Examine the use of international debt markets as a source of funding

1. IRL 6230: INTERNATIONAL
FINANCIAL MECHANISMS
Financial and
Sovereign Debt

2. 11-2
Learning Objectives
Examine the use of international debt markets
as a source of funding
Describe the role of euromarkets and US
capital markets
Distinguish between eurocurrency, Euronote
and Eurobond markets
Describe the parties borrowing in these
markets
Consider debt markets and securities
Explain the role of credit rating agencies

3. International debt markets
Consist of large unregulated money and capital
markets
Major centres in London, the Middle East and
Asia
USD is the dominant currency
Euro-zone is the domestic market for countries
adopting the euro currency
Debt securities denominated in euros have
grown as the predictability, liquidity and volatility
of the euro consolidates

4. The Euromarkets
Initially evolved to enable countries to hold USD
outside of the US, e.g. USSR
Although euromarkets originated in Europe,
euromarket transactions can occur in any nation-
state of the world
‘Euro’ means ‘outside’
A euromarket transaction is conducted in a
foreign country but not in its currency
Growth in euromarket transactions are driven
mainly by interest rate factors, i.e. lower
borrowing and higher lending rates

5. The Euromarkets cont.
Provide intermediated and direct finance
over a range of terms to maturity and are
categorised as follows:
Eurocurrency markets
Provide intermediated bank finance
Euronote markets
Provide short-term direct finance
Eurobond markets
Provide medium- to long-term direct
finance

6. The Euromarkets cont.
International debt markets
 Are used by
Financial institutions, who are the largest
borrowers
Governments and corporations
 Attract investors as they
Provide a deep and liquid market
Allow higher investment returns
Are a form of portfolio diversification
 Have grown in importance due to deregulation of FX
markets
 Accessible to borrowers with a strong financial
reputation and a very good credit rating

7. Eurocurrency Market
The major forms of
eurocurrency facilities
discussed are
Short-term bank advances
Stand-by arrangements
Medium- to long-term
eurocurrency loans

8. Short-term bank advances
Similar to term loans or fully-drawn advances
Term determined, and full amount drawn-down
on approval
Commitment fee may be charged if advance not
drawn-down immediately after approval
May be extended by ‘revolving credit’, where a
mixture of currencies can be chosen at each
rollover (to match borrower’s currency inflows)
LIBOR typically used as indicator or reference
rate

9. Eurocurrency stand-by facilities
A source of ‘back-up’ funds to meet
short-term cash shortfalls
Funds more likely to be available
offshore in periods of tight domestic
liquidity
Short-term finance (up to two years)
Interest charge and commitment fee
apply

10. Medium- to long-term eurocurrency bank loans
Loan size about USD3–100 million
Larger loans may involve a syndicate of banks
Term is typically 5 to 10 years
Loans usually fully drawn-down at
commencement of loan unless an availability
period is arranged, which attracts a
commitment fee
Interest rate normally above LIBOR and fixed
for a period of 1 to 12 months, plus other fees
apply

11. Euronote Market
Active market for short-term promissory
notes or commercial paper
Euro-notes take several forms, two of
which are:
Euronote issuance facility (NIF)
Euro-commercial paper (ECP)
Demystified in that these securities are
fundamentally the same as domestic
money-market and capital-market securities

12. Euronote issuance facility (NIF)
A short-term unconditional bearer promissory
note drawn by the borrower in borrower’s name
Underwriting banks guarantee funds at issue
and convert funding into medium term through
a rollover facility
The instrument
Discount security
Maturity usually 30 to 180 days
Bearer securities in denominations of USD
100 000 to 500 000

13. Bonds
A bond is a long-term debt investment in which an
investor loans money to an entity (typically
corporate or governmental) which borrows the funds
for a defined period of time at a variable or fixed
interest rate.
Bonds are used by companies, municipalities, states
and sovereign governments to raise money and
finance a variety of projects and activities.
Owners of bonds are debt-holders, or creditors, of
the issuer.
Can be domestic or International
Domestic bonds
Bonds issued into a local market, in the local
currency, by a local company

14. Convertible Bonds
A convertible bond issue allows the investor to
exchange the bond for a predetermined number of
equity shares of the issuer.
The floor-value of a convertible bond is its straight
fixed-rate bond value.
Convertibles usually sell at a premium above the
larger of their straight debt value and their
conversion value.
Investors are usually willing to accept a lower coupon
rate of interest than the comparable straight fixed
coupon bond rate because they find the conversion
feature attractive.

