Chapter 7 International Bond Markets Management 3460 Institutions and Practices in International Finance Fall 2003 Greg Flanagan
Dec 28, 2015
Chapter 7 International Bond Markets
Management 3460 Institutions and Practices in
International Finance
Fall 2003Greg Flanagan
November 4, 2003 2
Chapter Objectives The student will be able to:
explain the difference between domestic, foreign, and Euro bonds.
use present value in determining a bond’s price.
describe the world’s bond markets and explain their relative importance in international finance.
be aware of the currency distribution, nationality, type of Issuer.
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Chapter Objectives The student will be able to:
explain the factors that affect the price and sales of different bonds.
list and describe the different types of bond instruments.
be aware of International bond market credit ratings
explain the Eurobond market structure & practices.
describe the J.P Morgan Domestic and other International Bond Market Indices
November 4, 2003 4
BondsDomestic bond—issued in the country by a
domestic firm, government, or institution, in local currency.
Foreign bond—issued in a country in local currency by a foreign agent (borrower).
Eurobond—issued in a particular currency and sold in countries other than the denominated currency.
International bonds—foreign and Euro bonds.Consul—perpetual bond a P = A/r
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Present Value (basic) PV is what one would be willing to pay today for
the right to receive a certain value in the future.
Example: T-bills auctions determine the bank rate.
with annual interest rate r (assumed constant); time period T in years; and future payout R (no inflation)
PV = R Note: r PV and T PV a
(1+r)T
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Present Value (general) r the interest rate can vary. The future payment may be a stream of
annual payments with interest rate ri; time period T ; and future
payouts Ri (no inflation)
PV = R0 + R1 + R2 … + RT a
(1+r1)1 (1+r2)2 (1+rT)T
PV = Ri / (1+ri)i
i
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Present Value (inflation) The PV decreases because the interest rate r
includes inflation r + .
The PV increases with inflation in terms of future nominal payment
PV = R0 + (1+) R1 + (1+) R2 … + (1+) RT a
(1+)(1+r1)1 (1+) (1+r2)2 (1+) (1+rT)T
PV = R0 + (1+) R1 + (1+) R2 … + (1+) RT a
(1+)(1+r1)1 (1+) (1+r2)2 (1+) (1+rT)T
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Present Value (inflation)
The PV is the same in nominal and real if calculated consistently.
PV = R0 + R1 + R2 … + RT a
(1+r1)1 (1+r2)2 (1+r)T
Use either Real or Nominal for both
but do not mix.
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The World’s Bond Market The total market value of the world’s bond
markets are about 50% larger than the world’s equity markets.
Most issues are denominated in U.S. dollars (50%), Japanese Yen are second, followed by the Euro, and British pound sterling.
~82 percent of outstanding bonds are domestic.
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Currency Domestic Percent InternationalPercent Total Weighted %US $ 15,377 50.4% 3,466 50.7% 18,843 50.5%Euro € 5,226 17.1% 2,170 31.7% 7,396 20.4%Pound £ 921 3.0% 505 7.4% 1,426 4.0%Yen ¥ 5,847 19.2% 409 6.0% 6,256 16.2%other 3,118 10.2% 289 4.2% 3,407 8.9%Total 30,489 100.0% 6,839 100% 37,328 100%
Domestic and International Bonds Outstanding As of Year-End 2001 in US $Billions
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Domestic and International Bonds Outstanding As of Year-End 2001 in U.S. $Billions
$-
$5,000.0
$10,000.0
$15,000.0
$20,000.0
$25,000.0
$30,000.0
$35,000.0
$40,000.0
Domestic
International
Total
November 4, 2003 12
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
U.S.dollar
Euro Pound Yen Other
Domestic
International
Total
Domestic and International Bonds Outstanding As of Year-End 2001 in U.S. $Billions
November 4, 2003 13
International BondsNationality 2001 US$B PercentAustrailia 99.8 1.5%Canada 208.3 3.0%France 366.7 5.4%Germany 889.4 13.0%Italy 259.3 3.8%Japan 245.6 3.6%Netherlands 293.9 4.3%United Kingdom 571.5 8.4%United States 2,170.3 31.7%Other developed 788.2 11.5%Off-shore 87.0 1.3%Developing 481.3 7.0%Int Institutions 377.1 5.5%Total 6,838.4 100.0%
Distribution of International Bond Offerings by Nationality
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2001 US$B
France
Germany
Italy
Japan
Netherlands
United KingdomUnited States
Other developed
Off-shore
Developing
Int Institutions
AustrailiaCanada
November 4, 2003 15
Type 1997 1998 1999 2000 2001 2001%Financial Institutions 1,475.1 1,885.8 2,397.2 3,470.1 4,030.3 58.9%Governments 710.3 863.4 1,032.1 1,173.3 1,416.5 20.7%International Institutions 299.5 370.8 375.2 374.1 377.7 5.5%Corporations 837.9 983.4 1,301.0 861.8 1,014.6 14.8%Total 3,322.8 4,103.4 5,105.5 5,879.3 6,839.1 100.0%
International Bonds by Type of Issuer
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International Bonds by Type of Issuer
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
1997 1998 1999 2000 2001
Year
US
$ (B
illl
ion
s)
Financial InstitutionsGovernmentsInternational InstitutionsCorporationsTotal
November 4, 2003 17
International Bonds by Type of Issuer 2001 US$ (Billions)
Financial Institutions
International Institutions
Corporations
Governments
November 4, 2003 18
Bearer Bonds and Registered Bonds
Bearer Bonds are bonds with no registered owner. As such they offer anonymity but they also offer the same risk of loss as currency.
