Mauritius

1
Mauritius

• In 1992, Mauritius became the first offshore
  financial center in the southern hemisphere.
  There are now over 1500 offshore/international
  companies incorporated in Mauritius.

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International Financial Management INBU
4200Fall Semester 2004

• Lecture 7
• The International Bond Markets
• (Chapter 7)

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International Capital Markets

• International Capital Markets Consist of
• International Money Markets
• Corporate short term borrowing and depositing
  through
• Global commercial banks (both offshore and
  domestic markets)
• International Debt (Bond) Markets
• Corporate and Government long term borrowing and
  institutional and individual investing through
• Euro bond markets (offshore)
• Foreign bond markets (domestic markets)
• Equity Markets (Stock Markets)
• Corporate fund raising (IPOs) and institutional
  and individual investing through
• National stock markets

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Importance of These Markets

• Borrowers
• Provides them with a wide range of borrowing
  possibilities (global in nature).
• Offshore and foreign domestic markets
• Provides them with potential swap arrangements
• Borrowing in one market and swapping out to
  another.
• Interest rate/currency swaps.
• Investors
• Provides them with a wide range of investing
  possibilities in terms of
• Returns
• Types of assets,
• Currencies.

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International Bond Markets

• Three basic segments for corporates, governments
  and investors
• Foreign Bonds (external borrowers in domestic
  financial markets)
• Issued by a non-resident and denominated in the
  currency of the country in which it is being
  offered.
• GE issuing a yen denominated bond in Japan
• Republic of China issuing a dollar denominated
  bond in the U.S.
• Foreign Bonds (internal, domestic borrowers)
• Issued by a resident and denominated in the
  currency of the country in which it is being
  offered.
• U.K. Government issuing a pound sterling bond in
  the U.K.
• This market is potentially important to global
  investors seeking foreign bonds.
• Eurobond (offshore)
• Issued by a non-resident and denominated in a
  currency other than the currency of the country
  in which it is being sold.
• GE issuing a dollar denominated bond in Europe.

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Characteristics of Foreign Bonds for U.S.
Investors

• From a U.S. investor standpoint, a foreign bond
  has three distinct characteristics
• The bond is normally issued by a foreign entity
• Such as a foreign government, foreign
  municipality or foreign corporation.
• Exception U.S. entity (corporation) could be
  the borrower in a foreign market.
• The bond is traded on a foreign financial market.
• Domestic market of the foreign borrower.
• The bond is denominated in a foreign currency.
• Not the U.S. dollar!
• Domestic currency of the foreign borrower, or
  where the U.S. entity is borrowing.

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Risk with Foreign Bonds

• Foreign bonds carry two major risk elements
• Risk of default
• A primary risk of a foreign bond is that it is an
  unenforceable claim. An investor that owns the
  bonds of a borrower in his or her home country
  has specific legal recourse in the event of
  default. Foreign bonds, however, offer no such
  protection.
• An extremist political movement (e.g., Iran in
  the 1970s) could come to power and seize or deny
  all foreign assets and claims.
• A country may become engaged in a military
  conflict and prohibit its currency from leaving
  its borders. After World War II, for example,
  U.S. investors holding bonds in Great Britain
  were paid interest in pounds yet were unable to
  convert those pounds to dollars the money could
  only be reinvested in pound-denominated
  investments or spent within the borders of
  Britain or her colonies.
• Foreign exchange risk
• the potential for loss due to fluctuations in
  exchange rates.
• Currency risk can literally turn a profit on a
  foreign investment into a loss or visa versa.

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Foreign Government Bonds

• Foreign Government Bonds Bonds which are a
  direct obligation of a foreign government.
• These bonds are of two classes
• (1) external bonds, those marketed and intended
  for investment by investors in another country
  and payable as to both principal and interest in
  the currency of that country, and
• (2) internal bonds, those marketed in the home
  country of the government in question and payable
  in the currency of that country.
• A few foreign government issues are payable in
  several currencies and are known as multiple
  currency issues.
• The external bonds of foreign countries which
  have been marketed in the United States are also
  known as Yankee (dollar) bonds.

