FINANCING IN
INTERNATIONAL MARKETS
1. INTERNATIONAL BOND
MARKETS
International Bond Markets
The bond market (debt, credit, or fixed income market) is the financial
market where participants buy and sell debt securities, usually bonds.
Size of the world bond market (’09 debt outstanding): USD 82.2 trillion.
- U.S. bond market debt: USD 31.2 trillion (38%).
Organization
- Decentralized, OTC market, with brokers and dealers.
- Small issues may be traded in exchanges.
- Daily trading volume in the U.S.: USD 822 billion
- Government debt dominates the market.
- Used to indicate the shape of the yield curve.
•Typical Bond Market: Canada
Dominated by government issues.
• The world bond market is divided into three segments:
- Domestic bonds: Issued locally by a domestic borrower.
Usually denominated in the local currency.
Largest segment: 71% of the bond market (2008).
- Foreign bonds:
Issued on a local market by a foreign borrower.
Usually denominated in the local currency.
- Eurobonds:
Placed mainly in countries other than the one in
whose currency the bond is denominated.
Example: Distinction between bond markets.
(A) Domestic bonds.
Amoco Canada issues a bond denominated in CAD in Canada. Issue is
underwritten by a syndicate of Canadian securities houses.
(B) Foreign bonds.
Amoco Canada issues bonds denominated in USD in the U.S. Issue is
underwritten by a syndicate of U.S. securities houses.
(C) Eurobonds.
Amoco Canada issues bonds to be placed internationally. Issue is
underwritten by an international syndicate of securities houses. Issue is
denominated in a currency different from the local currency where the
bond is issued. ¶
=> The Foreign bond and Eurobond markets make up the
International Bond Market.
• Corporate Issuances in U.S. Bond and Eurobond Markets
• The U.S. Market is losing appeal. => Less competitive?
Type of Instruments
Popular Instruments in International Bond Markets
i.
Straight or fixed income bonds.
ii.
Partly paid bonds.
iii.
Zero-coupon bonds.
iv.
Floating rate notes (FRNs).
v.
Perpetual FRNs.
vi.
Convertible bonds.
vii.
Bonds with warrants.
viii. Dual-currency bonds.
Example: Straight bond
4.375% May 2015 Slovak Republic EUR bond
Amount =
EUR 2 billion
Issue date =
May 14. 2009
Face value: F =
EUR 1,000
Coupon: C = 4.375% =
EUR 43.75
Maturity =
6 years (May 2015)
Interest payment dates:
May 14
Every May 14, the Slovak Republic pays EUR 43.75 to bondholders, for
6 years. ¶
• Tombstone of Slovak Republic’s Eurobond
Example: Zero-coupon bonds ("zeros").
Zero June 1984 PepsiCo Overseas USD bond
Amount =
USD 100 million.
Issue date =
June 1981
Maturity =
June 1984 (3 years)
Face value: F =
USD 100
Coupon: C =
0.
Issue Price =
67.255.
Compounded annual interest yield: (100/67.25)1/3 - 1 = 14.14% ¶
Example: FRNs ("floaters").
LIBOR + 1/8 March 2024 Swedish Government USD bond.
Amount =
USD 500 million.
Issue date =
March 1 1984
Maturity =
March 1, 2024 (40 years).
Face value: F =
USD 1000
Coupon: C =
6-mo. LIBOR + 1/8
Interest payment dates:
March 1 and September 1
At the time the notes were offered (3/84), 6-mo. LIBOR was 10(7/16)%
First Coupon = 10(7/16)% + (1/8)% = 10(9/16)%.
Afterward, at the end of each 6-mo. period the interest rates on the notes
are updated to reflect the current 6-mo. LIBOR rate for dollars. ¶
Example: Convertible bonds ("convertibles").
8% May 2002 Cantim (a Canadian co.) convertible USD eurobond.
Amount:
USD 100 million
Issue date =
May 1995
Maturity:
May 2002 (7 years)
F=
USD 1000
C=
8%.
Conversion price =
CAD 23.125
Conversion St =
1.2007 CAD/USD
Conversion period:
Any time after first interest payment
Principal is convertible into Cantim common stock at a conversion price
per share of CAD 23.125, where each USD of face value would be
convertible to CAD at a fixed exchange rate of 1.2007 CAD/USD.
 each bond can buy 51.92 shares. ¶
Example: Bonds with equity warrants.
