Eurocurrency Markets
The Global Cost of Capital
Global Equity Financing
Global Debt Financing
EUROCURRENCY MARKETS
2
Eurocurrencies
• These are domestic currencies of one country on deposit in a
second country
– Example: a Eurodollar is a US dollar denominated deposit in a bank outside
of the United States
• Banks in which Eurocurrencies are deposited Eurobanks.
• A Eurobank is a financial intermediary that simultaneously bids
for time deposits and makes loans in a currency other than that
of the country in which it located.
• Eurobanks are major world banks that conducts a Eurocurrency
business in addition to all other banking functions.
• The Eurocurrency operation that qualifies a bank for the name
“Eurobank” is in fact a department of a large commercial bank.
3
Eurocurrency Markets
• Serve two valuable purposes:
– Eurocurrency deposits are an efficient and convenient money
market device for holding excess corporate liquidity
– The Eurocurrency market is a major source of short-term
bank loans to finance corporate working capital needs
(including export and import financing)
• A large international money market but “gently
regulated” market, relatively free from governmental
regulation and interference.
– No reserve requirement
– No deposit insurance
4
Eurocurrency Market
U.S.
internal
credit market
$
¥
Japanese
internal
credit market
Eurocurrencies
external
credit
markets
external
credit
markets
£
U.K.
internal
credit market
5
Potential Confusion
• Eurocurrencies deposits and loans in different
currencies typically have “Euro” attached as a prefix;
as in Eurodollars, Euroyen, Euromarks, and
Europounds.
• Don’t confuse Eurocurrencies with the European euro,
the successor to the European currency unit. Euros are
a currency. Eurocurrencies are deposits and loans in
various currencies (including the euro).
• Similarly, Eurobonds are NOT necessarily “bonds issued
in euros.”
– French corporate bond issued in France is not a Eurobond,
although it is a euro bond--that is, a bond denominated in
euros.
6
How the Eurocurrency is Created
• Example: StarSpangle Corp., a manufacturer of bowls, has a
time deposit maturing at Megasouth Bank in 2 business
days, on Wed., August 27, 2013.
• StarSpangle plans to invest the $1,000,000 principal of this
time deposit in another time deposit for 1 year, and has
been contacted by a German bank active in the
Euromarkets, Volksbank, with an indication that they are
paying 6.125% (6 1/8%) on 1 year Eurodollar time
deposits.
• Suppose this rate is better than on-going rate StarSpangle
could get domestically. On Monday, August 25, 2013,
StarSpangle agrees to deposit funds with Volksbank for 1
year.
7
Using Eurocurrency Deposits
• Banks which take Eurocurrency deposits do
so for several reasons:
– To trade them in the interbank market.
• Volksbank might redeposit the $1,000,000 it has just
received with another bank, hopefully at a slightly
higher interest rate. Banks active in the market stand
ready to take deposits from other banks, and quote a
bid rate, or to place deposits with other banks, and
quote an offer rate.
– To fund bank assets.
• Volksbank might use the $1,000,000 it has acquired to
fund a dollar loan to a German importer.
8
LIBOR
• Eurocurrency Interest Rates: LIBOR
– In the Eurocurrency market, the reference rate of
interest is the London Interbank Offered Rate
(LIBOR)
– LIBOR is officially defined by the British Bankers
Association (BBA).
• U.S. dollar LIBOR is the mean of 16 multinational bank’s
interbank offered rates as sampled by the BAA at 11 A.M.
London time.
– This rate is the most widely accepted rate of interest
used in standardized quotations, loan agreements,
and financial derivatives transactions.
9
U.S. Dollar-Denominated Interest Rates,
June 2005
10
LIBOR (contd)
• The Eurocurrency loan market has the narrow interest rate
spread as small as 1% between the deposit rate and loan
rate.
• This is because the Eurocurrency market is a wholesale
market, where deposits and loans are made in amounts of
$500,000 or more.
• Borrowers are usually large corporations or government
entities that qualifies for low rates because of their credit
standing.
• Deposit rates are higher in the Eurocurrency markets
because financial institutions offering Eurocurrency activities
are not subject to many of the regulations and reserve
requirements imposed on traditional domestic banks.
• Also deposit insurance fees are not assessed on
Eurocurrency.