15. International bonds
The same as normal bonds.
But the key concept is that
international bonds are issued
either in a currency other than that
of the country in which they are
issued or by an issuer that doesn’t
reside in the country in which they
are issued.

16. International Bond Market participants
International Bond Market participants are either
buyers (debt issuers) or sellers (institutions) of funds
and often both of them. Participants include −
Institutional investors
Governments
Traders
Individuals
Since there is a specificity (quality) of individual bond
issues, and a condition of lack of liquidity in case of
many smaller issues, a significantly larger chunk of
outstanding bonds are often held by institutions, such
as pension funds, banks, and mutual funds.

17. International bonds
Foreign Bonds can be issued in any currency and can have colorful
nicknames such as :
Yankee Bonds Foreign Bonds sold in U.S. (Attract the max number of
issuance)
Samurai Bonds Foreign Bonds sold in Japan. (Attract the max number of
issuance)
Bulldog Bonds Foreign Bonds sold in U.K.
Rembrandt Bonds Foreign Bonds sold in Netherland.
Matador Bonds Foreign Bonds sold in Spain.
Maple Bonds Foreign Bonds sold in Canada.
Kangaroo Bonds Foreign Bonds sold in Australia.
Supranational Bonds Issued when two or more central governments issue
foreign bonds to promote economic development for the member countries.
These include bonds issued by the International Bank for Reconstruction
and Development, or World Bank, and the International American
Development Bank.

18. Types of the International Bonds
Divided into four separate
segments
Sovereign Bonds
Foreign Bonds
Global Bonds
Eurobonds

19. Sovereign Bonds
Bonds issued by a country's central government.
Tend to be the largest sector of a bond market in any
country.
They can be issued in their home country, the Eurobond
market or the foreign sector of another country.
They are typically denominated in the home country's
currency, however, but they are not required to be.
Countries with an unstable economy tend to denominate its
bonds in the currency of a country with a stable economy.
(Ex: Developing Countries having emerging markets such as
those in Africa, Asia, Latin America, Middle East, Russia, and
eastern/southern Europe ).

20. Foreign Bonds
Type 1
Bonds Issued by foreign entity
Outside the country where the entity resides
Denominated in the currency of the country where issued
Example:
Toyota issues $ denominated bonds in USA.
Type 2
Bonds Issued by foreign entity
Outside the country where the entity resides
Denominated in currency OTHER THAN THAT of the country where
issued
Example:
Toyota issues Yen denominated bonds in USA

21. Global Bonds
Similar to Foreign bonds market, but issued in
many different countries and sold worldwide
(practically: North America, Europe, Asia)
Denominated in 1 or many currencies and can
be issued in the same currency as the country of
issuance.
Registered in each market where issued.
Global bond issues were first offered in 1989.
Typically Issued by international companies that
possess high credit ratings.

22. Eurobond
A bond issued and traded
outside the country whose
currency it is denominated in,
and outside the regulations of a
single country;
Usually a bond issued by a non
European for sale in Europe
It is also called global bond

23. Eurobonds cont.
Differ from the others in that; Bonds are not sold in any
national bond market.
Issued by a group of multinational banks.
If a Eurobond is designated in any currency, it would be
sold outside the country which uses that currency.
Ex : if a Eurobond is denominated in the US $ , it would not
be sold in the US.
Very Preferable because it has comparatively lower
costs and lower regulations.
Example 1: Toyota issues Yen-denominated bonds in
“offshore” market. (Foreign Banks or corporations located
outside of one’s national boundaries).
EUROYEN Bond

24. EuroBonds Example 2
Swiss borrower issues $ denominated bonds to
investors in UK, India, and Japan.
Bearer Bonds
Bonds with no registered owner.
They offer anonymity but they also offer the
same risk of loss as currency.
Registered Bonds
The owner’s name is registered with the
issuer. Ex: U.S. security laws require Yankee
bonds sold to U.S. citizens to be registered.