4% May 1995 Cannon Euro-USD bonds with equity warrants attached.
Amount:
USD 370 million.
Maturity:
May 31, 1995 (5 years).
F=
USD 5,000
C=
4%
Number of warrants:
74,000
Warrants per bond:
1
Shares per warrant:
468.06
Exercise price:
JPY 1487
Conversion St:
139.2 JPY/USD
Exercise period:
At any time after the first interest payment
=> Almost all Japanese Euro-USD bond with equity warrant attached
(USD Eurowarrants) have similar terms. ¶
Example: Dual-currency bonds.
Note: Dual-currency bonds are purchased in terms of one currency but
pay coupons or repay principal at maturity in terms of a second currency.
10% July 1995 First City Financial CHF Eurobond.
Maturity =
July 1995 (10 years).
F=
CHF 5,000.
C=
10% (=CHF 500).
Feature = At maturity, the bond is repaid in the amount of USD 2,800.
At the time of the issue, this bond represented a combination of
(a) a 10-year CHF bond that repays principal: CHF 5000
+
(b) a 10-year forward contract to buy USD 2800 at 1.7857 CHF/USD
= (CHF 5000/USD 2800 x S7/01/95 = 1.7304 CHF/USD).¶
• More on Dual Currency Bonds.
Japanese firms have frequently issued CHF denominated bonds
convertible into common shares of a Japanese company.
A foreign investor can benefit from purchasing this bond:
- a drop in the market interest rate on CHF bonds;
- a rise in the price of the company's stock; or
- a rise in the JPY against to the CHF.
=> Dual currency bonds represent a combination of an ordinary
bond combined with one or more forward contracts.
Eurobond Markets
Euro-what?
• Euro-zzz: the currency of denomination of the zzz instrument is not the
official currency of the country where the transaction takes place.
Example: a Malayan firm deposits USD not in the U.S. but with a bank
outside the U.S., for example in Singapore or in Switzerland.
Euromarket
- Offshore money market
- Low costs and lack of regulations
- Instruments traded in any currency.
The Eurobond market is just one segment of the Euromarket.
Birth and Development of Euromarkets
- Decline of the GBP
- Rise of the USD as the international currency
- Cold war forced Russia to deposit USD not in the U.S.
- EEC allowed financial deregulation
More important:
- Interest Equalization Tax (IET) (1963)
- Foreign Credit Restraint Program (1965)
- Foreign Investment Program (1968)
These restrictions brought the major financial institutions to European
money centers like London, Zurich, and Luxembourg.
Characteristics of Eurobonds
• A Eurobond is an international debt security.
Structure: similar to the standard debt security used in domestic markets.
Basic characteristics:
- Eurobonds are transferable (usually, bearer).
- Eurobonds are intended to be tradable.
- Eurobonds are a medium- to long-term debt security.
- Eurobonds are generally launched through a public offering.
- Eurobonds are generally listed on a stock exchange.
Transferability should be simple:
bearer bond
(you have it, its yours)
registered bond
(your name should be in a book to own the bond)
=> the majority of Eurobonds are bearer bonds.
• Attractive characteristic of Eurobond markets for issuers:
The Eurobond and foreign bond markets seem to be segmented.
Example: The World Bank has issued in the U.S. foreign bond market
and in Euromarkets. Issues of similar maturity have yielded 10 to 20
bps less.
Usual explanation: no requirement of registered form for Eurobond. ¶
=> Formal characteristics of Eurobonds: no different from domestic or
foreign bonds.
=> The structure of the underwriting syndicate is the main difference
between other bonds and Eurobonds.
Issue Procedures
Organization of a Traditional Eurobond Syndicate
• Eurobonds are issued and sold through underwriting syndicates.
• Participants in these syndicates are investment banks:
• Players:
- lead manager (organizes the managing group).
- managing group (buys the bonds).
- underwriters (commitment to buy ahead of time at a set price).
- selling group (no commitment to buy at a set minimum price).
- principal agent (responsible for receiving and making payments).
- fiscal agent and trustee (represent the borrower and bondholders
respectively).
• Roles in a Eurobond syndicate are nested: Managers are also
underwriters and sellers, and underwriters are usually also sellers.
• Roles in a Eurobond syndicate are nested: Managers are also
underwriters and sellers, and underwriters are usually also sellers.