11
THE GLOBAL COST OF
CAPITAL
12
Why Cost of Capital is Important
• We know that the return earned on assets depends on
the risk of those assets (risk and return trade-off)
• Our cost of capital provides us with an indication of
how the market views the risk of our assets
• Knowing our cost of capital can also help us determine
our discount rate for capital budgeting projects
– The firm uses it to discount future cash flows from
investment to be made by the firm. That is, it is a rate in
computing NPV.
• Managers need to earn at least the cost of capital to
compensate our investors for the financing they have
provided.
13
Optimal Financial Structure
• Most finance theorists are now in agreement about whether an
optimal financial structure exists for a firm, and if so, how it can be
determined.
• When taxes and bankruptcy costs are considered, a firm has an
optimal financial structure determined by that particular mix of
debt and equity that minimizes the firm’s cost of capital for a given
level of business risk.
• The following exhibit illustrates that as the debt ratio increases, the
overall cost of capital (kWACC) decreases because of the heavier
weight of low-cost (due to tax-deductibility) debt ([kd(1-t)]
compared to high cost equity (ke).
14
Weighted Average Cost of Capital
• A firm normally finds its weighted average cost of capital (WACC)
by combining the cost of equity with the cost of debt in proportion
to the relative weight of each in the firm’s optimal long-term
financial structure:
kWACC = ke(E/V) + kd(1-t)(D/V)
kWACC = weighted average after-tax cost of capital
ke = risk-adjusted cost of equity
kd = before-tax cost of debt
t = marginal tax rate
E = market value of the firm’s equity
D = market value of the firm’s debt
V = total market value of the firm’s securities (D+E)
15
The Cost of Capital and Financial
Structure
16
Global Cost and Availability
of Capital
• Global integration of capital markets has given many firms access
to new and cheaper sources of funds beyond those available in
their home markets.
• A firm that must source its long-term debt and equity in a highly
illiquid domestic securities market will probably have a relatively
high cost of capital and will face limited availability of such capital
which will, in turn, damage the overall competitiveness of the firm.
• If a firm is located in a country with illiquid, small, and/or
segmented capital markets, it can achieve this lower global cost
and greater availability of capital by a properly designed and
implemented strategy.
• Firms resident in countries with segmented capital markets must
devise a strategy to escape dependence on that market for their
long-term debt and equity needs.
17
Dimensions of the Cost and
Availability of Capital Strategy
18
Improving Market Liquidity by
Going Globally
• Market liquidity (observed by noting the degree to which
a firm can issue a new security without depressing the
existing market price) can affect a firm’s cost of capital.
• In the domestic case, a firm’s marginal cost of capital will
eventually increase as suppliers of capital become
saturated with the firm’s securities.
• In the multinational case, a firm is able to tap many
capital markets above and beyond what would have been
available in a domestic capital market only.
– Raising funds in the Euromarkets
– Selling security issues abroad
– Tapping local capital markets through foreign subsidiaries
19
Overcoming Market Segmentation
by Going Globally
• Market Segmentation arises from imperfections in
the financial markets that preclude the smooth
transfer of capital
• Fundamental Question: Are securities priced
relative to returns in their domestic market, or are
they priced relative to an international market
return?
• No clear answer - depends on the degree of
integration of the market with the rest of the
world
20
Market Segmentation
• Capital market segmentation is caused mainly by:
– Asymmetric information
– Lack of transparency
– High transaction costs
– Political risks (e.g., government controls over
local markets)
– Corporate governance issues
– Regulatory barriers
– Other political risks
21
Lowering the Cost of Capital by
Going Globally
• Where Diversification Advantages Arise
– Diversification by industry – the smaller the country,
typically, the less the choices for sectoral diversification
• Response – global sectoral funds
– Diversification by country or geographic region – distance,
cultural differences may reduce correlation among
investments (and therefore reduce the cost of capital)
• Response – country or regional funds
– Diversification by state of economic development – emerging
market country returns may not be completely correlated
with fully developed markets
• Response – emerging markets funds
22
Correlation Matrix for Developed
Countries
23
The Case for International
Diversification
24
Do MNEs Have a Higher or Lower WACC
Than Their Domestic Counterparts?
25
Optimal Financial Structure
and the MNE
• The domestic theory of optimal financial
structures needs to be modified by four more
variables in order to accommodate the case of
the MNE.
