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
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.
Slide 25
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