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Record of Foreign Government Bonds

• The performance record of foreign government
  bonds sold in the United States over the last 100
  years is uneven at best.
• During the Great Depression of 19291933, many
  South American governments defaulted on their
  bonds.
• World War II resulted in default on various
  European government issues.
• The late 70s and 80s were characterized by many
  government debt defaults (throughout the emerging
  world).
• Third World Debt Crisis in response to global
  slowdown and rising price of oil

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Governments in the Foreign Bond Market

• Why do Governments borrow in foreign bond
  markets?
• Foreign market may be larger and thus offer
  opportunities for larger borrowings and at better
  borrowing terms (interest rates).
• Many countries bypass their smaller domestic
  markets to issue in larger foreign markets,
  especially the U.S. market.
• Interest rates in domestic markets may be
  relatively high due to internal economic factors
• Inflation, business cycle, central bank policies.
• Foreign markets may be more transparent then
  domestic markets, and thus offer better
  protection for investors.
• More transparency means potentially less risk and
  thus a lower required return (i.e., lower
  borrowing costs).
• Especially true with the worlds major capital
  markets such as the United States.

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Government Bond Markets 10-year Bond Yields and
Spreads October 21, 2004
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Corporates in the Foreign Bond Market

• Corporates are also attracted to the foreign bond
  markets
• Domestic markets may be fairly developed but
  small and thus result in higher borrowing costs.
• Many markets in Europe prior to the single
  market.
• Smaller markets in emerging Asian nations today.
• Domestic markets may be underdeveloped and small
  and result in less favorable borrowing terms.
• China today.
• These countries are attempting to enhance their
  domestic markets.
• Vietnam (Postal savings scheme similar to
  Japanese model).
• Domestic markets may be less transparent
  resulting in less investor protection.
• Requiring higher required returns (i.e.,
  borrowing costs).

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Postal Savings Systems

• Japan Essentially a government run banking
  system based on the post office.
• Japan has 24,000 post offices, and each has a
  bank inside.
• System was created in 1875 and modeled after a
  British system established in 1861.
• The United States created one in 1910, attracting
  mostly urban immigrants who distrusted private
  banks. It never gained the popular appeal that
  the Japanese version has and was dismantled in
  1967.
• It is the largest financial institution in the
  world, with about 2.4 trillion (250 trillion
  yen) on deposit.
• Many government corporations have financed
  projects with loans from the postal savings
  system.
• Now going through a process of privatization!

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Examples of International Bonds Issued October
21, 2004 by Currency, Amount, Yield, and
Book-Runners

• In U.S. Dollars
• Republic of China, 500M, 3.8,
  Merrill/JPMorgan
• In Euros
• BNG (Benetton Group, Italian company) 1.5B 3.3,
  Citi/JPMorgan (through London)
• In British Pounds
• KBC Bank (Belgium Bank) 175m 5.8, HSBC/Lehman
• In Canadian Dollars
• Toyota Credit of Canada100m 4.2,TD Securities

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SEC Requirements

• U.S. Federal securities laws are designed to
  provide disclosure of financial information about
  borrowers
• seeking an initial public stock offering (IPO) or
  issuing bonds, and/or
• those already publicly held.
• The Securities Act of 1933 requires that a
  borrower, before offering securities to the
  public, must file a report detailing several
  categories of information specified by the
  Securities and Exchange Commission (SEC).
• The Securities Exchange Act of 1934 deals mainly
  with securities already publicly held. Issuers of
  such securities must publish periodic reports
  outlining current material information.

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Registering Bonds in the U.S.

• All bonds being offered to the investing public
  in the United States must be registered with the
  Securities Exchange Commission.
• U.S. government, federal agency and municipal
  bonds are exempt from the registration rule.
• Registration requires that specific information
  be disclosed, such as
• include financial data about the borrower,
• how the money will be spent,
• how the borrower intends to repay.
• the terms of the bond itself.
• Included in the bonds indenture.

