International Financial Markets
Prices and Policies
Second Edition ©2001
Richard M. Levich
10

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The Eurobond Market
10 - 2
Overview
 Historical Overview and Dimensions of the
Eurobond Market
A First Stimulus to the Eurobond Market: The IET
 A Second Round of Stimulus to the Eurobond
Market
 The Eurobond Market Endures

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10 - 3
Overview
 Regulatory and Institutional Characteristics of
the Market
Regulatory Bodies and Disclosure Practices
 Issuing Costs, Ratings, and Exchange Listings
 Queuing, Currency of Denomination, and Speed of
Offering
 The Pros and Cons of Onshore and Offshore
Markets

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10 - 4
Overview
 Issuing Practices and Competitive Conditions in
the Eurobond Market
A Brief Sketch of Eurobond Underwriting
 Tensions and Incentives within a Eurobond
Syndicate
 The Gray Market
 Evidence of Competition among Eurobond Lead
Managers
 Another Innovation: Global Bonds

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10 - 5
Overview
 Pricing Eurobonds
Market Segmentation and the Pricing of Eurobonds
 Eurobonds and Secrecy
 Eurodollar Bond Prices
 Onshore-Offshore Arbitrage Opportunities
 Eurodollar Bond Prices: A General Model

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10 - 6
Overview
 Policy Matters - Private Enterprises
Onshore-Offshore Arbitrage Once Again: Exxon
Capital Corporation
 Using the Eurobond Market to Enhance the Value of
the Firm

 Policy Matters - Public Policymakers
The U.S. Competitive Response
 European Union and the Eurobond Market