• These variables include:
– Availability of capital
– Diversification of cash flows
– Foreign exchange risk
– Expectations of international portfolio investors
26
Optimal Financial Structure
and the MNE
• Availability of capital:
– A multinational firm’s marginal cost of capital is constant
for considerable ranges of its capital budget
– This statement is not true for most small domestic firms
(as they do not have equal access to national capital
markets), nor for MNEs located in countries that have
illiquid capital markets (unless they have gained a global
cost and availability of capital)
27
Optimal Financial Structure
and the MNE
• Diversification of cash flows:
– The theoretical possibility exists that multinational firms
are in a better position than domestic firms to support
higher debt ratios because their cash flows are diversified
internationally
– As returns are not perfectly correlated between countries,
an MNE might be able to achieve a reduction in cash flow
variability (much in the same way as portfolio investors
who diversify their security holdings globally)
28
Optimal Financial Structure
and the MNE
• Foreign exchange risk:
– When a firm issues foreign currency denominated debt,
its effective cost equals the after-tax cost of repaying the
principal and interest in terms of the firm’s own currency
– This amount includes the nominal cost of principal and
interest in foreign currency terms, adjusted for any
foreign exchange gains or losses
– If a foreign currency is appreciated, it takes more
domestic currency to pay off the foreign currency debt.
29
Optimal Financial Structure
and the MNE
• Expectations of International Portfolio
Investors:
– The key to gaining a global cost and availability of capital
is attracting and retaining international portfolio investors
– If a firm wants to raise capital in global markets, it must
adopt global norms that are close to the US and UK
norms as these markets represent the most liquid and
unsegmented markets
30
Financial Structure
of Foreign Subsidiaries
• In addition to choosing an appropriate financial structure for
foreign subsidiaries, financial managers of MNEs must
choose among alternative sources of funds to finance the
foreign subsidiary.
• These funds can be either internal to the MNE or external to
the MNE.
• Ideally the choice should minimize the cost of external funds
(after adjusting for foreign exchange risk) and should choose
internal sources in order to minimize worldwide taxes and
political risk.
• Simultaneously, the firm should ensure that managerial
motivation in the foreign subsidiaries is geared toward
minimizing the firm’s worldwide cost of capital
31
Internal Financing of the Foreign
Subsidiary
32
External Financing of the Foreign
Subsidiary
33
Calculation of Trident’s Weighted
Average Cost of Capital
34
Cost of Debt
• The normal procedure for measuring the cost of
debt requires a forecast of interest rates for the
next few years, the proportions of various classes
of debt the firm expects to use, and the corporate
income tax rate.
• The interest costs of different debt components
are then averaged (according to their proportion).
• The before-tax average, kd, is then adjusted for
corporate income taxes by multiplying it by the
expression (1-tax rate), to obtain kd(1-t), the
weighted average after-tax cost of debt.
35
Cost of Equity
• The capital asset pricing model (CAPM)
approach is to define the cost of equity for a
firm by the following formula:
ke = krf + βj(km – krf)
ke = expected (required) rate of return on equity
krf = rate of interest on risk-free bonds (Treasury bonds, for
example)
βj = coefficient of systematic risk for the firm
km = expected (required) rate of return on the market
portfolio of stocks
36
International CAPM (ICAPM)
• ICAPM assumes the financial markets are
global, not just domestic.
• Our WACC equation adjusts for new
opportunities:
keglobal = krfg + βjg(kmg – krfg)
• The risk-free rate is unlikely to change
much, but beta easily could change.
37
Estimating the Global Cost of Equity
for Nestlé (Switzerland)
38
Cost of Equity
• While the field of finance does agree that a cost of equity
calculation should be forward-looking, practitioners typically
use historical evidence as a basis for their forward-looking
projections.
• While the CAPM is widely accepted as the preferred method
of calculating the cost of equity for a firm, there is rising
debate over what numerical values should be used in its
application (especially the equity risk premium).
• This risk premium is the average annual return of the market
expected by investors over and above riskless debt, the term
(km – krf).
• The equity risk premium varies internationally.
39
Equity Risk Premiums around the World,
1900–2002
40
Alternative Estimates of Cost of Equity for a
Hypothetical U.S. Firm
Assuming β = 1 and krf = 4%
41
Cost of Equity
Arithmetic vs. Geometric Returns
•
There is less debate regarding the use of arithmetic returns over
geometric returns.
