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The International Bond Market

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Outline Types of bondsTypes of bonds Comparative bond characteristicsComparative bond characteristics The Gray MarketThe Gray Market Onshore-Offshore arbitrageOnshore-Offshore arbitrage

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Classification Foreign BondsForeign Bonds Global bondsGlobal bonds EurobondsEurobonds

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Foreign Bonds Issued by a foreign entity and denominated in domestic currency

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Foreign Bonds: Examples Samurai bondsSamurai bonds Bulldog bondsBulldog bonds Rembrandt bondsRembrandt bonds Yankee bondsYankee bonds

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Global bonds Sold simultaneously on several markets in the currency of each market

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

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Eurobonds Issued by a foreign entity and sold in a foreign currency, other than the currency of the country in which the issuer is located.

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Eurobonds: Exemplification A bond issued by Rhone-Poulenc and sold in the US in Swiss francs.

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Eurobonds

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Selecting the currency of issue Foreign exchange risk affects coupon and principal payments It is preferable to make those payments in a currency that is weakening.

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Selecting the currency of issue: Exemplification Coca-Cola wishes to raise $1 b. The company can issue dollars or pounds denominated bonds. For simplicity, assume all payments are made at maturity.

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Selecting the currency of issue: Exemplification Coca-Cola will float the pound bond only if: [1+r($)] n > E[S] [1+r(pounds)] n /S [1+r($)] n > E[S] [1+r(pounds)] n /S Writing E[S] = S(1+d) n, where d is the expected annual rate of change in the exchange rate, Coca-Cola will float the pound bond only if: r($) > r(pounds ) + d

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Selecting the currency of issue: Exemplification The pound is expected to appreciate by an average of 1.2% per year; hence, at maturity, Coca-Cola will have to make payments in a more expensive pound.

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Comparative characteristics of bonds issues Comparative characteristics of bonds issues

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Eurobond underwriting In general, similar to regular bond underwriting Differences: Lead manager separate from selling groupLead manager separate from selling group Variable price re-offeringVariable price re-offering

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

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The Gray Market: Exemplification

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The Eurobond pricing paradox The Eurobond pricing paradox Eurobonds yields are lower, but issuance costs are higher than in North-America.

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The Eurobond pricing paradox: Exemplification US treasury issues Specially Targeted Notes on October 24, 1984: $ 1 b at 11.375% maturing on September 30, 1988, bearer notes to foreign investors $ 1 b at 11.7% maturing on September 30, 1988, registered notes to American and foreign investors

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The Eurobond pricing paradox Could tax withholding and/or reporting to national authorities make a difference?

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Onshore-Offshore Arbitrage O-OA represents an attempt at taking advantage of the Eurobond pricing paradox.

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Onshore-Offshore Arbitrage Issuers have an incentive to engage in arbitrage by: issuing securities offshore and covering their liability with a purchase of risk-free government securities whose cash inflow match the cash outflow of the Eurobonds. If the matching is perfect, and the government securities can be pledged to pay off the Eurobond liability, the transaction qualifies as a pure arbitrage.

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

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Up-front arbitrage profit: $17.6 m Japanese investors were particularly interested in buying the Euro-discount bonds because of: Absence of taxes on capital gains in Japan (at that time) No coupon reinvestment risk