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10 - 7
The Eurobond Market
 The Eurobond market is the market for longterm debt instruments issued and traded in the
offshore market.
 Like the Eurocurrency market, differences in
national regulation helped developed the
Eurobond market, while increasing capital
mobility and greater ease in
telecommunications enabled it to flourish.
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10 - 8
The Eurobond Market
 A Eurobond is offered for sale simultaneously
in a number of countries.
 A domestic bond is an obligation of a domestic
issuer, underwritten by a syndicate of domestic
investment banks, denominated in domestic
currency, and offered for sale in the domestic
market.
 A foreign bond is similar to a domestic bond
except that the issuer is a foreign entity.
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10 - 9
The Eurobond Market
 Foreign bonds are called Yankee bonds in the
U.S. market, Samurai bonds in the Japanese
market, and Bulldog bonds in the U.K. market.
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Historical Overview and Dimensions of
10 - 10
the Eurobond Market
 The Interest Equalization Tax (IET) of 1963
taxed purchases of foreign stocks and bonds
issued or trading in the United States.
 The IET was proposed as a temporary measure
to reduce U.S. capital outflows and take
pressure off the U.S. balance of payments.
 However, it effectively closed down the Yankee
bond market, and induced foreign borrowers to
migrate offshore and set up a US$-bond market
in London and Luxembourg.
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Historical Overview and Dimensions of
10 - 11
the Eurobond Market
 In 1965 and 1968, further policy measures were
taken to limit the direct foreign investments
made by U.S. corporations.
 These programs effectively forced U.S.
multinationals offshore to meet the financing
needs for their foreign projects.
 When the stimulating U.S. regulations were
scrapped in 1974, the Eurobond market volume
first collapsed and then grew steadily, before
surging during the 1980s.
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Historical Overview and Dimensions of
10 - 12
the Eurobond Market
 Now, the annual volume of new issues often
nears or surpasses the annual volume of new
U.S. corporate bond issues.
 Increasingly too, Eurobonds have been issued
in currencies other than the US$, and then
combined with a currency swap to achieve
lower cost funds in US$, etc.
 At the same time, the market has grown in
terms of bond maturities, issue size, and
secondary market trading.
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10 - 13
Comparative Characteristics of Bond Issues
in the International Bond Market
Regulatory
Bodies
U.S. Market
Non-U.S. Market
Securities
and Exchange
Commission
Official agency
approval
Eurobond Market
Minimum
regulatory
control
Disclosure More detailed
Variable
requirements • High initial and
ongoing expense
• Onerous to nonUS firms
Determined by
market practices
Issuing costs 0.75-1.00%
Variable to 4.0%
2.0-2.5%
Rating
Yes
requirements
Usually not
No, but
commonly done
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10 - 14
Comparative Characteristics of Bond Issues
in the International Bond Market
U.S. Market
Non-U.S. Market
Eurobond Market
Exchange
listing
Usually not listed Listing is usual
Listing is usual
Queuing
No queue
Queuing is
common
No queue
Part of queuing
• Many countries
have in the past
or now restrict
use of currency
No restrictions
on use of US$ or
C$
Currency of United States
denomination does not restrict
restrictions the use of US$
Speed of
issuance
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Relatively slow
Variable
until Rule 415 on
shelf registration
Usually fast bought deal leads
to fast issuance
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10 - 15
Comparative Characteristics of Bond Issues
in the International Bond Market
U.S. Market
Borrower / + Large market,
Issuer
great depth
incentives – Disclosure is
costly to
foreigners,
speed
Non-U.S. Market
+ Local visibility, + Lower annual
diversification of interest expense,
funding sources
speed of placement
– Markets may be – Cannot sell issue
small, queuing
in U.S. until
may prevail
seasoned
Lender / + Great depth & + Diversified
Investor
liquidity, appeal currency
incentives of standardized
portfolio
information
– Reporting to
– Reporting to tax tax authorities,
authorities,
withholding
withholding tax tax may apply
prior to 1984
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Eurobond Market
+ Diversified
currency portfolio,
bearer bonds, no
withholding tax
– Less liquidity &
information
disclosures
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10 - 16
Structure of a Eurobond Syndication
A Eurobond offering brings together the bond issuer and investor.
The process is facilitated by intermediaries.
The lead management group meets with the issuer to design the
issue size, currency, maturity,
coupon, etc...
Bond Issuer
Intermediaries
Underwriters
Management
Group
Selling Group
Fiscal Agent
or Trustee
& Principal
Paying Agent
Bond Investor
and then assembles
other firms to share
in the underwriting Finally, the management group
organizes a group of firms to place the
risks of the issue.
bonds with the ultimate investors.
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Structure of a Eurobond Syndication
 In practice, a single firm may play more than
one role.
 In the case of a bought deal, lead management,
underwriting, and bond sales are all provided
by a single intermediary.
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Tensions and Incentives within
10 - 18
a Eurobond Syndicate
 Selling agents were happy to avoid taking on
any underwriting risks in return for the
prospective fees and prestige associated with a
Eurobond deal.
 On the other hand, lead managers were
confident that the selling group will meet their
selling commitments out of fear of being
dropped from future syndicates.
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Tensions and Incentives within
10 - 19
a Eurobond Syndicate
 As a result, lead managers felt they could form
syndicates to sell “overpriced” bonds in order to
enhance their volume of business.
 Then, the bonds left unsold have to be marked
down in price, thus cutting into the profits of
the selling group and the investors who
purchased the bonds at par.
 Financial journalists characterized this situation
as excessive competition.
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Tensions and Incentives within
10 - 20
a Eurobond Syndicate
 The variable-price reoffering system of the
Eurobond market during the 1960s and 1970s
resulted in another problem too.

As portfolio managers were often employed by the
same financial institutions as the selling group,
portfolio managers faced a possible conflict of
interest - to assist their colleagues in the selling
group by selling as many bonds as possible at full
price, or to maximize the performance of their retail
clients’ investment portfolios
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10 - 21
The Gray Market
 In the 1970s, market participants developed a
method to deal with excessive competition.
Some firms sell their allotment of bonds forward for
delivery on a when-issued basis, so as to hedge
against further price declines.
 Lead managers criticized this gray market, but
could not effectively monitor the transactions.
 Ultimately, the prices in the gray market have to be
considered by the lead managers and issuers, and
they also enabled the retail investor to monitor the
performance of his/her portfolio manager.

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Evidence of Competition Among
Eurobond Lead Managers
10 - 22
 The Eurobond market has been characterized by
competition to participate in the selling group, and
 competition to lead manage primary issues.

 Statistics suggest that there has been
considerable competition and mobility of firms
across the rankings for the top lead managers
and underwriters.
 Firms also exhibit a willingness to switch lead
managers when launching separate Eurobond
issues.
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10 - 23
Another Innovation: Global Bonds
 Like a Eurobond, a global bond issue is offered
for sale in many countries simultaneously.
 However, unlike a Eurobond, it is a registered
security, usually in the U.S. and sometimes in
other countries as well.

