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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
Brady Bonds

Pallavi Rao

Morris Chen

brady bonds1
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
what is a brady bond
What is a Brady Bond?
  • 􀂾 Principal collateral
  • 􀂾 Rolling-interest guarantee
  • 􀂾 Value recovery rights
  • 􀂾 Par bonds
  • 􀂾 Discount bonds
mexico par discount
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%
mexico par discount1
Mexico Par/Discount
  • Mexico Par

NPV = 40.88

  • Mexico Discount

NPV = 56.72

Recommendation: Buy Mexico Par

venezuela par discount
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%
venezuela par discount1
Venezuela Par/Discount
  • Venezuela Par

NPV = 36.66

  • Venezuela Discount

NPV = 47.03

Recommendation: Buy Venezuela Par

costa rica principal series a
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%

costa rica principal series a1
Costa Rica Principal Series A
  • Costa Rica Principal Series A

NPV = 49.15

hold or sell mexico brady bond
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%
hold or sell mexico brady bond1
Hold or Sell Mexico Brady Bond
  • Mexico Par as of 11/2003

NPV = $68.83

Current Selling Price = $100.00

Recommendation: Sell Mexico Par

useful diversification tool
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.

estimate country risk with brady bond
Estimate Country Risk with Brady Bond
  • Brady Bond YTM = US T-bill + Spread

Therefore,

Country Risk = Brady Bond YTM – Risk Free YTM

hedge mexican exposure
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

probability of default
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