•
The arithmetic mean is simply the average of the annual percentage
changes, while the geometric man is the compounded growth rate from
beginning to the end, without paying attention to the specific path
taken in between.
– The arithmetic average return answers the question: “What was
your return in an average year over a particular period?”
– The geometric average return answers the question: “What was
your average compound return per year over a particular period?”
•
Arithmetic returns capture the year-to-year volatility in markets;
geometric returns do not.
•
For this reason, most practitioners prefer the arithmetic measurement.
42
SOURCING EQUITY
GLOBALLY
43
The Global Sources of Funds for
International Firms
• Sources of funds for international firms
– Internal – retained earnings
– External – debt/equity/loans/hybrids
• The financing mix around the world
– Firms use different capital structures globally
– Internal capital generally utilized first
– Equity and bond markets dominate the U.S.:
• Most U.S companies tend to go public and raise capital in the
marketplace.
– Bond market dominates in Japan
– Loans dominate in Europe:
• Most European corporations tend to maintain private ownership, are
undercapitalized and tend to rely on bank financing.
44
Sources of Long-Term Capital for a
Multinational Corporation
45
Market Capitalization of the World
Market
• At year-end 2009, total market capitalization of the
world’s equity markets stood at $48,713 billion.
• Of this amount, 81 percent is accounted for by market
capitalization of major equity markets from 29
developed countries.
• The other 19% is accounted for by market
capitalization of developing countries in emerging
markets:
–
–
–
–
Latin America
Asia
Eastern Europe
Mideast/Africa
46
World Stock Market Capitalization
47
Market
Capitalization
as a
Percentage of
GDP
48
Recent Cross-Border Alliances of
Stock Exchanges
• Euronext represents the successful merger
between Paris, Amsterdam, Brussels and
Lisbon.
• In 2007…
– NYSE and Euronext merged.
– Deutsche Boerse purchased 5% of the Bombay
Stock Exchange.
– Tokyo Stock Exchange announced an alliance
with NYSE and the London Stock Exchange.
49
Designing a Strategy
to Source Equity Globally
• To implement the goal of gaining access to global capital
markets a firm must begin by designing a strategy that will
ultimately attract international investors.
• Most firms raise their initial capital in their own domestic
market.
• However, most firms that have only raised capital in their
domestic market are not well known enough to attract
foreign investors.
• Incremental steps to bridge this gap include conducting an
international bond offering and/or cross-listing equity shares
on more highly liquid foreign stock exchanges.
50
Crosslisting on Foreign Stock
Exchanges
1. Reasons for Cross-listing
2. Barriers to Cross-listing
3. American Depositary Receipts
51
Reasons for Cross-Listing
• To improve the liquidity of existing shares and to create a liquid
secondary market for any new equity issues in the market
– Liquidity refers to how quickly an asset can be sold without a
major price concession
• Increase its share price by attracting foreign investors and
overcoming mis-pricing in a segmented and illiquid home capital
market
• To increase firm’s visibility to and acceptance by customers,
suppliers, creditors, and/or host governments
• To establish a secondary market for shares used in acquisitions in
the host country
• To create a secondary market for shares for use in options and
other incentives for local managers and workers.
52
Barriers to Cross-Listing
and Selling Equity Abroad
• The most serious barriers of cross-listing includes
the cost associated with the listing on the
exchange such as
– Listing fees
– The future commitment to providing full and transparent
disclosure of operating results and balance sheets
– Increase cost of a continuous program of investor relations.
• However, the worldwide trend toward requiring
fuller, more transparent, and more standardized
financial disclosure of operating results and
balance sheet positions may have the desirable
effect of lowering the cost of equity capital.
53
American Depositary Receipts (ADRs)
•
American depository receipts (ADRs) are negotiable certificates issued
by a bank to represent the underlying shares of foreign stock, which
are held in trust at a foreign custodian bank,
•
Represents foreign shares that are deposited with a U.S. bank which in
turn issues ADRs in the name of the foreign company.
•
Traded in the United States and denominated in US dollars.
•
The price of a ADR generally tracks the price of the foreign security in
its home market, adjusted for the ratio of ADRs to foreign company
shares.
•
In the U.S, there are some 450 foreign companies listed on NYSE,
representing over 10% of NYSE transaction volume.
