Amrutha R

Lyman B

INTERNATIONAL BOND MARKET

Mohini K

Deepa

CHAPTER OUTLINE1.2.

3. 4. 5.

6. 7. 8.

INTRODUCTION The Worlds Bond Markets: A Statistical Perspective Foreign Bonds and Eurobonds Types of Instruments Currency Distribution, Nationality, Type of Issuer International Bond Market Credit Ratings Eurobond Market Structure & Practices International Bond Market Indices

INTERNATIONAL BOND MARKET

Domestic Bonds The market for domestic bonds is a part of the international bond market. Domestic bonds are brought out on a local basis and domestic borrowers are responsible for issuing the local bonds. Domestic bonds are normally designated in the local currency.

Eurobonds Eurobonds differ from the others in that they are not sold in any particular national bond market. Eurobonds are issued by a group of multinational banks. If a Eurobond is designated in any currency, it would be sold outside the country which uses that currency. For example if a Eurobond is denominated in the United States dollar, it would not be sold in the United States.

FOREIGN BONDS

The foreign bond market is that in which bonds are bought out by foreign borrowers. The foreign bonds are normally designated in the local currency. The local market authorities look after the issuing and selling of foreign bonds.The foreign bonds are traded in the foreign bond markets which constituted significant portion of the international bond market until a few decades ago. Some defining characteristics of the foreign bond markets are: Issuers are normally governments and private sector utilities such as the railway companies 1. It was standard practice to underwrite as well as organize underwriting risk 2. Issues were pledged by the retail investors and the institutional investors 3. The structure of a foreign bond at that time is similar to the present day foreign bonds 4. Continental private banks and old merchant houses in London connected the investors and the issuers

THE WORLDS BOND MARKETS A STATISTICAL PERSPECTIVE

1. The total market value of the worlds bond markets are about 50% larger than the worlds equity markets. 2. The U.S. dollar, the euro, the pound sterling, and the yen are the four currencies in which the majority of domestic and international bonds are denominated. 3. Proportionately more domestic bonds than international bonds are denominated in the dollar (44.2 percent versus 36.1 percent) and the yen (15.4 percent versus 2.6 percent) while more international bonds than domestic bonds are denominated in the euro (47.5 percent versus 21.5 percent) and the pound sterling (8.3 percent versus 2.5 percent).

AMOUNTS OF DOMESTIC AND INTERNATIONAL BONDS OUTSTANDING

Currency Domestic Percent

International Percent Total

Percent

U.S. $Euro Pound Yen Other Total

18,596.109,032.50 1,033.70 6,478.20 6,968.20 42,108.70

44.2%21.5% 2.5% 15.4% 16.5% 100%

7,129.209,395.80 1,635.20 504.8 1,099.00 19,764.00

36.1%47.5% 8.3% 2.6% 5.6% 100%

25,725.30 41.6%18,428.30 29.8% 2,668.90 4.3%

6,983.00 11.3% 8,067.20 61,872.70 13% 100%

FOREIGN BONDS AND EUROBONDS

1. Bearer Bonds and Registered Bonds 2. National Security Registrations 3. Withholding Taxes 4. Recent Regulatory Changes 5. Global Bonds

BEARER BONDS AND REGISTERED BONDS

1. Bearer Bonds are bonds with no registered owner. As such they offer anonymity but they also offer the same risk of loss as currency. 2. Registered Bonds: the owners name is registered with the issuer. 3. U.S. security laws require Yankee bonds sold to U.S. citizens to be registered.

NATIONAL SECURITY REGISTRATIONS

1. Yankee bonds must meet the requirements of the SEC, just like U.S. domestic bonds. 2. Many borrowers find this level of regulation burdensome and prefer to raise U.S. dollars in the Eurobond market. 3. Eurobonds sold in the primary market in the United States may not be sold to U.S. citizens. 4. Of course, a U.S. citizen could buy a Eurobond on the secondary market.

WITHHOLDING TAXES

1. 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. 2. The repeal of this tax led to a substantial shift in the relative yields on U.S. government and Eurodollar bonds.

