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