54
Mechanics of American Depositary
Receipts (ADRs)
55
Mechanics of Issuance of ADRs
NYSE
NASDAQ
OTC
U.S. Broker
Broker
orders
shares for new
ADR
Foreign Broker
Depository
issues new
ADR
Foreign broker
deposits shares
Depository
Depository
receives
confirmation
of
share deposit
Broker buys existing ADR
Delivery
Place order
ADR Investor
Custodian
Foreign broker buys shares
Foreign Exchange
56
Types of ADRs
57
Volvo ADR
• A good example of a familiar firm that trades
in the U.S. as an ADR is Volvo AB, the
Swedish car maker.
• Volvo trades in the U.S. on the NASDAQ under
the ticker VOLVY.
– The depository institution is JPMorgan ADR Group.
– The custodian is a Swedish firm, S E Banken
Custody.
• Of course, Volvo also trades on the Stockholm
Stock Exchange under the ticker VOLVB.
58
Valuation of ADRs
• For most ADRs, the price quoted by market makers is simply
the home price of the share adjusted by the exchange rate.
• Sold, registered, and transferred in the US in the same manner
as any share of stock with each ADR representing some
multiple of the underlying foreign share (allowing for ADR
pricing to resemble conventional US share pricing between $20
and $50 per share).
• ADRs can be exchanged for the underlying foreign shares, or
vice versa, so arbitrage keeps foreign and US prices of any
given share the same after adjusting for transfer costs.
• Since the ADR market is less liquid, a large bid-ask spread is
added.
59
ADRs - Advantages
• Easy, direct, and cost efficient investment in
foreign firms.
– ADRs are traded during US trading hours.
– Significant savings in trading costs and custody fees for
US investors.
– ADRs are issued in registered form, not bearer form.
– For some ADRs issued by emerging market companies
execution costs may be lower on U.S. than on local
markets.
– Simplification of payment of dividends and taxes on
dividends.
– Some ADRs issued by emerging market companies have
larger trading volume on NYSE than in their home
market.
60
ADRs – Advantages (contd)
• Classified as a U.S. domestic security even though
it represents ownership of a foreign security.
• Dollar price reflects local price movements
adjusted for change in the exchange rate.
Arbitrage between the ADR and the underlying
stock keeps prices in the two markets
synchronized.
• ADRs allow adjustment of the trading unit to an
attractive trading range (see next slide).
61
Using the ADR to Create a Favorable
Trading Range for a Stock
• Example: Besto Corp. in the UK trades at GBP
2.00 per share. At the current exchange rate of
$1.90/GBP, the share would trade at $3.80 per
share.
• One ADR is set to equal ten shares in Besto. The
price of the ADR is
• 10 x $3.80 = $38.00/ADR
62
ADRs - Disadvantages
• Only a limited number of companies have issued
ADRs and represent only a small proportion of
foreign market capitalization.
– Tend to be large companies in home country
and thus do not offer full international
diversification benefit.
• The foreign company must provide detailed
financial information to the sponsor bank, which is
a burden to the company who is not familiar with
U.S. security regulation.
63
Share of the Ten Largest Listed Companies
in the National Market Capitalization
64
Execution Costs in Basis Points
65
ADRs - Summary
• This is an excellent way to buy shares in a foreign company
while realizing any dividends and capital gains in U.S. dollars.
• However, ADRs do not eliminate the currency and economic risks
for the underlying shares in another country.
– For example, dividend payments in euros would be converted to U.S. dollars,
net of conversion expenses and foreign taxes and in accordance with
the deposit agreement.
• For individuals, ADRs are an easy and cost-effective way to buy
shares in a foreign company.
– They save money by reducing administration costs and avoiding foreign
taxes on each transaction.
• Foreign entities like ADRs because they get more U.S. exposure,
allowing them to tap into the wealthy North American equities
markets.
• In return, the foreign company must provide detailed financial
information to the sponsor bank.
66
Top 10 Most Widely Held DRs
67
Global Registered Shares (GRSs)
• While ADRs are quoted only in US dollars and
traded only in the US, Global Registered Shares
(GRSs) can be traded on equity exchanges around
the globe in a variety of currencies
• Simultaneously listed on several national markets.
• Give firms access to a larger base of new capital.
• London has proved to be very popular markets for
depositary receipts.