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Regulation S Bonds

• As noted, qualified bonds issued in the United
  States must be registered with the Securities and
  Exchange Commission.
• However, Regulation S permits a US dollar bond
  offered outside America without registration
  under the US Securities Act of 1933. These bonds
  cannot be sold to Americans.
• Telekom (Malaysian telecommunications Moodys
  A3), 500M, 5.3 yield, offered September 15,
  2004. Book runners Deutsche Bank and UBS.
• Sold to 183 investors representing a mix of
  pension funds, asset managers, banking/financial
  institutions, and private banks all sales
  outside of the United States 61 in Asia and 39
  in Europe.

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Global Bond Data

• Year end 2002, the face value of bonds
  outstanding in the world was estimated at 37.3
  trillion.
• Domestic bonds represented the largest share of
  this amount, or about 82 (30.5 trillion).
• This measures borrowing by residents in their own
  markets.
• The U.S. market dominates, with about 59 of this
  total.
• International bonds (foreign and euro bonds) only
  represent about 18 (6.8 trillion)
• By currency of denomination (total bond market)
• 50 denominated in U.S. dollars,
• 20 in euros, and
• 17 in yen.
• By currency of denomination (International bond
  market)
• 51 in U.S. dollars
• 32 in euros
• 7 in pounds, and
• 6 in yen

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Amounts of Domestic and International Bonds
Outstanding As of Year-End 2002 in U.S. Billions
Currency Domestic Percent International Percent Percent Total Percent
U.S. dollar 15,377.0 50.4 3,465.6 50.7 18,842.6 18,842.6 50.5
Euro 5,226.1 17.1 2,170.2 31.7 7,396.3 7,396.3 19.8
Pound 920.8 3.0 505.3 7.4 1,426.1 1,426.1 3.8
Yen 5,846.8 19.2 409.1 6.0 6,255.9 6,255.9 16.8
Other 3,118.2 10.2 288.9 4.2 3,407.1 3,407.1 9.1
Total 30,488.9 100.0 6,839.1 100.0 37,328.0 37,328.0 100.0
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International Bonds Eurobonds

• In any given year, about 80 of the worlds
  international bonds are likely to be euro bonds
  (as opposed to foreign bonds).
• Offshore issues.
• They are noted by the name of the currency in
  which they are denominated
• Eurodollar bonds,
• euroyen bonds,
• euroeuro bonds
• They may or may not be available to home currency
  investors.

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International Bonds Foreign Bonds

• Foreign bonds represent about 20 of the new
  international bond offerings in any year.
• They are noted by the country where they are
  issued and have taken on rather unique names
• Yankee bonds (issued in the U.S.)
• Samurai bonds (issued in Japan)
• Bulldogs (issued in the United Kingdom)
• Matadors (issued in Spain)
• Kiwi bonds (issued in New Zealand)
• They are usually issued because of attractive
  interest rates and then swapped out the issuing
  currency into a home currency.
• Especially true with regard to Samurai bonds
  today.

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Who Issues International Bonds?

• Distribution (2002) of International Bond
  Offerings by Nationality
• U.S. borrowers represent about 32 of total.
• Germany, 13
• U.K., 8

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What Type of Borrower is Involved in the
International Bond Markets?

• Financial institutions are the major borrowers
  with 59
• Governments at 21
• Corporates at 15

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Bearer Versus Registered Bonds

• Bearer Bonds
• Possession is evidence of ownership.
• Issuers does not keep ownership records.
• Offer privacy and anonymity to holders.
• Thus, carry a lower interest rate than registered
  bonds.
• Eurobonds are bearer bonds.
• Registered bonds
• Owners name is recorded by issuer.
• Yankee bonds and U.S. corporate bonds must be
  registered.

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Regulations of International Bonds

• Foreign bonds must meet the registration and
  listing regulations of the country in which they
  are issued.
• Yankee bonds must comply with 1933 Securities Act
  requiring full financial disclosure and the
  offering of a prospectus to potential public
  buyers.
• Eurobonds are not required to meet registration
  requirements
• For example, not required of euro-dollar bond
  offerings outside of the United States (Reg S).
• Issue of time and expense in bring a foreign bond
  to market has resulted in a general preference
  for eurobond offerings by global borrowers.
• Response of U.S. to timing and disclosure issue
• U.S. shelf registration, or pre-registration,
  (rule 145) since 1982 has reduced the time issue.
• Private placements (rule 144A) since 1990 do not
  have to meet the full disclosure requirements of
  the 1933 Act.