Selecting a Lead Manager
• Market for Lead Managers is very competitive.
• The selection of a professional issuing house to lead-manage the issues
is a critical decision for the borrower.
• Factors:
- Established relations
- Price
- Market making ability
- Coordination of the syndicate
- Derivatives products
=> The advantage of a Eurobond issue may not the cost. An issue may be
preferred in terms of longer maturities, early call options, issue sizes.
• Eurobond Market: Lead Managers in April 2011 (from Reuters)
Fee Structure for new Eurobond Issues
• Fees: extracted by discounts on the prices provided to syndicate
members.
Example:
A French company issues USD 1,000 bonds at 100 (100% of FV, "par").
Managing group pays the borrower USD 975 for each USD 1,000 bond.
The USD 25 discount (2.5%) is the flotation cost. ¶
• Syndicate members really receive the full flotation cost if the bonds are
actually sold to retail at the issue price. This might not happen.
Reasons:
- unenforceable contracts.
- competition.
- price discrimination.
Example:
Lead manager pays borrower USD 975 per USD 1,000 bond.
Lead manager makes bonds available to underwriters at USD 980
Lead manager makes bonds available to sellers at USD 985
$1,000 - $975 = $25
$1,000 - $985 = $15
$985 - $980 = $5
$980 - $975 = $5
"Flotation cost" or "spread"
"Selling concession"
"Underwriting allowance"
"Management fee"
• Typical spread for USD Eurobonds:
2% for issues ten years or longer.
Less than 2% for shorter maturities.
(100% of spread)
(60% of spread)
(20% of spread)
(20% of spread)
Traditional Time Schedule for a New Offering
Gray Market
• A seller knows she will receive bonds at a 1.5% discount:
"I am getting a discount of 1.5% on a certain number of bonds."
"I could sell these now for 1%, I would lock in a .5% profit."
"I could avoid the risk that interest rates (and bond prices!) will change."
• The bonds themselves (and the terms!) are not yet in formal existence.
=> This pre-market is the gray market.
• Bonds trade in the gray market at a discount on the future (yetunknown) issue price.
Example: A price of "less 1" would mean a price of 98.75 if the bonds
are issued at 99.75. A USD 1,000 bond would then be exchanged
between the two parties for 98.75% of its face value, or USD 987.50.
=> The gray market -or forward- price represents the price at which
potential demand is brought into equilibrium with potential supply.
Variations on Issuing Procedure
• Bought deal (lead manager buys the entire bond issue at set terms).
Example: In April 1980, CSFB bought an entire USD 100 million issue
overnight from GMAC. ¶
• Auction issue, (the borrower announces the maturity and the coupon
rate of a new bond issue and invites investors to submit bids).
It eliminates management fees and the costs of syndication.
Auction systems are popular domestically: government securities.
Example: The Peruvian Central Bank announces an issue of 100,000
USD 1,000 8.5% Treasury Bonds with a maturity of 1 year.
GMAC bids 95.3 percent for an amount of 30,000.
Cut-off rate: 95.0 (all offers above 95.0 are accepted).
GMAC pays USD 28,590,000 for the bonds. ¶
• Fixed price reoffer (FPRO), (lead manager and co-managers sign a
contract obligating them not to discount fees).
It is the way bonds are underwritten in the U.S. domestic market.
20% of new eurobonds are issued under FPRO terms.
Typical spreads are (5/16) to (3/8) percent instead of 2 percent.
U.S. Legal Aspects of Eurodollar Bond Issues
• U.S. authorities do not attempt to control the issuing of USDdenominated eurobonds by foreigners.
• U.S. regulations affect the management and sale of USD eurobonds.
• Only U.S. investment banks get involved in USD Eurobond issues.
• U.S. banks can participate in Eurobond issuing syndicates only if they
guarantee that U.S. investors cannot purchase the bonds.
• A Eurobond offering could be structured to fall under the "private
placement" exemption of the Securities Act of 1933.
Then it can be sold to U.S. nationals at issue. But, this exemption applies
when the purchasers of the bonds meet the following features:
1. They are limited in number.
2. They are "sophisticated."
3. They are able to bear the loss if the bond issuer defaults.
4. They purchase bonds as principals (i.e., not for resale).
5. They have access to information similar to that which would be
contained in a registered offering prospectus.
