The International Bond

Market
 Outline

• Types of bonds
• Comparative bond characteristics
• The Gray Market
• Onshore-Offshore arbitrage
 Classification

• Foreign Bonds

• Global bonds

• Eurobonds
 Foreign Bonds

Issued by a foreign entity and denominated in

domestic currency
 Foreign Bonds: Examples

• Samurai bonds
• Bulldog bonds
• Rembrandt bonds
• Yankee bonds
 Global bonds

Sold simultaneously on several markets in

the currency of each market
 Global bonds

First offered by the World Bank, Ontario-

Hydro, and Hydro-Quebec.
 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.
Eurobonds: Exemplification

A bond issued by Rhone-Poulenc and

sold in the US in Swiss francs.
 Eurobonds
INSTRUMENT INTEREST COUPON TYPE CURRENCY PAYOFF
FREQUENCY
Straight fixed-rate annual Fixed Currency of issue
Floating rate note annual or Variable Currency of issue
quarterly
Convertible bond annual Fixed Currency of issue or
convertible
Straight fixed-rate with annual Fixed Currency of issue plus
equity warrants shares
Zero-coupon bond none Zero Currency of issue
Dual-currency bond annual Fixed Dual Currency
Composite currency annual Fixed Composite currency
bond
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.
 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.

Dollars (billions) Pounds (billions)

Initial amount raised 1 1/S($)
n n
Principal payment [1+r($)] [1+r(pounds)] /S
 Selecting the currency of issue:
Exemplification

Coca-Cola will float the pound bond only if:

[1+r($)]n > E[S] [1+r(pounds)]n /S

Writing E[S] = S(1+d) 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

 Selecting the currency of
issue: Exemplification

r($) r(pounds ) d
5% 7% 1.2%

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.
 Comparative characteristics of bonds issues

North-America (US) Non-US Eurobond

Regulatory SEC, provincial Specialized agency Minimum regulatory control
Disclosure Detailed Variable Determined by market
practice
Issuing costs 0.75-1.25% Up to 4% 2-3%
Rating required Usually not Not required but done
required
Speed of issuance Moderate Variable Fast (bought deals)
Rrestrictions No restrictions Restrictions are No restrictions
common
Other advantages  Large market  Local  Lower interest expense
visibility
 Liquidity  Bearer bonds
 Standardized  No withholding tax
information
 Currency diversification
Other disadvantages  Disclosure is  Small Less liquidity and information
costly markets disclosure
 Reporting to tax  Low liquidity
authorities
 Reporting to
tax
authorities
 Eurobond underwriting
In general, similar to regular bond underwriting

Differences:
• Lead manager separate from selling group
• Variable price re-offering
 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.
 The Gray Market: Exemplification
Issuer Weyerhauser (1983) Osaka Gas (1993)
Amount $60 m $250 m
Maturity 7 years 5 years
Coupon 11.5% 5.75%
Issue price $100 $101.489
Listing LuxSE London
Total commission 1.875% 1.875%
Lead Manager Morgan Stanley Goldman Sachs
Gray market price -1.5 to -1.25% + 0.25%
 The Eurobond pricing paradox

Eurobonds yields are lower, but issuance

costs are higher than in North-America.
 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
 The Eurobond pricing paradox

Could tax withholding and/or reporting to

national authorities make a difference?
 Onshore-Offshore Arbitrage

O-OA represents an attempt at taking

advantage of the Eurobond pricing paradox.
 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.
 Onshore-Offshore Arbitrage: EXXON Capital
Corporation, a subsidiary of EXXON Corporation.

Date Oct. 19,1984 October 1984

Type of security Issues $1.8 b Euro-discount bonds Buys $1.8 b of US T- bonds
Maturity November 15, 2004 November 15, 2004
yield 11.65% 11.825%
Net proceeds +$ 198.6 m -$181 m
 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