Interest Rate

1
International Debt Markets (or part II of
chapter 13)
2
Agenda

• What is Eurocurrency?
• International debt market instruments
• Bank loans Syndicated Credits.
• Euro-note Market Instruments.
• International Bond Market Instruments.
• Project financing.

3
Eurocurrency Markets

• Eurocurrencies domestic currencies of one
  country on deposit in 2nd country.
• Pros flexible maturities higher yields govt
  regulation-free.
• E.g. Eurosterling, Euroeuro,Euroyen, Eurodollar.
• Eurodollar deposits / demand deposits!
• Cant transfer by check.
• Underlying balance kept _at_ US correspondent bank.
• History why Eurocurrency market so popular?
• Eastern-Europe holders post-WW2 deposited US
  funds in London.
• Central banks kept reserves in Eurodollar
  deposits.
• 1957 Bank of England imposed tight controls on
  sterling lending.
• 1960s US BOP problems segmented US debt market.

4
International Debt Markets
5
Bank Loans Syndicated Credits

• Eurocredits
• Loans denominated in eurocurrencies extended by
  banks in countries other than country of
  denominating currency.
• Tied to LIBOR.
• Short-term maturities 6 months.
• Narrow spreads, usually less than 100 basis
  points.
• Syndicated credits
• Arranged by lead bank w/ other banks
  participation.
• Interest expense tied to LIBOR.
• Upfront fee.
• Commitment fee (on unused portion).

6
Euronote Market

• Medium- short- term debt instruments.
• Two types
• Underwritten facilities.
• Non-underwritten facilities Euro-commercial
  paper (ECP) Euro Medium-term notes (EMTN)
• Euronote
• Short-term, negotiable promissory notes in
  eurocurrency.
• E.g. Revolving Underwriting Facility Note
  Issuance Facility.
• Cheaper than syndicated loans. Why?
• Euro-commercial paper (ECP)
• Maturities of 1,3, 6 months.
• Euro Medium-term notes (EMTN)
• Maturities 9 months to 10 years.
• Allows continuous issuance.
• Coupons paid on set calendar dates.
• Issued in small chucks (2-5m).

7
International Bond Market

• World bond market 50 larger than world equity
  market.
• Bonds currencies 2001 US (49), Euro (37)
  Yen (5).
• Popular no regulatory interference, lax
  disclosure, tax anonymity.
• Bond types
• Eurobonds
• Sold to investors in national capital markets
  other than country of denominating currency.
• E.g. Evian (France) issues -denominated bonds in
  UK Japan.
• Types
• Straight Fixed-rate issue.
• Floating rate note (FRN).
• Equity related issue convertible bond.
• Foreign bonds
• Sold w/in country of denominated currency,
  however issuer is from another country.
• E.g. Air Portugal offers bond in US priced in .
• Include Yankee bonds (sold in US), Samurai bonds
  (Japan), Bulldogs (UK).

8
Currencies to denominate bonds?
(in US billions) 2000 2001
US 791.8 1,131.9
Euro 581.7 841.9
Yen 128.7 125.3
Other currencies 201.2 207.5
Source BIS Quarterly Review, December 2002
9
Types of Eurobonds issued?
(in US billions) 2000 2001
Floating rate 518.2 643.6
Fixed rate 1,128.7 1,590.7
Equity-related 56.5 72.2
Source BIS Quarterly Review, December 2002
10
Eurobonds

• Straight Fixed Rate Debt
• Plain vanilla bond w/ specified coupon
  maturity.
• Most Eurobonds are bearer bonds gt coupon dates
  annual.Why?
• Vast majority (65) of new international bond
  offerings are straight fixed-rate.
• Floating Rate Notes (FRN)
• Like adjustable rate mortgage.
• Allows shifting interest rate risk to borrower.
• Reference rates are 3- 6-month US LIBOR.
• Equity-Related Bonds
• Convertibles
• Allow exchange bond for shares in issuers firm.
• Sell _at_ lower coupon rate of interest. Why?
• Bonds w/ equity warrants
• Allow holder keep bond buy shares in issuers
  firm _at_ specified price.

11
Eurobond Credit Ratings

• Main providers Moodys, Fitch, Standard
  Poors.
• Moodys nine categories from Aaa to C.
• Investment grade ratings Aaa ? Baa.
• Focus on default risk, not exchange rate risk.
• Default rate is higher for foreign currency debt
  than local currency debt.
• Inflation is key factor.

12
US Regulation on Intl Bonds

• Eurobonds US citizen cannot buy them in US
  primary market gt U.S. citizen could buy on
  secondary market.
• Yankee bonds Yankee bonds sold to US citizens
  are registered.
• Bearer vs. Registered No registration for bearer
  bonds. gt Investor anonymity. Opens door for tax
  evasion
• Tax Concerns until 1984, US had 30 withholding
  tax on interest to nonresident holder of US
  T-bonds.

13
Project Financing

• Financing arrangement for long-term, large-scale
  capital projects, generally w/ high risk.
• Used by MNE in development of infrastructure
  projects in emerging markets
• Projects highly leveraged (60 debt). Why?
• Scale of project precludes single equity
  investor.
• Many projects funded by governments.

14
Project Financing Characteristics

• Separation of project from its investors
• Project legally financially separate.
• Allows project to obtain own credit rating cash
  flows.
• Long-lived capital intensive
• Cash flow predictability from third-party
  commitments
• Third party commitments are usually suppliers or
  customers of project
• Finite projects with finite lives

15
Things to remember

• What is Eurocurrency?
• International debt market instruments
• Bank loans Syndicated Credits.
• Euro-note Market Instruments.
• International Bond Market Instruments.
• Project financing.