Management 3460
Institutions and Practices in
International Finance
Fall 2003
Greg Flanagan
Chapter 7
International Bond Markets
Chapter Objectives
The student will be able to:
explain the difference between domestic,
foreign, and Euro bonds.
use present value in determining a bond’s
price.
describe the world’s bond markets and explain
their relative importance in international
finance.
be aware of the currency distribution,
nationality, type of Issuer.
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Chapter Objectives
The student will be able to:
explain the factors that affect the price and sales
of different bonds.
list and describe the different types of bond
instruments.
be aware of International bond market credit
ratings
explain the Eurobond market structure &
practices.
describe the J.P Morgan Domestic and other
International
Bond Market Indices
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Bonds
Domestic bond—issued in the country by a
domestic firm, government, or institution, in local
currency.
Foreign bond—issued in a country in local
currency by a foreign agent (borrower).
Eurobond—issued in a particular currency and
sold in countries other than the denominated
currency.
International bonds—foreign and Euro bonds.
Consul—perpetual bond a P = A/r
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Present Value (basic)
 PV is what one would be willing to pay today for
the right to receive a certain value in the future.
 Example: T-bills auctions determine the bank
rate.
 with annual interest rate r (assumed constant);
time period T in years; and future payout R (no
inflation)
PV = R
(1+r)T
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Note: r # PV $ and T # PV $ a
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Present Value (general)
 r the interest rate can vary.
The future payment may be a stream of
annual payments
with interest rate ri; time period T ; and future
payouts Ri (no inflation)
PV = R0 + R1 + R2
(1+r1)1 (1+r2)2
 PV =
ST Ri / (1+ri)i
…+
RT a
(1+rT)T
i=1
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Present Value (inflation)
The PV decreases because the interest rate r
includes inflation r + p.
The PV increases with inflation in terms of
future nominal payment
 PV
= R0 + (1+p) R1 + (1+p) R2
… + (1+p) R
T a
(1+p)(1+r1)1 (1+p) (1+r2)2
 PV
= R0 + (1+p) R1 + (1+p) R2
… + (1+p) R
(1+p)(1+r1)1 (1+p) (1+r2)2
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(1+p) (1+rT)T
T a
(1+p) (1+rT)T
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Present Value (inflation)
The PV is the same in nominal and real
if calculated consistently.
PV = R0
+
R1 + R 2
… + RT a
(1+r1)1 (1+r2)2
(1+r)T
a Use either Real or Nominal for both
but do not mix.
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The World’s Bond Market
The total market value of the world’s bond
markets are about 50% larger than the
world’s equity markets.
Most issues are denominated in U.S.
dollars (50%), Japanese Yen are second,
followed by the Euro, and British pound
sterling.
~82 percent of outstanding bonds are
domestic.
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Domestic and International Bonds
Outstanding As of Year-End 2001 in US $Billions
Currency Domestic Percent InternationalPercent Total
Weighted %
US $
15,377
50.4%
3,466 50.7% 18,843
50.5%
Euro €
5,226
17.1%
2,170 31.7%
7,396
20.4%
Pound £
921
3.0%
505 7.4%
1,426
4.0%
Yen ¥
5,847
19.2%
409 6.0%
6,256
16.2%
other
3,118
10.2%
289 4.2%
3,407
8.9%
Total
30,489 100.0%
6,839 100% 37,328
100%
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Domestic and International
Bonds Outstanding
As of Year-End 2001 in U.S. $Billions
$40,000.0
$35,000.0
$30,000.0
$25,000.0
Domestic
$20,000.0
International
$15,000.0
Total
$10,000.0
$5,000.0
al
To
t
th
er
O
en
Y
un
d
Po
o
Eu
r
U
.S
.d
ol
la
r
$-
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Domestic and International
Bonds Outstanding
As of Year-End 2001 in U.S. $Billions
60.0%
50.0%
40.0%
Domestic
International
30.0%
Total
20.0%
10.0%
0.0%
U.S.
dollar
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Euro
Pound
Yen
Other
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Distribution of International Bond
Offerings by Nationality
13
International Bonds
Nationality
2001 US$B Percent
Austrailia
99.8
1.5%
Canada
208.3
3.0%
France
366.7
5.4%
Germany
889.4
13.0%
Italy
259.3
3.8%
Japan
245.6
3.6%
Netherlands
293.9
4.3%
United Kingdom
571.5
8.4%
United States
2,170.3
31.7%
Other developed
788.2
11.5%
Off-shore
87.0
1.3%
Developing
481.3
7.0%
Int Institutions
377.1
5.5%
Total
6,838.4 100.0%
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2001 US$B
Int Institutions
Austrailia
Canada
France
Developing
Off-shore
Germany
Other developed
Italy
Japan
Netherlands
United Kingdom
United States
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International Bonds by Type of Issuer
Type
1997
Financial Institutions 1,475.1
Governments
710.3
International Institutions 299.5
Corporations
837.9
Total
3,322.8
15
1998
1,885.8
863.4
370.8
983.4
4,103.4
1999
2,397.2
1,032.1
375.2
1,301.0
5,105.5
2000
3,470.1
1,173.3
374.1
861.8
5,879.3
2001 2001%
4,030.3 58.9%
1,416.5 20.7%
377.7
5.5%
1,014.6 14.8%
6,839.1 100.0%
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International Bonds by Type of Issuer
8,000
US$ (Billlions)
7,000
6,000
Financial Institutions
Governments
International Institutions
Corporations
Total
5,000
4,000
3,000
2,000
1,000
0
1997 1998 1999 2000 2001
Year
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International Bonds by Type of
Issuer 2001 US$ (Billions)
International Corporations
Institutions
Governments
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Financial
Institutions
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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: the owners name is
registered with the issuer.
