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“International Finance and Payments”
Lecture IX
“International Bond Market”
Lect. Cristian PĂUNLect. Cristian PĂUN
Email: Email: [email protected]
URL: http://www.finint.ase.roURL: http://www.finint.ase.ro
Academy of Economic Studies
Faculty of International Business and Economics
General Situation
CountriesWeight
Developed Countries 96,1 %
Asia 2,3 %
South America 0,8%
Eastern Europe + Africa 0,7%
International Bond Market
Types of Bonds
BondsWeight
T Bonds Peste 50 %
Corporate Bonds 30 %
Foreign Bonds 10 %
Euro Bonds 20 %
Situation by Issuing Institutions
International Bond Market
Issuing Institution Weight
Government Over 50 %
- Public Companies 30 %
Banks 10 %
Private Companies 20 %
International Institutions 12,4 %
Value Lead Manager Maturity Coupon
225 bil USD Merill Lynch 1999 9,75 %
52 000 bil ¥ Nomura Securities 1999 5,20 %
30.000 bil ¥ Nomura Securities 2001 5,05 %
600 mil DM Credit Suisse 2002 7,75 %
Romanian Experience on International Bond Market
International Bond Market
Bonds 1985 1987 1988 2000 2002
Fixed Rate Notes 53 % 63 % 70 % 71,2% 71,3%
Floating Rate Notes 41 % 11 % 10 % 25,1% 25,1%
Convertible Bonds 4 % 9 % 3 % 3,5% 3,4%
Bonds with warrant 2 % 17 % 17 % 0,1% 0,1%
LowerHigherCost
LowerHigherRisk
LowerHigherMaturity
LowerHigherVolum
Foreign currencyLocal currencyDenomination
AnywhereAnywhereInvestors
AnywhereAnywhereIssuers
Euro-BondsForeign BondsDifferences
LowerHigherCost
LowerHigherRisk
LowerHigherMaturity
LowerHigherVolum
Foreign currencyLocal currencyDenomination
AnywhereAnywhereInvestors
AnywhereAnywhereIssuers
Euro-BondsForeign BondsDifferences
Bond Issuing Mechanism - IPO
Beneficiary
Underwritting Group
Co - managers
Lead Manager BankCoordination
and/or guarantee group
Selling group
Private Investors
Step VI
Step III
Step II
Step I
Private Investors
Step VI
Step IV
Tombstone
IPO description: Step 1: Contacting a lead manager bank and this bank will create the
coordinating group (if the amount is too important) Step 2: Creating the Underwriting group that will sign up for 70% from
the total bond’s quantity with the condition of including the unsold bonds in their own portfolio;
Step 3: Creating the Selling group that will try to sell in advance the remaining 30% from the total bonds;
Step 4: Selling the bonds to private investors Step 5: Listing the bonds on capital markets, starting the secondary
market, closing operation (tombstone)
If the private investors will be not interested for IPO of bonds:- Redesigning the bonds conditions (issuing price, call price)- Road Show (promoting the IPO at the level of private investors)- Guarantee for IPO granted by lead bank (the unsubscribed bonds will
be included in its own portfolio)
Bond Definition
- Bond = a security that is issued in connection with a specific borrowing arrangement
-Bond indenture = the contract between the issuer and the borrower
- Main elements of the contract:
- Face value
- Coupon rate
- Issuing price
- Bond premium
- Bond classification:
- T-Bonds
- Municipal Bonds
- Corporate Bonds
Types of Corporate Bonds
1. Call Provisions on Corporate Bonds:
- allows the issuer to repurchase the bond at a specific call price before the maturity
- The call price is above par value according with maturity (it falls as time passes);
- Usually offers a higher coupons rates then noncallable bonds.
2. Convertible Bonds:
- Give to the bondholders an option to exchange each bond for a specified number of shares of common stock of the firm;
- The Conversion Rate = Number of Bonds / Number of Stock
- The Conversion Premium = Bond Par Value x Number of Bonds – Current Stock Price x Number of Stock
Types of Corporate Bonds
3. Puttable Bonds:
- Allows the bond holder to extend or to sell bond at a specific date (call date)
- The holder is interest to extend the bond life when the bond current yield exceeds current market yields;
- When the coupon rate is too low the holder will reduce the holding period
4. Floating Rate Note:
- Make interest payments that are tied to some measure of current market rate (T-Bill rate adjusted with 4%)
- Major risk: changes in the company’s financial strength (if the financial situation will be worse the price of the bond would fall because the investor’s will require a greater yield premium than the security can offer).