68
Global Registered Shares
• The merger of Daimler Benz AG and Chrysler Corporation in
November 1998 created DaimlerChrysler AG, a German
firm. The merger simultaneously created a new type of
equity share, called Global Registered Shares (GRSs).
• GRSs are traded globally, unlike ADRs, which are traded on
foreign markets.
• The company was renamed Daimler AG in October 2007
when it spun off Chrysler. The primary exchanges for
Daimler GRSs are the Frankfurt Stock Exchange and the
NYSE; however, they are traded on a total of 20 exchanges
worldwide.
• The shares are fully fungible—a GRS purchased on one
exchange can be sold on another. They trade in both U.S.
dollars and euro.
69
SOURCING DEBT GLOBALLY
70
Three Major International Debt
Markets and Instruments
71
International Debt Markets
• Bank loans and syndications:
– International bank loans have traditionally been sourced
in the Eurocurrency markets, there is a narrow interest
rate spread between deposit and loan rates of less than
1%.
– Eurocredits are bank loans to MNEs, sovereign
governments, international institutions, and banks
denominated in Eurocurrencies and extended by banks
in countries other than the country in whose currency
the loan is denominated.
– The syndication of loans has enabled banks to spread
the risk of very large loans among a number of banks
(this is significant for MNEs as they usually need credit
in an amount larger than a single bank’s loan limit).
72
International Debt Markets
• The Euronote market:
– Euronotes and Euronote facilities are short to medium in
term and are either underwritten and non-underwritten
– Euro-commercial paper is a short-term debt obligation of
a corporation or bank (usually denominated in US dollars)
– Euro medium-term notes is a new entrant to the world’s
debt markets, which bridges the gap between Eurocommercial paper and a longer-term and less flexible
international bond
73
International Debt Markets
• The International Bond Market
– Euro Bond
• Denominated in one or more currencies
• Traded in external markets outside the borders of the
countries issuing the currencies
• Euro bonds are not necessarily restricted to bonds sold in
Euroland.
– GM issues a dollar denominated bonds in Germany or Japan
– US. dollar Eurobonds, yen Eurobonds, Swiss frac Eurobonds
– Foreign Bond
•
•
•
•
Issued in domestic market by a foreign borrower
Denominated in domestic currency
Marketed to domestic residents
Regulated by domestic authorities
– Yankee bonds: Toyota issues a dollar denominated bonds in U.S.
– Samurai bonds: IBM issues a Yen denominated bonds in Japan
74
Types of Long-Term Debt
Instruments
• Straight fixed-rate issues – coupon fixed
– Zero coupon bonds or coupon
• Floating-rate notes – coupon based on base rate
such as LIBOR or Euribor
• Equity-related bonds
– Convertible bond – convertible into a number of shares
of equity
– Warrant – grants the bondholder the right to purchase a
certain amount of common stock at a specified price
75
Euro Bond
• Underwritten by a multinational syndicate of banks
• Issued by borrowers on the unregulated (or gently
regulated) external capital markets outside the borders of
the countries issuing the currencies.
• The major types of instruments are:
– Straight bonds with fixed coupons
– Floating-rate notes (FRNs) with a coupon indexed on a
short-term interest rate
– Bonds with some equity feature (convertibles).
• The euro is the major currency of issuance, followed by the
dollar.
76
Characteristics of Euro Bond
• Absence of regulatory interference
– National governments often impose tight controls on foreign issuers
of securities denominated in local currencies. However,
governments in general have less stringent limitations for securities
denominated in foreign currencies and sold within their markets (no
SEC registration or waiting period).
• Less stringent disclosure
– Disclosure requirements less stringent than those of the SEC
• Favorable tax status
– Eurobonds offer tax anonymity and flexibility. Interest paid on
Eurobonds is generally not subject to an income withholding tax
77
Characteristics of Euro Bond
• Legal and Fiscal Aspects:
– Bearer form (e.g., Eurobonds).
• The bearer of the bond is assumed to be its legal owner.
• Provide confidentiality of ownership.
– Registered form (e.g., In the United States, owners must be
registered in the issuer’s books)
• Allows for easier transfer of interest payments and amortization.
• Tax aspects
– Avoiding double taxation was a major impetus behind the development of the
international (Eurobond) market.
– To attract foreign investors in their government bonds, most countries
eliminate withholding taxes on foreign investment in their domestic bond
markets.