SECURITY REGULATIONS THAT EASE BOND ISSUANCE

1. Shelf Registration (SEC Rule 415)Allows the issuer to preregister a securities issue, and then offer the securities when the financing is actually needed. 2. 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.

GLOBAL BONDS 1. A global bond is a very large international bond offering by a single borrower that is simultaneously sold in North America, Europe and Asia. -Global bond issues were first offered in 1989. Special Features :

1.2. 3. 4.

They carry high rating.They are normally large in size. They are offered for simultaneous placement in different countries. They are traded on home market basis in different region.

Deutsche Telekom Global Bond The largest corporate global bond issue to date is the $14.6 billion Deutsche Telekom multicurrency offering.

TYPES OF INSTRUMENTS

1. Straight Fixed Rate Debt 2. Floating-Rate Notes 3. Equity-Related Bonds -Convertible Bonds -Bonds with equity warrants. 4. Zero Coupon Bonds 5. Dual-Currency Bonds 6. Composite Currency Bonds

STRAIGHT FIXED RATE DEBT

1. These are plain vanilla bonds with a specified coupon rate and maturity and no options attached. 2. Since most Eurobonds are bearer bonds, coupon rates tend to be annual rather than semi-annual. 3. The vast majority of new international bond offerings are straight fixed-rate issues.

FLOATING-RATE NOTES

1. Just like an adjustable rate mortgage. 2. Common reference rates are 3-month and 6-month U.S. dollar LIBOR 3. Since FRN reset every 6 or 12 months, the premium or discount is usually quite smallas long as there is no change in the default risk

EQUITY RELATEDCONVERTIBLE BONDS

1. A convertible bond issue allows the investor to exchange the bond for a predetermined number of equity shares of the issuer.2. The floor-value of a convertible bond is its straight fixed-rate bond value. 3. Convertibles usually sell at a premium above the larger of their straight debt value and their conversion value. 4. Investors are usually willing to accept a lower coupon rate of interest than the comparable straight fixed coupon bond rate because they find the conversion feature attractive.

BONDS WITH EQUITY WARRANTS

1. These 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. They can be viewed as straight fixed-rate bonds with the addition of a call option (or warrant) feature. The warrant entitles the bondholder to purchase a certain number of equity shares of the issuer at a pre stated cash price over a predetermined period of time. 2. With a convertible bond, you surrender the bond to get the shares. Here you pay cash and keep the bond.

ZERO COUPON BONDS

1.2.

3.

Zeros 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:

PAR PV = (1 + r)T

DUAL-CURRENCY BONDS

1. A straight fixed-rate bond, with interest paid in one currency, and principal in another currency. 2. Japanese firms have been big issuers with coupons in yen and principal in dollars. 3. Good option for a MNC financing a foreign subsidiary. 0 1 3 4 N1 $ N

COMPOSITE CURRENCY BONDS

1. Denominated in a currency basket, like the SDRs or ECUs instead of a single currency. 2. Often called currency cocktail bonds. 3. Typically straight fixed rate debt.

CHARACTERISTICS OF INTERNATIONAL BOND MARKET INSTRUMENTS

Instrument

Frequency of PaymentAnnual Every 3 or 6 months Annual

Size of CouponFixed Variable Fixed

Payoff at MaturityCurrency of issue Currency of issue Currency of issue or conversion to equity shares. Currency of issue plus conversion to equity shares. Currency of issue Dual currency

Straight Fixed-Rate Floating Rate Note Convertible Bond

Straight fixed rate with equity warrants Zero Dual Currency Bond

Annual

Fixed

none Annual

zero Fixed

CURRENCY DISTRIBUTION OF INTERNATIONAL BOND AMOUNTS OUTSTANDING

Currency Euro U.S. $ Pound Yen Swiss franc Canadian dollar Other Total

2003 4,834.50 4,492.50 778.7 488.6 195.6 79.3 233.3 11,102.50

2004 6,216.00 4,906.30 981.8 530.5 227.9 112.6 306.7 13,281.80

2005 6,317.80 5,380.50 1,063.70 472.2 208.8 146.7 394.3 13,984.00

2006 8,310.10 6,400.60 1,450.00 487.3 253.8 178 649.3 17,569.10

2007 9,395.80 7,129.20 1,635.20 504.8 273.5 232.6 592.9 19,764.00

DISTRIBUTION OF INTERNATIONAL BOND OFFERINGS 2003Australia Canada France Germany 162 267.2 700.8 1,810.30

2004225.5 294.8 888.5 2,110.20

2005259.3 311 937.8 2,071.80

2006352 346.7 1,197.20 2,463.80

2007405 401.1 1,309.20 2,612.80

ItalyJapan Netherlands U.S.