Innovation in the Bond Market
• Reverse Floater Bonds: the coupon rate falls when the general interest rates
rises (the benefit of the investors is double when the rates falls – higher price
and higher interest rate);
• Asset - Backed Bonds: - issuing a bond with a coupon rate connected to the
financial performance of several firms from the same group (example: Walt
Disney, David Bowie)
• Catastrophe Bonds: - issuing a bond with a final payment that depended on
whether there a catastrophe will be produced (example: Electrolux and a
possible earthquake in Japan).
• Indexed Bonds: - make payments that are tied to a general price index or a
particular commodity price (example: Mexico issued a bond tied to the price of
oil).
Indexed Bonds: Example
Par Value 15 USD
Number 100 Bonds
Coupon 5%
Time Inflation Par Value Coupon Repayments Annuity
0 0 1500 0 0 0
1 2% 1530 76.50 0 76.50
2 3% 1575.9 78.80 0 78.80
3 1% 1591.659 79.58 1591.659 1671.24
Nominal Return=(Interest+Price Appreciation)/Initial Price
Real Return=(1+Nominal Return)/(1+Inflation)
Time Nominal Real
0 - -
1 7.10% 5.00%
2 8.15% 5.00%
3 6.05% 5.00%
Bond Value and Bond Price
Tt i)(1
ValuePar
i)(1
CouponValue Bond
Par Value 100 USDCoupon 9% paid annualy
Time 6% 7% 9% 11% 12%1 year 102.8302 101.869159 100 98.1982 97.32143
10 years 122.0803 114.047163 100 88.22154 83.0493320 years 134.4098 121.188028 100 84.07334 77.5916730 years 141.2945 124.818082 100 82.61241 75.83445
Interest Rate
00 i1
ΔiDUR
p
Δp
Bond Yields – Yield to Maturity
30
1t
130t )k1(
$100
)k1(
$9$08.22
Selling price 122.08 USDCoupon 10%Par value 100 USDMaturity 10 years
Bond Yields – Current Yield
YTM = 6 %
122.08$
9$
Price Selling
InterestYieldCurrent
Bond Yields – Yield to Call
Selling price 122.08 USDCoupon 10%Par value 100 USDMaturity 10 yearsCall Price 110 USD
30
1t
130t )k1(
$110
)k1(
$9$08.22 YTM = 6.23 %
Determinants of Bond Safety
1. Coverage Ratios: ratios of company to fixed costs
• Times – interest – earned ratio (EBIT/Interest Obligations)
• Fixed Charge Coverage Ratio (EBIT/(Interest+Lease)
2. Leverage Ratio (Debt-to-Equity Ratio)
3. Liquidity Ratios:
• Current Ratios = Current Assets / Current Liabilities
• Quick Ratios = (Current Assets – Inventories) / Current Liabilities
4. Profitability Ratios
• ROA = EBIT / Total Asset
5. Cash Flow to Debt Ratio (Cash Flow to Outstanding Debt)
Financial Ratios by Rating Classes
US Industrial Long Term Debt AAA AA A BBB BB B
EBIT interest coverage ratio 17.5 10.8 6.8 3.9 2.3 1.0
EBITDA interest coverage ratio 21.8 14.6 9.6 6.1 3.8 2.0
Funds Flow / Total Debt 105.8 55.8 46.1 30.5 19.2 9.4
Free operating cash flow / Total Debt 55.4 24.6 15.6 6.6 1.9 -4.6
Return on capital 28.2 22.9 19.9 14.0 11.7 7.2
Operating Income / Sales 29.2 21.3 18.3 15.3 15.4 11.2
Long Term Debt / Capital 15.2 26.4 32.5 41.0 55.8 70.7
Total Debt / Capital 26.9 35.6 40.1 47.4 61.3 74.6
Source: Bodie, Kane, Marcus “Investment”, page 437, McGraw-Hill Irwin, 2003