This will enhance secondary market trading in local
markets and among investors in different regions.
 By reaching the widest possible investor
audience, the global bond strategy is designed
for issuers with substantial funding needs.
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10 - 24
Another Innovation: Global Bonds
 On January 19, 2000, the World Bank issued a
$3 billion “electronic” global bond.
The 5-year issue was sold and distributed entirely
over the internet.
 This offering format allows the World Bank to
monitor the order flow in real time to gauge the
demand for the issue.
 It also allows all investors, including retail
investors, to purchase bonds in the primary market
at identical transaction fees.

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10 - 25
Pricing Eurobonds
 As a parallel market, the Eurobond market must
offer prices and terms that are advantageous to
both issuers and investors to attract them from
the traditional onshore markets.
 In particular, the Eurobond market often allows
firms to issue bonds more quickly and with
lower disclosure costs.
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10 - 26
Pricing Eurobonds
 But even more important is the ongoing savings
that comes from a lower annual interest cost in
the Eurobond market than in the onshore
market.

The Eurobond market has appeared to function as a
segmented capital market, such that investors may
willingly pay higher prices for debt securities in the
Eurobond market.
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10 - 27
Pricing Eurobonds
 The retail investor often sacrifices yield,
apparently in exchange for a bearer instrument
with no withholding taxes and no disclosures
made to the tax authorities.
 For institutional investors, the Eurobond market
offers a greater variety of high-quality issuers,
ease of clearing and settlement, and larger
issues with good liquidity.
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10 - 28
Eurodollar Bond Prices
 The magnitude of the yield differential between
offshore and onshore bonds has varied over
time, and there are also differences across
firms.
 In particular, investors whose base currency is
not the US$ may be more willing to sacrifice
yield when they expect foreign exchange gains
from a strong US$.
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10 - 29
Onshore-Offshore Arbitrage Opportunities
 During some periods, certain U.S. firms were
able to issue Eurodollar bonds not only at prices
below onshore rates, but also at prices below
U.S. Treasury rates.
 This raises the prospect of arbitrage:
 Firms
may issue debt in the Eurodollar market and
close their position by purchasing U.S. Treasury
securities with the same maturities.
 The U.S. Treasury itself may reduce its funding
costs by going to the Eurobond market.
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Eurodollar Bond Prices:
A General Model
10 - 30
 Arbitrage should link the prices of Eurodollar
bonds with the prices of similar bonds in the
onshore market.
 For example, a regression of issuer cost (Y1),
reoffering yield (Y2), and underwriting spread
(Y3) against a set of control variables (Xi) and a
dummy variable for the location of sale (EURO)
may be set up:
Yi  b0  b1 X 1  b2 X 2    bn X n  bE EURO
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10 - 31
Policy Matters - Private Enterprises
 Both retail and institutional investors have
benefited from the Eurobond market.
 The market has also been a venue for financial
innovation.

Institutional investors may find Eurobonds with
unusual features that allow them to tailor a portfolio
or take on uncommon bets.
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10 - 32
Policy Matters - Private Enterprises
 For issuers, the issue is how to make the most
effective use of this alternative marketplace.
 When
Eurobond rates are lower than the yield on
government securities, issuers may engage in
arbitrage by issuing securities onshore and covering
their liability with risk-free government securities.
Example: Exxon Capital Corporation in 1984.
 Issuers are also concerned with funding strategies
and opportunities to exploit their excess borrowing
capacity and scarcity. The lower interest rate
available to some firms is one measure of this value.
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10 - 33
Policy Matters - Public Policymakers
 The Eurobond market was too large to be
ignored by the U.S. financial regulators and
European policymakers.
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10 - 34
Policy Matters - Public Policymakers
 The U.S. competitive response includes:
A “shelf registration” procedure introduced in 1982
lowered the amount of paperwork and time required
for a capital issue.
 In 1984, the withholding tax on interest paid to
foreigners was dropped. U.S. corporations were also
permitted to issue Eurobonds to foreigners directly.
 Introduced in 1990, the Rule 144a market essentially
enhances the private placement market such that it
becomes similar to the Eurobond market.

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10 - 35
Policy Matters - Public Policymakers
 The European Union’s competitive response
includes:
In 1985, the European Commission drafted the
“Europe 1992” plan, which called for unified
banking and financial markets (as well as markets
for goods and services), to be achieved primarily
through the removal of internal barriers.
 The specification of the common core regulations
for the financial community is still evolving within
the present European Union.

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