510.5255.2 532.8 1,032.10

716.4280.7 652.8 1,267.90

705.1261.2 680.7 1,426.30

903.4304.1 870.4 1,881.30

996.6316.3 961.4 2,117.00

U.K.Other Developed Countries Off-shore Centers Developing Countries International Institutions Total (in U.S. $Billions)

3,011.801,559.00 128.9 630.8 501 11,102.50

3,262.702,090.70 151.4 790.9 549.3 13,281.80

3,446.302,320.90 173.3 855.6 534.7 13,984.00

4,297.303,191.70 195.7 989.8 575.7 17,569.10

4,947.103,774.20 213 1,109.50 600.8 19,764.00

DISTRIBUTION OF INTERNATIONAL BOND OFFERINGS BY TYPE OF ISSUER

2003Financial institutions Governments International Corporate issuers Total (in U.S. Billions) 8,032.50 1,122.30 501.1 1,446.60

2004

2005

2006

2007

9,756.70 10,509.00 13,537.50 15,404.50 1,413.80 549.3 1,562.10 1,431.90 534.7 1,508.50 1,621.90 575.8 1,834.00 1,739.90 600.8 2,019.00

11,102.50 13,281.80 13,984.00 17,569.10 19,764.00

INTERNATIONAL BOND MARKET CREDIT RATINGS

Fitch IBCA, Moodys and Standard & Poors sell credit rating analysis. Focus on default risk, not exchange rate risk.

EURO BOND MARKET

1. 2.3. 4.

Major source of borrowing in the Eurocurrency market. These are bonds sold in international markets by international borrowers, who are a group of international banks called Syndicate. Unsecured bonds hence issued by Governments. Merchant bankers assist and each issue is underwritten by a group of underwriters and then sold.Euro bond market is an offshore operation not subjected to domestic regulations. Not subjected to costly & time consuming registrations. Issued in bearer form ultimate owners country need not be recorded. Offers investors exemption from tax-withholding provisions applicable to other bonds.

Features :1. 2. 3. 4.

EUROBOND MARKET STRUCTURE

1.

Primary MarketVery similar to U.S. underwriting. OTC market centered in London. -Comprised of market makers as well as brokers. -Market makers and brokers are members of the International Capital Market Association (ICMA), a self-regulatory body based in Zurich. Clearing Procedures Euroclear and Cedel handle most Eurobond trades.

2.

EUROBOND PRACTICES: SECONDARY MARKET

1. The secondary market comprises market makers and brokers connected by an array of telecommunications equipment. 2. Market makers stand ready to buy or sell for their own account by quoting two-way bid and ask prices. 3. Market makers trade directly with one another, through a broker, or with retail customers.-The bid-ask spread represent market makers only profit; no other commission is charged.

DIFFERENCES BETWEEN FOREIGN BOND & EUROBOND

Foreign Bond1) The issuer selects a foreign financial market and the bonds are issued in the currency of that country. Underwritten by underwriters of that country where it is issued. Its determined keeping the investors of that country only. They are regulated by the rules governing the country where its issued. 1)

Euro BondEuro bonds are denominated in US Dollar the bonds will be issued in any country other than USA. Underwritten by underwriters of multinational companies. Issued keeping multinational investors in mind. Euro bonds are not subjected to any rules & regulations of that country where they are issued. They do not affect the BOP of that country.

2) 3) 4)

2)3) 4)

INTERNATIONAL BOND MARKET INDICES

1. There are several international bond market indices used to look at the performance of the market overtime. 2. Widely referenced and often used as a benchmark for bull & bear bonds. 3. They yield high returns, maturity & convexity aggregated by individual bonds. 4. Broader and more rule based. 5. Weighted by Market Capitalization.