ibus 302 topic 13-international bonds
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IBUS 302: International Finance
Topic 13-International Bonds
Lawrence Schrenk, Instructor.
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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.▪
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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.
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Market Demographics Bond Market Segments: Domestic Bonds,
Foreign Bonds, Eurobond Total market value of the world’s bond
markets are about 50% larger than the world’s equity markets.
Denominations: 1. U.S. $ = 47% (46% of
international) 2. Euro = 18% (23% of international)3. Yen = 19% (4.0% of
international)
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• Domestic Bond Market
• Foreign Bond Market
• Global Bond Market
• EuroBond Market
International
Internal
External / Offshore
Classification
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Domestic Bonds
Issued by domestic entity Denominated in that country’s currency Corporate
IBM issues $ denominated bonds in USA Governments:
Treasury Bonds (USA) Gilts (UK) Bunds (Germany)
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Domestic Bonds: Review Key Variables
Principal, Par Value, Face Value Coupon, Coupon Rate Maturity (t) Discount Rate (r) Periods (per year), (m)
tmtm
mr
ParValue
mr
mr
CouponPV
11
11
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Domestic Bonds: Review Premium versus Discount Bonds Features
Callable Bonds Convertible Bonds Sinking Funds
Debt Covenant Financial Ratios Technical Default
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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.
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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
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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 $)
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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.
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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
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Bond Return of Foreign Currency Bonds RETURN
= local currency return + foreign exchange
return= YTM + %change in spot exchange
rate
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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).
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Summary of Features Affecting Eurobond Yields
Yield impact Eurobond Feature
– Tax Free Interest
+ Registration and Regulation
+ Annual Coupons
– Quality of Issuer
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Types of Instruments Straight Fixed Rate Debt Floating-Rate Notes Zero Coupon Bonds Equity-Related Bonds Dual-Currency Bonds
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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.
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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
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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%
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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.
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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’
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Credit Ratings Corporate Debt
Fitch IBCA, Moody’s and Standard & Poor’s 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 country’s central government.
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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