The International Bond Market

Ravi Agarwal

Types of Bond Markets

Corporate

Government and agency

Mortgage backed, asset backed, CDO.

Funding

Municipal

Participants

Institutional Investors

Governments

Traders

Individuals

Types of Bonds

Foreign BondsForeign Bonds

Global BondsGlobal Bonds

EurobondsEurobonds

Foreign Bonds

Issued in a country's national bond market by an issuer not domiciled in that country where those bonds are subsequently traded and they are denominated in the domestic currency.

There is no direct exchange rate exposure.

Types of Foreign Bonds

Yankee bond in the US

Samurai bond in Japan

Bulldog bond in the UK

Rembrandt Bond in Spain

What lead to Global Bond / Eurobond ?

Introduction of Interest Equalization Tax.

Restricted financing of FDI by US

corporations

The Glass-Steagall Act prevented US

commercial banks from issuing and dealing

in bonds.

Global Bonds

Sold simultaneously on several markets in Sold simultaneously on several markets in the currency of each marketthe currency of each market

First offered by the World Bank, Ontario-First offered by the World Bank, Ontario-Hydro, and Hydro-Quebec.Hydro, and Hydro-Quebec.

Eurobonds (part of Global Bond)

A Eurobond is a bond issued and traded in a A Eurobond is a bond issued and traded in a country other than the one in which its country other than the one in which its currency is denominated. A Eurobond does currency is denominated. A Eurobond does not necessarily have to originate or end up in not necessarily have to originate or end up in Europe although most debt instruments of Europe although most debt instruments of this type are issued by non-European entities this type are issued by non-European entities to European investors.to European investors.

Features

Underwritten by international syndicate of banks.

Issued by MNEs, large domestic corporations,

government and international institution.

Offered simultaneously in different capital markets.

Examples of Eurobond

Wal-Mart issues bonds denominated in U.S. dollars on the German financial markets.

The French government issues euro-denominated bonds on the Japanese financial markets.

Why attractive ?

Absence of regulatory interference

Less stringent disclosure

Favorable Tax status

Eurobonds are rated by Moody’s , S&P just

as its done in US markets

Market Composition

Issuer Lead and Co-Manager Underwriter Sellers Trustees Paying Agents

Types of Instruments

Straight Fixed-Rate Issues (66%)

Structured Notes and Floating-Rate Notes (32%)

Equity Related Issues (2%)

Different options

INSTRUMENT INTERESTFREQUENCY

COUPON TYPE CURRENCY PAYOFF

Straight fixed-rate annual Fixed Currency of issue

Floating rate note annual orquarterly

Variable Currency of issue

Convertible bond annual Fixed Currency of issue orconvertible

Straight fixed-rate withequity warrants

annual Fixed Currency of issue plusshares

Zero-coupon bond none Zero Currency of issue

Dual-currency bond annual Fixed Dual Currency

Composite currencybond

annual Fixed Composite currency

Selecting the Currency

Coca-Cola wishes to Coca-Cola wishes to raise $1 b. The raise $1 b. The company can issue company can issue dollars or pounds dollars or pounds denominated bonds. denominated bonds.

Dollars (billions) Pounds (billions)

Initial amount raised 1 1/S($)

Principal payment [1+r($)]n [1+r(pounds)]n /S

Coca-Cola will float the pound bond only if:Coca-Cola will float the pound bond only if:

[1+r($)][1+r($)]n n > E[S] [1+r(pounds)]> E[S] [1+r(pounds)]nn /S /S

Writing E[S] = S(1+d)Writing E[S] = S(1+d) n n, where d is the expected annual rate of , where d is the expected annual rate of change in the exchange rate, Coca-Cola will float the pound change in the exchange rate, Coca-Cola will float the pound bond only if:bond only if:

r($) > r (pounds) + dr($) > r (pounds) + d

The Gray Market

It is a forward market for overpriced It is a forward market for overpriced EurobondsEurobonds

Once the issue has been announced the seller Once the issue has been announced the seller might decide to re-sell the bonds  immediately might decide to re-sell the bonds  immediately for forward delivery at 98-99% of par. This is an for forward delivery at 98-99% of par. This is an attempt to disguise the fact that the issue is attempt to disguise the fact that the issue is

overpriced.overpriced.

Exemplification

Issuer Weyerhauser (1983) Osaka Gas (1993)

Amount $60 m $250 m

Maturity 7 years 5 years

Coupon 11.5% 5.75%

Issue price $100 $101.489

Listing LuxSE London

Total commission 1.875% 1.875%

Lead Manager Morgan Stanley Goldman Sachs

Gray market price -1.5 to -1.25% + 0.25%

Date Oct. 19,1984 October 1984

Type of security Issues $1.8 b Euro-discount bonds Buys $1.8 b of US T- bonds

Maturity November 15, 2004 November 15, 2004

yield 11.65% 11.825%

Net proceeds +$ 198.6 m -$181 m

Onshore-Offshore Arbitrage: EXXON Capital Corporation, a Onshore-Offshore Arbitrage: EXXON Capital Corporation, a subsidiary of EXXON Corporationsubsidiary of EXXON Corporation

Up-front arbitrage profit: $17.6 mUp-front arbitrage profit: $17.6 m

Pfandbriefe Market

German mortgage-bond market– largest asset in European bond market and 6th

largest in world– bonds issued by mortgage banks in Germany

highly regulated bonds backed by mortgage pools so covered – no

single case of insolvency in this market

– public Pfandbriefe – loans to public sector entities– mortgage Pfandbriefe – residential and

commercial mortgages

Brady Bonds for emerging market

Bonds that represent a restructuring of nonperforming bank loans of governments into marketable securities.

Brady bonds are made more attractive than the original debt as they carry an array of guarantees These bonds are then offered through international commercial banks.

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