Debt And Equity Capital Markets:
Bonds Markets
Giovanna Zanotti
giovanna.zanotti@unibg.it
office hours: Thursday 14.00 room 210
Agenda
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Introduction do Equity and Debt capital Markets
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Debt capital markets
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Domestic, Foreign and Eurobond Market
The origin and the growth of Eurobond Market
Bond typologies
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International bonds definition and regulation
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Actors
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Evolution in Pricing mechanism
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Bonds characteristics
L’attività di Equity and Debt
Capital Markets
Debt Capital Markets ( emissione, collocamento di
bond plain vanilla e strutturati)
Prestiti sindacati
Capital
Equity Capital Markets (IPO, Secondary offering,…)
Markets
Operazioni di cartolarizzazione
Bond Market Introduction
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The bond market is today very complex and there is a wide
range of bonds.
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An ordinary bond is an agreement that merely entitles one
party to make and another to receive a series of cash flows.
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While differences among forms of equity are small, there is a
wide range of bonds; innovative financial engineers.
International Bond market
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Debt financing has always been international however there is still no a
unified international bond market. The international bond market is
divided into three market groups:
• Domestic bonds. They are issued locally by a domestic borrower and
are usually denominated in the local currency.
• Foreign bonds. They are issued on a local market by a foreign
borrower and are usually denominated in the local currency. Foreign
bond issues and trading are under the supervision of local market
authorities.
• Eurobonds. They are underwritten by a multinational syndicate of
banks and placed mainly in countries other than the one in whose
currency the bond is denominated. These bonds are not traded on a
specific national bond market.
International Bond Market
examples
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Domestic Bond
• Amoco Canada issues a bond in Canada for placement in the
Canadian domestic market, i.e., with investors resident in Canada.
The issue is underwritten by a syndicate of Canadian securities
houses. The issue is denominated in the currency of the intended
investors, i.e., CAD.
Foreign Bond
• Amoco Canada, a foreign corporation, issues bonds in the U.S. for
placement in the U.S. market alone. The issue is underwritten by a
syndicate of U.S. securities houses. The issue is denominated in the
currency of the intended investors, i.e., USD.
Eurobond Bond
• Amoco Canada, a foreign corporation, issues bonds, in a major
international financial centre, to be placed internationally. The issue is
underwritten by an international syndicate of securities houses. The
issue is denominated in the currency of the major financial center or
in any other currencies (multicurrency)¶
The International Bond Market
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The Eurobond market has had a fantastic growth during the past 30
years.
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At its inception, in the early 1960s, the Eurobond market was mainly a
Eurodollar bond market, that is, a market for USD bonds issued outside
the U.S.
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Today, the Eurobond market comprises bonds denominated in all the
major currencies and several minor currencies. The Eurobond market is
an offshore market where borrowers and lenders meet because of low
costs and lack of regulation.
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Together the foreign bond and Eurobond markets make up the
international bond market.
Origins of Eurobond markets :
the 1950s
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Before World War II it was not rare for banks outside the U.S. to accept
deposits denominated in U.S. dollars. The volume of such deposits,
however, was small and the market for them had little economic
significance.
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During the 1950s things began to change:
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Russia and other communist countries had to deal in hard currency for their
international trade transactions
The central banks of these countries ended up holding USD balances.
Initially these balances were held in New York. But as the cold war tensions
increased, the communist government transferred these balances to banks in
London and other European centres.
• USD emerged as the currency for international trade:
• sterling crisis in the U.K. in the mid-1950s. In 1957, the U.K. imposed
controls on non-resident GBP borrowing and lending by U.K. banks. These
institutions then turned to the USD to finance their
international
trade.
• In 1958, West European countries in preparation for the creation of the EU)
allowed banks to trade freely in USD to finance trade.
Origins of Eurobond markets:
the 1960s
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During the 1960s the U.S. government imposed several measures to control
international capital flows with the aim to improve the U.S. balance of
payments, which was in a big deficit:
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1963, Interest Equalization Tax (IET) on foreign securities held by U.S. investor. The
governmentʹs idea was to equalize the after-tax interest rate paid by U.S. and
foreign borrowers, and, thus, discourage U.S. residents to buy foreign securities
(reducing capital outflows). The IET forced non-U.S. corporations to pay a higher
interest rate in order to attract U.S. investors. Therefore, non-U.S. corporations
started to look into the Euromarket to borrow USD.
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1965, Foreign Credit Restraint Program (FCRP). The FCRP restricted the amount of
credit U.S. banks could extend to foreign borrowers. Foreign subsidiaries of U.S.
multinational corporations were considered ʺforeignʺ, under the FCRP. The
governmentʹs idea behind the FCRP was to reduce capital outflows.
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1968, the government passed the Foreign Investment Program, which limited the
amount of domestic USD U.S. corporations could use to finance foreign
Origins of Eurobond market:
other factors
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Regulation Q. For a long time, the Federal Reserve Board regulated
the interest rates that U.S. banks could pay on term deposit. The tight
money years of 1968 and 1969 made money market rates to rise above
the rates banks where allowed to pay under Regulation Q. Regulation
Q, widened the interest differential between a USD deposit in the
U.S. and a USD deposit abroad.