25. Historical Overview and
Dimensions of the Eurobond Market
The Interest Equalization Tax (IET) of 1963
taxed purchases of foreign stocks and bonds
issued or trading in the United States.
The IET was proposed as a temporary measure
to reduce U.S. capital outflows and take pressure
off the U.S. balance of payments.
However, it effectively closed down the Yankee
bond market, and induced foreign borrowers to
migrate offshore and set up a US$-bond market
in London and Luxembourg.

26. Historical Overview and Dimensions
of the Eurobond Market cont.
Now, the annual volume of new issues often
nears or surpasses the annual volume of new
U.S. corporate bond issues.
Increasingly too, Eurobonds have been issued in
currencies other than the US$, and then
combined with a currency swap to achieve lower
cost funds in US$, etc.
At the same time, the market has grown in
terms of bond maturities, issue size, and
secondary market trading.

27. Eurobond Practices:
Primary Market
A borrower desiring to raise funds by issuing Eurobonds
to the investing public will contact an investment banker
and ask it to serve as the lead manager of an
underwriting syndicate that will bring the bonds to
market.
The underwriting syndicate is a group of investment
banks, merchant banks, and the merchant banking arms
of commercial banks that specialize in some phase of a
public issuance.
The lead manager will sometimes invite co-managers to
form a managing group to help negotiate terms with
the borrower, ascertain market conditions, and manage
the issuance.

28. Issue and trading of eurobonds (cont.)

29. Bond Investor
Bond Issuer
Structure of a
Eurobond Syndication
Selling Group
Fiscal Agent
or Trustee
& Principal
Paying Agent
Underwriters
A Eurobond offering brings together the bond issuer and investor.
Intermediaries
The process is facilitated by intermediaries.
and then assembles
other firms to share
in the underwriting
risks of the issue.
Finally, the management group
organizes a group of firms to place the
bonds with the ultimate investors.
Management
Group
The lead management group meets with the issuer to design the
issue size, currency, maturity,
coupon, etc...

30. Structure of a
Eurobond Syndication
In practice, a single firm may play
more than one role.
In the case of a bought deal, lead
management, underwriting, and
bond sales are all provided by a
single intermediary.

31. Characteristics of Eurobonds
A Eurobond is an international debt security.
Structure: similar to the standard debt security
used in domestic markets.
Basic characteristics:
Eurobonds are transferable (usually, bearer).
Eurobonds are intended to be tradable.
Eurobonds are a medium- to long-term debt security.
Eurobonds are generally launched through a public offering.
Eurobonds are generally listed on a stock exchange.
Transferability should be simple
bearer bond (you have it, its yours)
registered bond (your name should be in a book to own the bond)
the majority of Eurobonds are bearer bonds.

32. How are bond priced?
Bonds typically trade in 1,000 increments of a given currency (say,
USD or EUR) and are priced as a percentage of par values (100%).
Price of a bond: The NPV of all future cash flows generated by the
bond discounted at an appropriate interest rate – i.e., YTM (there is a
one-to-one relation between the price of a bond (P) and the YTM of a
bond).
 P = C1/(1+YTM) + C2/(1+YTM)2 + C3/(1+YTM)3 + ... + CT/(1+YTM)T,
Ct = Cash flows the bond pays at time t. (CT = coupon + Face ValueT)
Once you know the YTM, you know the price –given that you know Ct.
Interesting mathematical fact: If C=YTM => P = 100 (par or
100%).

33. What Is Yield to Maturity (YTM)?
Yield to maturity (YTM) is the total return anticipated
on a bond if the bond is held until it matures.
Yield to maturity is considered a long-term bond
yield but is expressed as an annual rate.
In other words, it is the internal rate of return (IRR) of
an investment in a bond if the investor holds the bond
until maturity, with all payments made as scheduled
and reinvested at the same rate.
Yield to maturity is also referred to as "book yield" or
"redemption yield."

35. Pricing Eurobonds
As a parallel market, the Eurobond
market must offer prices and terms that
are advantageous to both issuers and
investors to attract them from the
traditional onshore markets.
In particular, the Eurobond market
often allows firms to issue bonds more
quickly and with lower disclosure costs.