• In 1984, the U.S. government deregulated bond and money markets:
- No U.S. withholding tax on payments to foreigners who hold U.S.
government or corporate bonds.
- U.S. corporations are allowed to issue bearer bonds directly to
non-U.S. residents.
Eurobond secondary market
The secondary bonds market handles the reselling of bonds by investors.
-It is almost entirely an OTC market. Most trades are conducted on
closed, proprietary bond-trading systems or via phone.
- It is self-regulated. Participants follow ICMA’s market conventions
and standards. ICMA: International Capital Market Association
=> The ICMA is similar to the U.S. NASD.
ICMA
• ICMA has over 400 members, located in over 50 countries.
• Majority of the members are in the U.K. (more than 50%), the U.S.
and Luxembourg.
• ICMA’s History
- In 1968, Eurobond dealers created the AIBD (Association of
International Bond Dealers).
- In 1991, the AIBD was reorganized into the International Securities
Market Association (ISMA), which is based in Zurich.
- In 2005, the ISMA and International Primary Market Association
merged to become the ICMA.
• Public Eurobond issues are listed on one or more stock exchanges.
The principal exchanges for issues are Luxembourg and London.
• European currency issues tend to be listed on the home exchange.
• There is no legal obligation to deal on the exchanges:
 OTC market.
Microstructure
• Market-makers and dealers in Eurobonds are members of the ICMA.
• A market-maker quotes a net bid-ask price:
 no commissions are charged.
• Bid-ask spreads on Eurobonds are around .50%.
• Settlement takes place on the value date, approximately a week later.
• Standard-size transaction is 100 bonds (with USD 1000 of face value).
• Quoted prices apply to standard-size transactions, smaller transactions
are negotiated at higher spread costs.
• Two international securities clearing systems (now linked):
- Euroclear was the first, set up in Brussels (1968).
- Clearstream, first established in Luxembourg (1970).
Liquidity problems
For certain issues, liquidity is still a big problem.
Not a problem of unreliable market making.
Problem: poor access to established and liquid bond markets.
Issuers take liquidity considerations into account:
The bigger the size of the issue, the more liquid in the secondary market:
 Issues tend to have sizes larger than USD 50 million equivalent.
Foreign Bond Markets
Yankee Bonds
• It used to be the largest and most important foreign bond market.
• Yankee bonds must be registered under the Securities Act of 1933.
• Yankees issues are usually rated by a bond rating agency.
• There is no withholding tax on coupon payments to foreigners.
• The secondary market for Yankee bonds is more liquid than that for
USD Eurobonds and bid/ask spreads are smaller.
German Eurobonds and German Foreign Bonds
• Investment banking and commercial banking are not separated.
International EUR bond market is dominated by German banks.
• A German Eurobond is legally the same as a German foreign bond.
Samurai Bonds and JPY Eurobonds
• Japanese and non-Japanese corporations make public Euroyen issues.
• Foreign banks are allowed to serve as lead managers.
Swiss Franc International Bonds
• Government does not allow issues in CHF outside Switzerland.
• Switzerland has the largest foreign bond market in the world.
• Common scenario: foreign savers lend to foreign borrowers in CHF.
• Swiss foreign bonds are bearer bonds and have annual coupons.
Differences Among Bond Markets
Issuing Techniques
Domestic bonds: issued by a syndicate of national banks.
Eurobonds: issued through an international syndicate.
Dealing
U.S. domestic market:
European bond markets:
Japan bond market:
Eurobond market:
OTC with some bonds are listed (NYSE).
Market makers and brokers.
Exchange markets.
OTC for non-government bonds. Brokers.
OTC and Exchange markets. Brokers.
OTC.
Few transactions go through the exchange.
Differences Among Bond Markets
US Market
Non-US Market
Eurobond Market
Regulation
Yes (SEC)
Yes (Local SEC)
No (Informal Rules)
Disclosure
High (regulated)
Varies (according
to local SEC)
Usual Market Practices
Issuing cost
0.75%-1%
Varies (1%-4%)
1.5%-2.5%
Speed of issue
Slow: 2-4 weeks
Varies
Fast: 14 days or less
Currency
USD, but no
restrictions
Usually local, but
with some
restrictions
Any. No restrictions.
Rating?
Yes
Varies
Not required, but it is
common
Bearer Bonds?