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International Bonds Global Bond

• Refers to a large international bond
  simultaneously offered in different financial
  markets (first appeared in 1989).
• May be issued in different currencies
• Deutsche Telekom 14.6 billion (2000 offering)
  multicurrency (dollar, euro, pound, yen) issue
• Or same currency
• ATT 8 billion (1999) U.S. dollar global
  offering (throughout the world).
• Usually sold throughout North America, Europe,
  and Asia!
• Usually sold to institutional investors.
• Pension funds, insurance companies, private
  banks, asset managers.

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Types of International Bonds

• Straight Fixed Rate Bond
• Most international bonds are of this type
• Designed maturity date,
• Fixed coupon payments ( of par value),
• Eurobond interest is typically paid annually
• Less costly for borrowers
• No options (e.g., convertibility) attached
• Entire issue brought to market at one time.
• U.S. dollar bonds the most popular
• Sometimes referred to as plain vanilla bonds!

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International Bonds Types

• Euro-Medium Term Notes (Euro MTNs)
• Similar to straight fixed rate bonds in that they
  have a fixed maturity and carry a fixed coupon
  rate.
• Unlike a straight fixed rate bond, they are sold
  on a continuous basis through some prearranged
  period (called an issuance facility).
• Allows issuers to raise money as needed
• Generally carry maturities from less than 1 year
  out to 10 years.

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International Bonds Types

• Floating Rate Notes (FRNs)
• Coupon rate is indexed to some reference rate.
• Usually LIBOR!
• Coupon reset at time of interest payment for the
  next period.
• Coupon payments generally reset every 3 or 6
  months.
• U.S. dollar and euro denomination dominate this
  market.

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International Bonds Types

• Equity Related Bonds
• Convertible issues
• Fixed income bond which,
• Allows the holder to exchange the bond for a
  predetermined number of share of common stock.
• Carry lower interest rates than a straight only
  bond.
• Bonds with Equity Warrants
• Fixed income bond with,
• Call option (or warrant) feature which allows the
  holder to purchase a certain number of equity
  shares at a pre-stated price over a predetermined
  period of time.

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International Bond Types

• Zero Coupon Bonds
• Sold at a discount from face (par) value,
• Do not pay any coupon interest
• At maturity, holder receives full face (par)
  value.
• Return is represented by the difference between
  price and face value.
• Most popular currencies have been the U.S. dollar
  and Swiss franc.
• Especially attractive to Japanese investors
• Their tax laws treat the return as a tax free
  capital gain (where coupon payments are taxable)!

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International Bonds Types

• Dual-Currency Bonds
• Fixed rate bond that pays interest in one
  currency, and
• Upon maturity, pays principal value in another
  currency.
• Very popular among Japanese firms
• Coupon payments in yen principal repayment in
  dollars.
• Used by Japanese companies wanting to establish
  or expand U.S. based subsidiaries.
• Japanese subsidiaries anticipate generating U.S.
  dollars needed to pay off the principal from
  their activities in the United States.

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Review Characteristics of International Bond
Market Instruments
Frequency of Payment
Size of Coupon
Payoff at Maturity
Annual
Currency of issue
Fixed
Every 3 or 6 months
Currency of issue
Variable
 
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Placing Eurobonds

• Lead Manager(s) (Book-runner)
• Primary investment banking firm(s)
• Lead manager of underwriting syndicate.
• Negotiate terms with the issuer, ascertain market
  conditions and timing.
• Put together the underwriting syndicate!
• Underwriting Syndicate
• Group of investment banks, merchant banks, and
  commercial banks that will bring the issue to
  market.
• Syndicate members commit their own capital to buy
  the issue from the issuer (at a discount) and
  then resell this issue.
• Underwriting spread is typically 2 to 2.5!
• Selling Group
• Includes the underwriting syndicate plus other
  institutions.
• Sell the bonds to the public and receive
  commission for doing so.