36. Tombstone of Slovak Republic’s Eurobond

37. Advantages of Eurobonds
Considerable market capacity
Diversifying sources of
borrowings
Source for long-term
investment resources
Access to a broad investor base
Establishing a credit history

38. International Bond Market Indices
A bond index or bond market index is a method of measuring
the value of a section of the bond market.
It is computed from the prices of selected bonds (typically a
weighted average).
It is a tool used by investors and financial managers to
describe the market, and to compare the return on specific
investments.
International Bond Market Indices :
(Bank of America) Merrill Lynch Global Bond Index
Barclays Capital Aggregate Bond Index
Citi World Broad Investment-Grade Bond Index (WorldBIG)
Government Bond Indices :
Barclays Inflation-Linked Euro Government Bond Index
Citi World Government Bond Index (WGBI)
FTSE UK Gilts Index Series 4. J.P. Morgan Government Bond Index

39. Credit Rating Agencies
An organisation specialising in assessing the credit
quality associated with financial obligations, e.g. S&P
(Standard & Poor’s)
The rating methodology develops a profile balancing
business risk, financial risk and environmental risk
factors
S&P provide
Long-term credit ratings (AAA to D), with BBB and above
being ‘investment grade’
Short-term credit ratings (A-1 to D)
A rating of a corporation overall

40. Credit Rating Agencies (cont.)
S&P provide (cont.)
Issue-specific credit ratings on the credit worthiness
of an obligor with respect to a specific financial
obligation
Credit ratings of specific issues into international
markets include
Country risk—risk that changes in the laws of a
foreign currency affect financial transactions
Sovereign risk—risk that a foreign government will
default on its obligations
Foreign exchange risk— risk that the value of one
currency, relative to another, will change

41. 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.

42. What is 'Sovereign Debt'
Sovereign debt - also referred to as government
debt, public debt, and national debt - is a central
government's debt.
Sovereign debt is issued by the national
government in a foreign currency in order to
finance the issuing country's growth and
development.
The stability of the issuing government can be
provided by the country's sovereign credit
ratings which help investors weigh risks when
assessing sovereign debt investments.

43. 'Sovereign Debt‘ cont.
Sovereign debt can either be internal debt or external
debt.
If categorized as internal debt, it is debt owed to
lenders who are within the country.
If categorized as external debt, it is debt owed to
lenders in foreign areas.
Another way of classifying sovereign debt is by the
duration until the repayment of the debt is due.
Debt classified as short-term debt typically lasts for less
than a year, while debt classified as long-term debt
typically lasts for more than ten years.

44. sovereign debt crisis
A sovereign debt crisis occurs when a country can no
longer pay the interest on its debt. Just like a business,
the nation finds that worried lenders demand greater
interest payments on new debt. There are three critical
differences between sovereign debt and household or
business debt that lays the groundwork for this crisis:
There is no international bankruptcy court that lenders
can go to for fair adjudication. That makes it easier for
countries to default.
Sovereign debt is not secured by any collateral. In that
regard, it is more like credit card debt than a mortgage or
auto loan.
Most countries can print their currency to pay off a debt.

45. Onshore-Offshore Arbitrage Opportunities
During some periods, certain U.S. firms were
able to issue Eurodollar bonds not only at prices
below onshore rates, but also at prices below
U.S. Treasury rates.
This raises the prospect of arbitrage:
Firms may issue debt in the Eurodollar market
and close their position by purchasing U.S.
Treasury securities with the same maturities.
The U.S. Treasury itself may reduce its funding
costs by going to the Eurobond market.

46. 11-46
Summary
International debt markets are attractive to both
investors and borrowers
Major eurocurrency facilities include short-term bank
advances, stand-by facilities and medium- to long-term
bank loans, and are attractive for
The lower cost of borrowing
Creating a natural hedge
The size of the eurocurrency market
The euronote market is a market for short-term direct
debt markets
Main security is the P-note (commercial paper) with two
main facilities, NIF and ECP

47. Summary (cont.)
The eurobond market is a market for the issue
of bonds in a currency other than the currency
of the market of issue, and it includes MTNs,
straight (fixed coupon) bonds and floating rate
notes
Debt markets in the US include commercial
paper (USCP), US foreign (Yankee) bonds and
American depository receipt (ADRs)
Credit rating agencies assess the credit quality
of a firm and/or its financial obligations

48. THANK YOU