The International Bond
Market
Outline
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Types of bonds
Comparative bond characteristics
The Gray Market
Onshore-Offshore arbitrage
Classification
• Foreign Bonds
• Global bonds
• Eurobonds
Foreign Bonds
Issued by a foreign entity and denominated in
domestic currency
Foreign Bonds: Examples
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Samurai bonds
Bulldog bonds
Rembrandt bonds
Yankee bonds
Global bonds
Sold simultaneously on several markets in
the currency of each market
Global bonds
First offered by the World Bank, OntarioHydro, and Hydro-Quebec.
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.
Eurobonds: Exemplification
A bond issued by Rhone-Poulenc and
sold in the US in Swiss francs.
Eurobonds
INSTRUMENT
INTEREST
FREQUENCY
COUPON TYPE
CURRENCY PAYOFF
Straight fixed-rate
annual
Fixed
Currency of issue
Floating rate note
annual or
quarterly
Variable
Currency of issue
Convertible bond
annual
Fixed
Currency of issue or
convertible
Straight fixed-rate with annual
equity warrants
Fixed
Currency of issue plus
shares
Zero-coupon bond
none
Zero
Currency of issue
Dual-currency bond
annual
Fixed
Dual Currency
Composite currency
bond
annual
Fixed
Composite currency
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.
Selecting the currency of
issue: Exemplification
Coca-Cola wishes to raise $1 b. The company can
issue dollars or pounds denominated bonds.
For simplicity, assume all payments are made at
maturity.
Dollars (billions)
Pounds (billions)
Initial amount raised
1
1/S($)
Principal payment
[1+r($)]
n
n
[1+r(pounds)] /S
Selecting the currency of issue:
Exemplification
Coca-Cola will float the pound bond only if:
[1+r($)]n > E[S] [1+r(pounds)]n /S
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($) > r(pounds ) + d
Selecting the currency of
issue: Exemplification
r($)
r(pounds )
d
5%
7%
1.2%
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.
Comparative characteristics of bonds issues
North-America (US)
Non-US
Regulatory
SEC, provincial
Specialized agency Minimum regulatory control
Disclosure
Detailed
Variable
Determined by market
practice
Issuing costs
0.75-1.25%
Up to 4%
2-3%
Rating
required
Usually not
required
Not required but done
Speed of issuance
Moderate
Variable
Fast (bought deals)
Rrestrictions
No restrictions
Restrictions are
common
No restrictions
Other advantages
 Large market
 Liquidity
 Local
visibility
 Standardized
information
Other disadvantages
Eurobond
 Lower interest expense
 Bearer bonds
 No withholding tax
 Currency diversification
 Disclosure is
costly
 Small
markets
 Reporting to tax
authorities
 Low liquidity
 Reporting to
tax
authorities
Less liquidity and information
disclosure
Eurobond underwriting
In general, similar to regular bond underwriting
Differences:
• Lead manager separate from selling group
• Variable price re-offering
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.
The Gray Market: Exemplification
Issuer
Weyerhauser (1983)
Osaka Gas (1993)
Amount
$60 m
$250 m
Maturity
7 years
5 years
Coupon
11.5%
5.75%
Issue price
$100
$101.489
Listing
LuxSE
London
Total commission
1.875%
1.875%
Lead Manager
Morgan Stanley
Goldman Sachs
Gray market price
-1.5 to -1.25%
+ 0.25%
The Eurobond pricing paradox
Eurobonds yields are lower, but issuance
costs are higher than in North-America.
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
The Eurobond pricing paradox
Could tax withholding and/or reporting to
national authorities make a difference?
Onshore-Offshore Arbitrage
O-OA represents an attempt at taking
advantage of the Eurobond pricing paradox.
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.
Onshore-Offshore Arbitrage: EXXON Capital
Corporation, a subsidiary of EXXON Corporation.
Date
Oct. 19,1984
October 1984
Type of security Issues $1.8 b Euro-discount bonds Buys $1.8 b of US T- bonds
Maturity
November 15, 2004
November 15, 2004
yield
11.65%
11.825%
Net proceeds
+$ 198.6 m
-$181 m
Onshore-Offshore Arbitrage: EXXON Capital
Corporation, a subsidiary of EXXON Corporation.
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