Brady Bonds

1
Brady Bonds

• Jose A. Boza
• David Marquez
• Elton Festari
• Rahul Bakshi

2
Presentation Outline

• Brady Bond Introduction
• Citibank Requirements
• Mexican Bond Calculations
• Venezuela Bond Calculations
• Costa Rica Bond Calculations
• Country Risk Using Brady Bonds
• Recommendations
• Questions

3
Brady Bonds

• Securities that have resulted from the exchange
  of commercial bank loans, sometimes defaulted
  loans, into new bonds.
• Purpose To replace the sovereign debt of
  developing countries (debt service reduction
  agreement).
• Par loans exchanged for fixed rate bonds,
  issued with below-market interest rates (issued
  at face value)
• Discount floating rate bonds, issued with
  market interest rates (issued below face value).

4
Citibank Requirements

• Should company buy Mexican par or discount bonds?
• Should company buy Venezuelan par or discount
  bonds?
• Fair opening price for Costa Rican bonds
• Should Citibank sell its Mexican bonds in 1996?
• How can Citibank hedge its Mexican exposure?

5
Mexico Bonds 1990 Issue

• Bond characteristics
• 30 year maturity
• 30-yr US treasury bond collateral for face value
• 3 coupon payments (18 months) collateral

6
Mexico Bonds 1990 Issue

• Par bonds
• Fixed coupon of 6.25
• Discount bonds
• LIBOR plus 13/16

7
Mexico Bond Calculations

• Data required
• YTM U.S. 7.925
• YTM Mexico 15
• LIBOR 8.5
• Default probability for Mexico 5.5

8
Mexico Bond Calculations

• Par bond NPV
• P 38.08

9
Mexico Bond Calculations

• Discount bond NPV
• P 51.77
• Recommendation
• Buy Par bonds.

10
Venezuela Bonds 1990 Issue

• Bond characteristics
• 30 year maturity
• 30-yr US treasury bond collateral for face value
• 2.3 (14 months) coupon payments collateral

11
Venezuela Bonds 1990 Issue

• Par bonds
• Fixed coupon of 6.75
• Discount bonds
• LIBOR plus 13/16

12
Venezuela Bond Calculations

• Data required.
• YTM U.S. 7.925
• YTM Venezuela 14
• LIBOR 8.5
• Default probability Venezuela 5

13
Venezuela Bond Calculations

• Par bond NPV
• P 40.52

14
Venezuela Bond Calculations

• Discount bond NPV
• P 52.06
• Recommendation
• Buy Par Bonds.

15
Costa Rica Bonds 1990 Issue

• Bond characteristics Principal Series A
• 20 year maturity
• No collateral for face value
• 3 coupon payments collateral

16
Costa Rica Bond Calculations

• Data required.
• YTM U.S. 7
• YTM Costa Rica 12.5
• Default probability Costa Rica 5

17
Costa Rica Bond Calculations

• Bond NPV
• P 32.45

18
1996 Sell Mexican Bonds?

• Ability to sell at 71.50
• Valuation (NPV) at 58.69
• D (1 ytm) / ytm - (1 ytm) yrs (i -
  ytm) / i (1 ytm) yrs - 1 i
• Duration Less than 6 years (5.93)
• Duration the average (cash-weighted)
  term-to-maturity of a bond.
• Yes, sell.

19
Mexican Par Bonds Useful Diversification Tool?

• US Rate DVBP The price rise (fall) of the bond
  for a 100 basis point shift downward in the US
  yield curve.
• DVBP for Mexican Par Bonds 8.48
• High negative correlation b/t US and Mexican Par
  Brady Bonds
• Yes, good diversification tool.

20
Method to Determine Country Risk

• State Variable Provides an estimate of country
  risk embedded in the bond higher state value,
  the lower risk of the bond.
• State Variable for Mexican Brady Bonds - .001210.
  
• SD .11895 (relatively high)
• YTM(Brady Bond) YTM(Risk Free) Country Risk

21
Hedging USD 600 Million of Mexican Brady par Bonds

• Options
• Put Options on Mexican Stock Exchange
• Put Options on CMEs options for Mexican par
  Brady Bonds

22
Forward Looking Mexicos Country Risk

• Mexico has industries growing in TeleCom and
  Media
• Growing correlation with US Economy
• Some political risks with upcoming elections in
  2002
• Ability for economic growth in 2002 and 2003
• Retiring Brady Bonds and replacing with US 1.5bn
  30-yr bond at 9 (frees up US Treasury assets
  held by Mexico)

23
QUESTIONS?