Registered Bonds: the owners name is registered with the issuer.
U.S. security laws require Yankee bonds sold to U.S. citizens to be registered.
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National Security Registrations
Yankee bonds must meet the requirements of the SEC, just like U.S. domestic bonds.
Many borrowers find this level of regulation burdensome and prefer to raise U.S. dollars in the Euro bond market.
Eurobonds sold in the primary market in the United States may not be sold to U.S. citizens.
U.S. citizen can buy Euro bonds on the secondary market.
November 4, 2003 20
U.S. Withholding Taxes Prior to 1984, the United States required a 30
percent withholding tax on interest paid to nonresidents who held U.S. government or U.S. corporate bonds.
The repeal of this tax led to a substantial shift in the relative yields on U.S. government and Eurodollar bonds.
market participants react to tax code changes.
November 4, 2003 21
Recent US Regulatory Changes Shelf Registration (SEC Rule 415)
Allows the issuer to preregister a securities issue, and then offer the securities when the financing is actually needed.
SEC Rule 144A Allows qualified institutional investors to
trade private placements.These issues do not have to meet the strict
information disclosure requirements of publicly traded issues.
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Global BondsA global bond is a very large international
bond offering by a single borrower that is simultaneously sold in North America, Europe and Asia.
Mostly institutional investors are the purchasers so far.
United States SEC Rule 415 and 144A have likely facilitated global bond offerings, and more can be expected in the future.
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Types of InstrumentsStraight Fixed Rate Debt
Floating-Rate Notes
Equity-Related Bonds
Zero Coupon Bonds
Dual-Currency Bonds
Composite Currency Bonds
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Straight Fixed Rate DebtThese are “plain vanilla” bonds with a
specified coupon rate and maturity and no options attached.
Since most Eurobonds are bearer bonds, coupon dates tend to be annual rather than semi-annual.
The vast majority of new international bond offerings are straight fixed-rate issues.
November 4, 2003 25
Floating-Rate NotesJust like an adjustable rate mortgage.Common reference rates are 3-month
and 6-month U.S. $ LIBORSince FRN reset every 6 or 12
months, the premium or discount is usually quite small…as long as there is no change in the default risk.
November 4, 2003 26
Equity-Related BondsConvertibles
Convertible bonds allow the holder to surrender his bond in exchange for a specified number of shares in the firm of the issuer.
Bonds with equity warrantsThese bonds 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.
November 4, 2003 27
Zero Coupon BondsZeros are sold at a large discount from face
value because there is no cash flow until maturity.
In the U.S., investors in zeros owe taxes on the “imputed income” represented by the increase in present value each year, while in Japan, the gain is a tax-free capital gain.
Pricing is very straightforward:Tr
parvaluePV
)1(
November 4, 2003 28
Dual-Currency BondsA straight fixed-rate bond, with
interest paid in one currency, and
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.
November 4, 2003 29
Composite Currency BondsDenominated in a currency basket,
like the SDRs or ECUs instead of a single currency.
Often called currency cocktail bonds.
Typically straight fixed rate debt.
November 4, 2003 30
Instrument
Straight Fixed-Rate
Floating Rate Note
Convertible Bond Annual Fixed Currency of issue or conversion to equity shares.
Straight fixed rate with equity warrants
Annual Fixed Currency of issue plus conversion to equity shares.
Zero none zero Currency of issue
Dual Currency Bond
Annual Fixed Dual currency
Frequency of Payment
Annual
Size of Coupon
Payoff at Maturity
Characteristics of International Bond Market Instruments
Currency of issueFixed
Every 3 or 6 months Variable Currency of issue
November 4, 2003 31
Brady Bonds Convert ‘bad’ loans to marketable bonds
at 65% of face value with reduced interest rate
Extend maturities to 25-30 years Buy collateral zero coupon US treasury
bonds with $100 million converted covering 92% of
private
November 4, 2003 32
International Bond Market Credit Ratings
Fitch IBCA, Moody’s and Standard & Poor’s sell credit rating analysis.
Focus on default risk, not exchange rate risk.
Assessing sovereign debt focuses on political risk and economic risk.
See: Exhibit 7.7
November 4, 2003 33
Eurobond Market Structure Primary Market
Very similar to U.S. underwriting. Secondary Market
OTC market centered in London.• Comprised of market makers as well as brokers.• Market makers and brokers are members of the
International Securities Market Association (ISMA).
Clearing ProceduresEuroclear and Cedel handle most Eurobond
trades.
November 4, 2003 34
International Bond Market Indices
J.P. Morgan and CompanyDomestic Bond Indices International Government bond index
for 18 countries.Widely referenced and often used as
a benchmark.Appears daily in The Wall Street
Journal