore currency, investors in euro-bonds assume both credit and foreign exchange risks (if the currency if denomination is other than their home currency).

Some publically offered eurobonds trade on stock exchanges, normally in London or Luxembourg. Others are placed directly with institutional investors without a listing (private placement).

Types of Eurobonds Conventional or Straight Eurobonds have a fixed coupon (usually paid on an annual

basis) and maturity date when all the principal is repaid.

Floating rate bond notes (FRN) are usually short to medium term bond issues, with a coupon interest rate that “floats,” i.e. goes up or down in relation to a benchmark rate plus some additional “spread” of basis points (each basis point being one hundredth of one percent). The reference benchmark rate is usually LIBOR (London interbank offered rate) or EURIBOR (Euro interbank offered rate). The “spread” added to that reference rate is a function of the credit quality of the issuer.

Zero-coupon bonds do not have interest payments.

Convertible bonds can be exchanged for another instrument, usually an ordinary share or shares (fixed ahead of time with a predetermined price) of the issuing organization. The coupon payable is usually lower than it otherwise would be. Because convertible bonds can be viewed more as equity shares than bonds, the credit and interest rate risks for investors are higher than with conventional bonds.

High-yield bonds are also part of the Eurobond markets, a class of bonds (rather than a type of bond) which individual investors may encounter. High-yield bonds are those that are rated to be “below investment grade” by credit rating agencies (i.e. issuer has a credit rating below BBB).

Rise of the Euro-Bond Market The Eurobond market offers several advantages

for borrowers that may account for its rising popularity. (1) It gives U.S. borrowers access to a wider range of

lenders and debt instruments, enabling them to diversify their sources of long-term funding.

(2) In addition, the market provides a good environment for internationally active companies to hedge foreign currency exposures (through offsetting liabilities)

(3) finally, through this market companies can enhance their global profile.

Euro-Dollar Bond Offering Announcement Development Bank of Japan Inc. (DBJ; President and Chief

Executive Officer: Minoru Murofushi) launched its Euro-Dollar bond, guaranteed by the government of Japan, on March 8 2011.

Details are as follows: Issue amount : U.S.$ 500 million Maturity : March 15 2016 Coupon : 2.750% Issue price : 99.486% Guarantor : Japan Listing : London Stock Exchange Lead Manager : Barclays Bank PLC, Merrill Lynch

International

Nicknames for Eurobonds

Dragons: U.S. dollar denominated bonds issued in Asia.

Shogun: Foreign currency bonds (including U.S. dollar bonds) issued in Japan

Dim-Sum: Chinese yuan denominated bond issued in Hong Kong.

Domestic Versus International Bond Market by Country; % of GDP, 2009

Relative Growth of Foreign Bonds and Euro Bonds, Early Years

Relative Growth of Foreign Bonds and Euro Bonds, Later Years

Euro-Bond Market Versus U.S. Bond MarketsEurobonds: 1964 - 1969 Eurobonds; 1995 - 2006

Emerging Market Bond TrendsImproving Credit Quality Spreads over U.S. AA Corporates

Foreign Ownership of U.S. Corporate Equities and U.S. Corporate Bonds

Estimated Ownership of U.S. Treasury Securities, June 2008

Estimated Ownership of U.S. Treasury Securities, 1997 - 2008

Foreign Ownership of U.S. Treasuries, December 2008 (Billions of $)

Volatility in the Bond Markets