No
In general, no.
Yes.
Listing?
Some (NYSE).
Many.
Very Rare
Liquidity
Very liquid
Varies, according
to size
Not very liquid.
Quotations
Bonds are usually quoted:
Cash price = Quoted price + Accrued Interest.
Exception: U.K. bonds (gilts) with more than five years to maturity.
Cash price = Quoted price.
Bonds also differ in the way accrued interest is calculated.
Example: U.S.
An investor holding a U.S. straight bond for February 1995 receives
30/360 or 1/12 of the annual coupons (1/6 of the semiannual coupon).
Example: Japan
An investor holding a Japanese straight bond for February 1995 will
receive 28/365 of the annual coupon.
Yields
Financial institutions around the world calculate YTM on bonds.
The methods differ across countries  YTM are not comparable.
Europe: Annual actuarial YTM using the ICMA-recommended formula.
U.S.: Institutions publish a semiannual actuarial yield.
Example: 12% 2010 IBM USD bond
- U.S.: it pays USD 6% semiannually and it has a YTM of 12% (s.a.).
- Europe: it has a (annual) YTM of 12.36% = (1.06)(1.06) = 1.1236. ¶
Yields (continuation)
Japan: Tend to report YTM based on simple-interest calculation:
Yield = (Coupon rate + 100 Years to maturity
P
) x 100,
P
where P is the current price of the bond.
This simple yield understates the true YTM for bonds priced over par
and overstates the yield for bonds priced below par.
Example: A Japanese bond with:
Years to maturity: 5 years.
C = 12%.
P= 95.
Yield (for a Japanese financial institution) = 13.68. ¶
Some Legal Aspects
• Bonds are issued in either bearer or registered forms.
- Eurobonds: The bearer of a bond is assumed its legal owner.
- U.S.: owners must be registered in the books of the issuer.
• Coupons are usually paid annually on markets where straight bonds are
issued in bearer form (cost reasons):
- Eurobond coupons in all currencies are paid this way.
- U.S. coupons are paid semiannually.
Today, the majority of Eurobond are owned in “electronic,” rather than
physical form. Coupons are paid electronically via the clearing system to
(Euroclear and Clearstream) the holder of the Eurobond.
Why Invest in International Bonds?
• Diversification
=> International bonds have lower correlations than domestic
bond correlations: Efficient frontier moves NW
Example:
The correlation between monthly U.S. investment grade bond returns
(using the Lehman Brothers index) range from about 0.87 to 0.99.
Government bond returns correlations of Canada with all European
countries is close to .50, while the Canada-U.S correlation is 0.73.
(Monthly bond returns measured in local currencies from 1986-2003).) ¶
• Note: But, bond correlations are bigger than stock market correlations.
• Correlations change depending on the base currency –local or
common currency.
Example: France and Germany government bond monthly returns have a
.87 correlation in local currency, but a .96 correlation if returns are
translated into USD.
=> If you are looking to diversify, higher benefits will be obtained by
investing in bonds with no hedging!
0.85
0.80
0.75
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
Jan-90
Jan-89
Jan-88
Jan-09
Jan-08
Jan-07
Jan-09
Jan-08
Jan-07
Jan-06
0.90
Jan-06
0.95
Jan-05
1.00
Jan-05
1.05
Jan-04
Bond (USD) Return Correlation: Germany and France
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
Jan-90
Jan-89
Jan-88
2-yr Rolling Correl
2-yr Rolling Correl
Bond Return Correlation: Germany and France
1.2
1.0
0.8
0.6
0.4
0.2
0.0
Unhedged Efficient Frontiers with Selected Government Bond
Unconstrained Efficient Frontier
With Riskless Asset (Unhedged)
30%
Expected Return
25%
20%
JPY
15%
USD
10%
DEM
GBP
FRF
CAD
ITL
5%
0%
0%
5%
10%
15%
20%
25%
30%
Standard Deviation
35%
40%
45%
50%
Hedged Efficient Frontiers with Selected Government Bond
Unconstrained Efficient Frontier
Without Riskless Asset (Hedged)
30%
Expected Return
25%
20%
GBP
15%
CAD FRF
DEM
ITL
JPY USD
10%
5%
0%
0%
5%
10%
15%
20%
25%
Standard Deviation
30%
35%
40%
45%
50%