• Rating aspects
– Traditionally unrated, but now almost all issues are rated by Moody’s and Standard
& Poor’s
78
Withholding Taxes
• Prior to 1984, the United States required a 30
percent withholding tax on interest paid to
nonresidents who held U.S. government or U.S.
corporate bonds.
• The repeal of this tax led to a substantial shift in
the relative yields on U.S. government and
Eurodollar bonds.
• This lends credence to the notion that market
participants react to tax code changes.
79
International
Bond Tombstone
80
Front Cover
of the Offering
Memorandum
of the Hertz
Junk Bond Issue
Source: Courtesy Hertz Corporation
81
Hertz’s December 2005 Junk Bond Issues
82
Foreign Bond
• Bonds issued by foreign borrowers on the regulated domestic
capital markets of major developed countries for local investors.
• Denominated in domestic currency and regulated by domestic
authorities
• Underwritten by a syndicate composed of members from a
single country, sold principally within that country, and
denominated in the currency of that country. The issuer,
however, is from another country.
– Yankee bonds: Toyota issues a dollar denominated bonds in
U.S.
– Samurai bonds: IBM issues a Yen denominated bonds in Japan
– Rembrandt bonds (in the Netherlands), Matador bonds (in
Spain), Bulldog bonds (in the UK)
83
Bearer Bonds and Registered Bonds
•
Bearer bonds are bonds with no registered owner. As such they offer
anonymity, but they also offer the same risk of loss as currency.
•
Registered bonds are bonds where the owner’s name is registered with
the issuer.
•
U.S. security laws require Yankee bonds sold to U.S. citizens to be
registered, and to meet the requirements of the SEC, just like U.S.
domestic bonds.
•
Many borrowers find this level of regulation burdensome and prefer to
raise U.S. dollars in the Eurobond market.
– Eurobonds sold in the primary market in the United States may not be sold
to U.S. citizens.
– Of course, a U.S. citizen could buy a Eurobond on the secondary market.
84
The World’s Bond Markets:
A Statistical Perspective
• The total market value of the world’s bond markets are about 50%
larger than the world’s equity markets.
• Size of world bond market is estimated to be $66 trillion at the
start of 2007.
• The U.S. dollar, the euro, the pound sterling, and the yen are the
four currencies in which the majority of domestic and international
bonds are denominated.
• More domestic bonds than international bonds are denominated in
the dollar (39 percent versus 36.2 percent) and the yen (17.9
percent versus 2.7 percent), while more international bonds than
domestic bonds are denominated in the euro (47.5 percent versus
22.3 percent) and the pound sterling (8.2 percent versus 2.4
percent).
85
The World’s Bond Markets:
A Statistical Perspective
• Currency of denomination
–
–
–
–
Dollar has been the dominant currency
Euro is now the dominant currency
Also pound, yen and Swiss franc
Dual-currency bond
• Issued and paying currency in one currency but paying back
principal in another
• Interest rate often higher
• Combination between straight bond and long-term forward
contract
• Whether it is a good investment depends on movement of
forex rate
86
Amounts of Domestic and International
Bonds Outstanding
Currency
Domestic
Percent
International
Percent
Total
Percent
U.S. $
25,064.1
39.0%
7,129.20
36.2%
34,493.6
38.2%
Euro €
14,293.3
22.3%
12,387.6
47.5%
26,680.9
29.5%
1,559.5
2.4%
2,145.6
8.2%
3,705.1
4.1%
Yen ¥
11,521.5
17.9%
693.9
2.7%
12,215.4
13.5%
Other
11,783.0
18.3%
1,422.5
5.5%
13,205.5
14.6%
Total
64,221.9
100%
26,078.5
100%
90,300.4
100%
Pound £
(As of Year-End 2009 in Billions of U.S. Dollars)
87
Domestic and International Bonds
Outstanding
100
90
80
70
Domestic
50
International
40
Total
Percentage
60
30
20
10
0
U.S. dollar
Euro
Pound
(As of Year0End 2009 in Billions of U.S. Dollars)
Yen
Other
Total
Market Capitalization of International
Bonds Total $17.6 trillion
89
The Size and Structure of the World
Bond Market (in billions of U.S. dollars)
90
The Size and Structure of the World
Bond Market (in billions of U.S. dollars)
(cont.)
91
Top Arrangers of International Debt
92
The Internationalization of the World
Bond Market
93