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All these restrictions brought the major financial institutions to
European money centres like London, Zurich, and Luxembourg. This
development had some spillover effects on financial centers in other
parts of the world such as Tokyo, Hong Kong, Singapore, Beirut,
Bahamas, and Bahrain.
Eurobond market today
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The regulations and restrictions that gave birth to Euromarkets have all
disappeared. Euromarkets, however, have continued to grow.
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Today, Euromarkets are free from regulations, exempt from national taxes
and reserve requirements.
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These conditions allow international banks to take advantage of the lower
cost of funds. Then, they can lend the funds to international borrowers at
lower rates than those that can be obtained in domestic markets.
International debt securities,
amount outstanding
http://www.jedh.org/jedh_dbase.html
Domestic debt securities, amount
outstanding
Type of Bond Instruments
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Wide and very complex range of bond typologies
• Zero coupon Bond
• Fixed rate or Straigth bond
• Floating rate Bond
• Convertible Bond
• Bond with warrant
• Structured bond
• Equity related
• Interest rate related
• Commodity related
Zero coupon bond
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Bond with no schedule of periodic interest payments.
Two payments, the receipt of the proceeds on issue date and the
repayment of principal on maturity.
For the issuer, zero coupon bonds are an ideal financing instrument
for a project, which generates no income for some years. On the other
hand, the loading of the debt service of the bond into a single payment
some years later creates a higher credit risk. For this reason the market
is confined to highly rated borrowers.
Investors are attracted to zero-coupon bonds to meet future liabilities.
P
=
100
(1 + r )
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Fixed rate or straight bond
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Bond specific interest payments on specified dates over a
period of years.
On the last specified date, or maturity, the payment includes a
repayment of principal.
The interest rate or coupon is expressed as a percentage of the
issue amount and is fixed at launch.
For the issuer, the attraction of these bonds is the knowledge of
level payments on interest and a set repayment schedule.
For investors, the attraction of straight bonds lies in a known
income.
Floating rate bond
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Medium-term instrument similar in structure to straight bonds but for
the interest base and interest rate calculations.
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The coupon rate is reset at specified regular intervals, normally 3
months, 6 months, or one year.
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The coupon comprises a money market rate (e.g.,the London Interbank
Offered Rate for 6-month deposits, or LIBOR) plus a margin, which
reflects the creditworthiness of the issuer.
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Investors like FRNs because the periodic resetting of the coupon offers
the strongest protection of capital.
Convertible Bond
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Bond that can be exchanged or converted at the option of the holder into
other assets at a fixed conversion rate set at time of launch.
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Usually launched in conditions of poor fixed-rate bond markets, high
interest rates, financial distress ,
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Issuers benefit from (1) the lower funding costs relative to short-term
money markets and (2) the possibility of no repaying the principal if the
conversion right is exercised.
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Investors benefit because they receive the benefit of regular coupon
payments plus the option of locking in to a better yield later.
Bonds with warrants
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Similar to convertibles except that the warrant can be
traded separately.
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The proceeds from the warrants are applied to the
reduction of the cost of issuing the bond.
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Bonds can have equity warrants, bond warrants, or
commodity warrants attached.
Structured bonds
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Bond built as combination of a plain vanilla bond and at least
one position in derivatives instruments
• Equity linked
• Interest rae linked
• Capital protected
• Non capital protected
Issuer benefits from a lower cost of funds
Investor benefits from diversification of underlying assets and
payoff structures
The primary market and the bond
issuing
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Selling of newly issued bond
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Public placement
• Bonds are sold to a wide arena of different investors
• Compliance to registration and disclosure requirements
• Intense marketing activity
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Private Placement
• Bonds are sold only to institutional investors already known
and interested to keep them
• Exempt from registration with regulators
• Intense relationship activity
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Actors in a public placement
Issuer
Corporation, Government,
Public agency
Lead Manager
Investment Bank
Investment bank 1
Investment bank 2
Investment bank 3
Underwriting syndicate
Selling
Group
Selling
Group
Selling
Group
Selling
Group
Investors
Selling
Group
Selling
Group
Selling
Group
The lead manager
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Presentation of a first time issuer
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Selection of a syndicate
• Small additional group (co-managers) of banks to assist lead
manager in negotiating terms with the borrower, assessing the
market
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Decision of a timely launch
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Support of the issue in the aftermarket
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Maintenance of an effective secondary market
Lead manager selection
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Relationship bank
Lowest cost of funds
Capital commitment
Effective market making
Market standing (euromoney league tables)
http://www.euromoney.com/Article/2087044/LeagueTable/4/Issue/120/Asset
Category/14/ChannelPage/8959/US-Investment-Grade-Year-End-2008.html
Ability to deliver a wide range of derivative products which may enter into
the structure of the issue
• A Eurobond issue is often raised in a currency, which is foreign to the
issuer, yet the end currency requirement is generally for funds
denominated in its domestic currency.
• A foreign currency Eurobond issue creates currency risk unless the issuer
is able to service the debt out of revenues in the same currency.
