Non-US Bonds

1. Non-US Bonds Chapter 9

2. Global Bond Markets • internal bond market (national bond market) • domestic bond market – bonds from issuers domiciled in the country • foreign bond market – bonds from issuers not domiciled in the country • external bond market (international bond market – offshore bond market – Eurobond market) • underwritten by international syndicate • at issue, they are offered to investors in multiple countries • issued outside jurisdiction of any single country • unregistered form • global bond – one issued simultaneously in several bond markets throughout world • trading blocs • dollar bloc • European bloc • Japan • emerging markets

3. Bond Returns • returns • local currency return • changes in foreign exchange rate (depreciated/appreciated) • reasons to allocate $$ to nondollar bonds • diversification • “increased opportunity to find value” in different markets • active currency bet if no hedge of foreign exchange

4. Eurobond Market • Eurodollar bonds – bonds denominated in US dollars • Euroyen bonds – bonds denominated in Japanese yen • often registered on national stock exchange but generally traded OTC market (some private placement also)

5. Securities in Eurobond Market • Euro straights – annual coupons / “plain vanilla” • Floating Rate Notes – LIBOR • cap / floor / collared • stated maturity vs. perpetual • Dual Currency Bonds – coupon in one currency but principal in another • exchange rate set at issue is used to convert principal and coupons into specific currency • applicable exchange rate is rate at time CF is made • offers investor or issuer the choice of currency (option currency bonds)

6. Securities in Eurobond Market • Convertible Bonds • Bonds with Warrants – large part of market • warrants generally detachable • equity warrant • debt warrant • currency warrant • Coupon Step-Up Bonds • rate “steps-up” over time due to passage of time or change in reference rate • Coupon Step-Down Bonds • some coupons change based on changes in isser’s credit rating

7. Yield Comparisons • bond-equivalent yield of Eurodollar bond = 2[(1 + yield to maturity on Eurodollar bond )½ – 1] • suppose YTM on Eurodollar bond is 6%, then BEQ = 2[(1.06)½ – 1] = 0.0591 = 5.91% • BEQ always less than Eurodollar bond’s YTM • convert BEQ of US bond to annual-pay basis

8. Distribution of Government Securities – nonUS Markets • regular calendar auction / Dutch style auction • regular auction with winning bidders allocated securities at yield (price) they bid • regular calendar auction / minimum-price offering system • regular auction with winning bidders awarded securities at highest yield accepted by government (stop-out yield) • ad hoc auction • announce auctions when market conditions are favorable with amt and maturity of issue announced at offer • tap system • additional bonds of previously outstanding issue are auctioned

9. Sovereign Bond Ratings • ratings assigned: • local currency debt rating • foreign currency debt rating – traditionally, defaults greater on foreign currency-denominated debt • generally consider economic risk and political risk

10. Sovereign Ratings Methodology • Political risk • Stability and legitimacy of political institutions • Popular participation in political processes • Orderliness of leadership succession • Transparency in economic policy decisions and objectives • Public security • Geopolitical risk • Income and economic structure • Prosperity, diversity, and degree to which economy is market oriented • Income disparities • Effectiveness of financial sector in intermediating funds; availability of credit • Competitiveness and profitability of nonfinancial private sector • Efficiency of public sector • Protectionism and other nonmarket influences • Labor flexibility • Economic growth prospects • Size and composition of savings and investment • Rate and pattern of economic growth

11. Sovereign Ratings Methodology • Fiscal flexibility • General government revenue, expenditure, and surplus/deficit trends • Revenue-raising flexibility and efficiency • Expenditure effectiveness and pressures • Timeliness, coverage, and transparency in reporting • Pension obligations • General government debt burden • General government gross and net (of assets) debt as a percent of GDP • Share of revenue devoted to interest • Currency composition and maturity profile • Depth and breadth of local capital markets • Off-budget and contingent liabilities • Size and health of NFPEs • Robustness of financial sector • Monetary flexibility • Price behavior in economic cycles • Money and credit expansion • Compatibility of exchange-rate regime and monetary goals • Institutional factors, such as central bank independence • Range and efficiency of monetary policy tools

12. Sovereign Ratings Methodology • External liquidity • Impact of fiscal and monetary policies on external accounts • Structure of the current account • Composition of capital flows • Reserve adequacy • Public sector external debt burden • Gross and net public sector debt, including structured debt, as a percent of CAR • Maturity profile, currency composition, and sensitivity to interest rate changes • Access to concessional funding • Debt service burden • Private sector external debt burden • Gross and net financial sector external debt, including deposits and structured debt, as a percent of CAR • Gross and net nonfinancial private sector external debt, including structured debt, as a percent of CAR • Maturity profile, currency composition, and sensitivity to interest rate changes • Access to concessional funding • Debt service burden • CAR—Current account receipts, NFPEs—Nonfinancial public sector enterprises.

13. Pfandbriefe Market • German mortgage-bond market • largest asset in European bond market and 6th largest in world • bonds issued by mortgage banks in Germany • highly regulated • bonds backed by mortgage pools so covered – no single case of insolvency in this market in over 100 years • public Pfandbriefe – loans to public sector entities • mortgage Pfandbriefe – residential and commercial mortgages

14. Emerging Market Bonds • governments of emerging countries issue: • Brady bonds – bonds that represent a restructuring of nonperforming bank loans of governments into marketable securities • Eurobonds • Global bonds