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Brady Bonds

Brady Bonds. Pallavi Rao Morris Chen. Brady Bonds. Buy Mexican par or discount bonds Buy Venezuela par or discount bonds Fair opening price of Costa Rican Principal Series A Hold or sell Mexican Brady Bond at Nov. 2003 Useful Diversification Tool?

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Brady Bonds

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  1. Brady Bonds Pallavi Rao Morris Chen

  2. Brady Bonds • Buy Mexican par or discount bonds • Buy Venezuela par or discount bonds • Fair opening price of Costa Rican Principal Series A • Hold or sell Mexican Brady Bond at Nov. 2003 • Useful Diversification Tool? • Method & estimate of country risk with Brady Bond • Hedge Mexican exposure • Probability of default in the Future

  3. What is a Brady Bond? • 􀂾 Principal collateral • 􀂾 Rolling-interest guarantee • 􀂾 Value recovery rights • 􀂾 Par bonds • 􀂾 Discount bonds

  4. Mexico Par/Discount Par Data • T-Bond 30 Yrs YTM 8.56% • T-Bill 1 Yr 8.35% • Country Risk CCC5.00% • Bond YTM 13.35% • Coupon Interest 6.25% • Face Value 100 • Prob of Default 4.00% Discount Data • T-Bond 30 Yrs YTM 8.56% • T-Bill 1 Yr 8.35% • Country Risk CCC5.00% • Bond YTM 13.35% • LIBOR + 13/16 9.31% • Face Value 100 • Prob of Default 4.00%

  5. Mexico Par/Discount • Mexico Par NPV = 40.88 • Mexico Discount NPV = 56.72 Recommendation: Buy Mexico Par

  6. Venezuela Par/Discount Par Data • T-Bond 30 Yrs YTM 8.24% • T-Bill 1 Yr 7.05% • Country Risk C8.00% • Bond YTM 15.05% • Coupon Interest 6.75% • Face Value 100 • Prob of Default 6.00% Discount Data • T-Bond 30 Yrs YTM 8.24% • T-Bill 1 Yr 7.05% • Country Risk C 8.00% • Bond YTM 15.05% • LIBOR + 13/16 9.31% • Face Value 100 • Prob of Default 6.00%

  7. Venezuela Par/Discount • Venezuela Par NPV = 36.66 • Venezuela Discount NPV = 47.03 Recommendation: Buy Venezuela Par

  8. Costa Rica Principal Series A Principal Series A Data T-Bond 30 Yrs YTM 7.73% T-Bill 1 Yr 8.32% Country Risk CC6.50% Bond YTM 14.82% Coupon Interest 6.25% Face Value 100 Prob of Default 5.00%

  9. Costa Rica Principal Series A • Costa Rica Principal Series A NPV = 49.15

  10. Hold or Sell Mexico Brady Bond Par Data as 11/2003 • T-Bond 30 Yrs YTM 5.15% • T-Bill 1 Yr 1.71% • Country Risk BB 4.50% • Bond YTM 6.21% • Coupon Interest 6.25% • Face Value 100 • Prob of Default 3.00%

  11. Hold or Sell Mexico Brady Bond • Mexico Par as of 11/2003 NPV = $68.83 Current Selling Price = $100.00 Recommendation: Sell Mexico Par

  12. Useful Diversification Tool? • Approx. 60% variance in Mexican par prices is attributable to changes in US Treasury. Conclusion: High correlation between Mexican Brady Bonds and US Treasury. Therefore, not a good diversification tool.

  13. Estimate Country Risk with Brady Bond • Brady Bond YTM = US T-bill + Spread Therefore, Country Risk = Brady Bond YTM – Risk Free YTM

  14. Hedge Mexican Exposure • Brady Bond has two risk components Sovereign Risk (Country’s political & econ. Risk) Interest Rate Risk (US Interest rate fluctuations) Solution: Hedge Interest Rate Risk with CBOT bond futures Hedge Sovereign Risk with put options in Mexico

  15. Probability of Default • Country Risk Ranking = 47 (100 most risky) • Brady Bond buybacks • Political Risks = C • Economic Policy Risk = B • Economic Structure Risk = C • Liquidity Risk = C • Overall Risk = C

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