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Title:

The International Bond Market

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Bulldog bonds. Rembrandt bonds. Yankee bonds. Global bonds ... 1 b at 11.7% maturing on September 30, 1988, registered notes to American and foreign investors ... – PowerPoint PPT presentation

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Title: The International Bond Market


1
The International Bond Market
2
Outline
  • Types of bonds
  • Comparative bond characteristics
  • The Gray Market
  • Onshore-Offshore arbitrage

3
Classification
  • Foreign Bonds
  • Global bonds
  • Eurobonds

4
Foreign Bonds
  • Issued by a foreign entity and denominated in
    domestic currency

5
Foreign Bonds Examples
  • Samurai bonds
  • Bulldog bonds
  • Rembrandt bonds
  • Yankee bonds

6
Global bonds
  • Sold simultaneously on several markets in the
    currency of each market

7
Global bonds
  • First offered by the World Bank, Ontario-Hydro,
    and Hydro-Quebec.

8
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.

9
Eurobonds Exemplification
  • A bond issued by Rhone-Poulenc and sold in the US
    in Swiss francs.

10
Eurobonds
11
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.

12
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.

13
Selecting the currency of issue Exemplification
  • Coca-Cola will float the pound bond only if
  • 1r()n ES 1r(pounds)n /S
  • Writing ES S(1d) 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

14
Selecting the currency of issue Exemplification
  • 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.

15
Comparative characteristics of bonds issues
16
Eurobond underwriting
  • In general, similar to regular bond underwriting
  • Differences
  • Lead manager separate from selling group
  • Variable price re-offering

17
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.

18
The Gray Market Exemplification
19
The Eurobond pricing paradox
  • Eurobonds yields are lower, but issuance costs
    are higher than in North-America.

20
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

21
The Eurobond pricing paradox
  • Could tax withholding and/or reporting to
    national authorities make a difference?

22
Onshore-Offshore Arbitrage
  • O-OA represents an attempt at taking advantage of
    the Eurobond pricing paradox.

23
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.

24
Onshore-Offshore Arbitrage EXXON Capital
Corporation, a subsidiary of EXXON Corporation.
25
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
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