U.S. security laws require Yankee bonds
sold to U.S. citizens to be registered.
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National Security
Registrations
Yankee bonds must 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 Euro bond market.
Eurobonds sold in the primary market in
the United States may not be sold to U.S.
citizens.
U.S. citizen can buy Euro bonds on the
secondary
market.
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U.S. 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.
a market participants react to tax code
changes.
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Recent US Regulatory Changes
Shelf Registration (SEC Rule 415)
Allows the issuer to preregister a securities
issue, and then offer the securities when the
financing is actually needed.
SEC Rule 144A
Allows qualified institutional investors to
trade private placements.
These issues do not have to meet the strict
information disclosure requirements of
publicly traded issues.
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Global Bonds
A global bond is a very large international
bond offering by a single borrower that is
simultaneously sold in North America,
Europe and Asia.
Mostly institutional investors are the
purchasers so far.
United States SEC Rule 415 and 144A
have likely facilitated global bond offerings,
and more can be expected in the future.
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Types of Instruments
Straight Fixed Rate Debt
Floating-Rate Notes
Equity-Related Bonds
Zero Coupon Bonds
Dual-Currency Bonds
Composite Currency Bonds
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Straight Fixed Rate Debt
These are “plain vanilla” bonds with a
specified coupon rate and maturity and no
options attached.
Since most Eurobonds are bearer bonds,
coupon dates tend to be annual rather than
semi-annual.
The vast majority of new international bond
offerings are straight fixed-rate issues.
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Floating-Rate Notes
Just like an adjustable rate mortgage.
Common reference rates are 3month and 6-month U.S. $ LIBOR
Since FRN reset every 6 or 12
months, the premium or discount is
usually quite small…as long as there
is no change in the default risk.
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Equity-Related Bonds
Convertibles
Convertible bonds allow the holder to
surrender his bond in exchange for a
specified number of shares in the firm of
the issuer.
Bonds with equity warrants
These bonds allow the holder to keep his
bond but still buy a specified number of
shares in the firm of the issuer at a
specified
price.
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Zero Coupon Bonds
Zeros are sold at a large discount from face
value because there is no cash flow until
maturity.
In the U.S., investors in zeros owe taxes on
the “imputed income” represented by the
increase in present value each year, while in
Japan, the gain is a tax-free capital gain.
Pricing is very straightforward:
parvalue
PV =
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(1  r )
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T
Dual-Currency Bonds
A straight fixed-rate bond, with
interest paid in one currency, and
principal in another currency.
Japanese firms have been big issuers
with coupons in yen and principal in
dollars.
Good option for a MNC financing a
foreign subsidiary.
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Composite Currency Bonds
Denominated in a currency basket,
like the SDRs or ECUs instead of a
single currency.
Often called currency cocktail
bonds.
Typically straight fixed rate debt.
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November 4, 2003
Characteristics of International
Bond Market Instruments
Instrument
Frequency of
Payment
Size of
Coupon
Payoff at
Maturity
Straight Fixed-Rate
Annual
Fixed
Currency of issue
Floating Rate Note
Every 3 or 6 months
Variable
Currency of issue
Convertible Bond
Annual
Fixed
Straight fixed rate
with equity warrants
Annual
Fixed
Zero
none
zero
Currency of issue
or conversion to
equity shares.
Currency of issue
plus conversion to
equity shares.
Currency of issue
Dual Currency
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Bond
Annual
Fixed
Dual currency
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Brady Bonds
Convert ‘bad’ loans to marketable bonds
at 65% of face value with reduced
interest rate
Extend maturities to 25-30 years
Buy collateral zero coupon US treasury
bonds with
$100 million converted covering 92% of
private
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November 4, 2003
International Bond Market
Credit Ratings
Fitch IBCA, Moody’s and Standard
& Poor’s sell credit rating analysis.
Focus on default risk, not
exchange rate risk.
Assessing sovereign debt focuses
on political risk and economic risk.
See: Exhibit 7.7
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Eurobond Market Structure
Primary Market
Very similar to U.S. underwriting.
Secondary Market
OTC market centered in London.
• Comprised of market makers as well as brokers.
• Market makers and brokers are members of the
International Securities Market Association (ISMA).
Clearing Procedures
Euroclear and Cedel handle most Eurobond
trades.
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International Bond Market
Indices
J.P. Morgan and Company
Domestic Bond Indices
International Government bond index
for 18 countries.
Widely referenced and often used as
a benchmark.
Appears daily in The Wall Street
Journal
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International Bond Market
Indices
Wall Street Journal publishes daily
values of yields Government bonds.
Compares interest rat s and term
structures
Financial Times publishes
“Benchmark Government Bonds”
table comparing coupon rates, prices,
yields etc.
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