• The advantage of Eurobond in a foreign currency may be in terms of
maturities, issue size, lower cost
The management group
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Lead managers priorities
• Sharing the risk of the issue
• Search for help to place it
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The lead manage consults with the co-managers on pricing deal
characteristics….
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The co managers give no commitment and in event of bas
market conditions may decline the invitation.
The other banks
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Underwriting group
• They commit themselves to buy the bonds at a set minimum
price from the managers even in the bonds cannot be resold
to sellers and final investors for a price greater than the preagreed minimum.
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Selling group
• They sell to final investors
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Principal paying agent
• Has the responsibility for receiving interest and principal
payments from the borrower and distributing them to final
investors
Fee structure
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Fees are extracted by discount on the prices at which bonds are provided to
syndicate members.
• Example… An Italian company issues USD bonds at 1000. The managing
group agreed to pay the borrower USD 975 for each USD 1000 bond.
• The USD 25 discount is the flotation cost or investment bank spread. (2.5%)
Gross spread will be then divided into
selling concession : price at which the lead manager makes bond available at
the selling group
• USD 1000 –USD 990 = USD 10
• underwriting fee : price at which the lead manager makes bond available at
the underwriting group
• USD 990 – USD 980 = USD 10
• management fee
• USD 980- USD 975 = USD 5
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Time Schedule for a new offering
2 weeks
Meeting
Meeting
Borrower and
lead manager
meets. Discuss
terms of the bond
issue. Provisional
until the offering
day
Syndication
strategy
7-10 days
AnnounAnnouncement
cement
subscription
period
Offering
Offering
Day
Day
10 days
syndication
stabilization
Press release
Invitation faxes (7-10 days)
Bonds formally offered
to the selling group
Road show
Bonds purchased from
the borrower at the
agreed price
Syndicate book
Preliminary allotment
Final terms decided
Start of gray
market
Sellers start their
activity
Start of primary
market
Closing
Closing
Day
Day
Syndicate members
pays for the bonds;
final investors
receives bonds;
borrowers receives
funds;
Tombstone
Start of secondary
market
Gray market
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It’s an OTC market for bonds to be issued in the near future
It starts with issue announcement and closes when primary market ends (or
the secondary market opens).
The bonds are not yet in formal existence. However on Reuters page bid and
prices for the new issues are quoted. People make contractual commitment
to trade bonds at agreed prices once the bonds will officially exists. Forward
market (if and when issued)
• Banks with a limited selling power may sell overallocated bond
• Undewriters reduced risk of not placing the bonds
• Traders.
• Institutional investors
Gray market prices can influence the final issuing price for the bond. Price at
which potential demand is brought into equilibrium with potential supply.
Price stabilization
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Between offering day and closing day the lead manager, in
cooperation with syndicate, try to stabilize the price of bonds. Price
stability is very important above in issues for retail investors were
distribution takes a long time
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The price of the bond will not be allowed to fall below the amount
of the selling concession.
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Reasons:
• lead bank reputation
• gray market flipping
• Changes in market interest rates
if IÏ…PÐ: lead manager will buy bond
if IÐ…PÏ: lead manager will issue more bonds
Evolution in issuing techniques
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Open priced issue
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Bought deal
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Fixed price re-offering
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Over-Allotment
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Pot system
Open priced issue
T-15 lead bank receives mandate from issuing company
T0 offering day – price fixing
T+15 closing day – end of issue
Open priced problems
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Uncertainty of final cost for issuer
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High costs of syndication
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Moral Hazard by members of the
syndicate (flipping in the gray market)
Bought Deal
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Bought deal
• lead manager buys the whole issue from the borrower at set terms
(amount, coupon, issue price..) and sell it back to the market.
• The lead manager assumes the full underwriting risk. This risk is
then syndicated among co-managers.
• The magnitude of the risk and the relative capital commitment make
the bought deal market a limited market.
• Example : in April 19/80 CSFB bougth and entire USD 100 million
issue overnight from General Motors. Only afterwards CSFB arranged
syndication.
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Very popular with borrowers
• The total time to bring the bond to the market is shortened
• No price risk
Auction system (tender system)
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The borrower announces the maturity and the coupon of a new bond
issue and invites investors to submit bids.
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Investors submit bid prices as a percentage of par along with a statement
of the amount they are willing to take at that price
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The borrower sells the bonds starting with the highest bidder and
working down until the bonds have been allocated.
• multiple-price auction: the winning bidders pay the price that they
bid for the amount that they requested.
• single-price auction, Dutch auction, all winning bidders will receive
the highest winning yield, or in the case of a discount bond, will pay
the same price.
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Eliminates management fees and cost of syndication.
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Used for governments bonds
Fixed price reoffering
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The lead manager and co managers
sign a contract legally obligating them
not to discount fees
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All bonds are sold to the same price to
all investors whether they are large
institutions or small investors.
Private placement
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Bonds are sold only to institutional investors already known and
interested to keep them
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Exempt from registration with regulators
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Term sheet and Offering memorandum
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Usually no rating
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Amount 100-500 mil $
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Banking involvement for distribution (1 lead bank)
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Best effort
Pricing occurs at the end of the marketing period
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