International Bond Markets CHAPTER 29 International Bond Markets Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall.

Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall. Learning Objectives The classification of global financial markets What the foreign bond market is What a global bond is What a Eurobond is and the different types of Eurobond structures The classification of the global bond market in terms of trading blocs The euro government bond market Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall. 2

Learning Objectives (continued) The methods of distribution of new government bonds The issuance of linkers by sovereign issuers Factors considered in the rating of sovereign bonds How to compare yields on U.S. bonds and Eurobonds The European covered bonds market Emerging market bonds Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall. 3

CLASSIFICATION OF BOND MARKETS There is no uniform system for classifying the sectors of the global bond market Within the domestic financial market, there is the domestic bond market This market is where issuers domiciled within the country issue bonds and where those bonds are traded Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall.

CLASSIFICATION OF BOND MARKETS (CONTINUED) In comparison, there is also the foreign bond market This is the market where bonds of issuers not domiciled in the country are issued and traded Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall. 5

CLASSIFICATION OF BOND MARKETS (continued) The external bond market, also called the international bond market, is that part of a country’s external financial markets that includes bonds with the following features Underwritten by international syndicate Issue offered simultaneously to investors in a number of countries Issued outside the jurisdiction of any single country Issued in unregistered form Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall.

CLASSIFICATION OF BOND MARKETS (continued) The external market is often called the offshore bond market, or Eurobond market A global bond is one that is issued simultaneously in several bond markets throughout the world Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall. 7

CLASSIFICATION OF BOND MARKETS (continued) Classification by Trading Blocs Another way to classify the global bond market is in terms of trading blocs Dollar bloc (US, Canada, Australia, and New Zealand) European bloc, which is divided into euro zone market bloc (countries with the euro as currency) Non-euro zone market bloc Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall.

Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall. EUROBOND MARKET The Eurobond market is classified by the currency denomination of the issue For example, there is the Eurodollar bond and the Euroyen bond Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall.

EUROBOND MARKET (continued) Securities Issued in the Eurobond Market Fixed coupon bonds are Euro straights There are floating-rate notes, whose coupon rate is stated as a margin over LIBOR Dual-currency issues pay coupon in one currency but pay the principal in a different currency Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall.

EUROBOND MARKET (continued) Securities Issued in the Eurobond Market An investor’s choice of currency is found in option currency bonds. Lastly, the bonds can be convertible or have warrants attached to them An equity warrant permits the warrant holder to buy the common stock of the issuer at a specified price Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall. 11

EUROBOND MARKET (continued) Securities Issued in the Eurobond Market A debt warrant entitles the warrant holder to buy additional bonds from the issuer at the same price and yields A currency warrant permits the warrant holder to exchange one currency for another at a set price Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall.

EUROBOND MARKET (continued) Comparing Yields on U.S. Bonds Eurobonds pay annual coupon whereas US bonds pay semiannual coupon To convert, we use the following formula: Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall.

GOVERNMENT BOND MARKETS Methods of Distribution of New Government Securities There are four methods to distribute new securities of central governments Regular calendar auction/Dutch-style system Regular calendar auction/minimum-price offering Ad hoc auction system Tap system Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall.

GOVERNMENT BOND MARKETS (continued) Inflation-Indexed Bonds Some Treasury securities, Treasury Inflation Protection Securities, are inflation protected, where coupons are linked to an inflation index Outside the US, bond coupon rates are linked to the rate of inflation and are called linkers Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall.

GOVERNMENT BOND MARKETS (continued) Sovereign Bond Ratings There are two sovereign debt ratings assigned by rating agencies: a local currency debt rating and a foreign currency debt rating The reason for distinguishing between the two is that historically the default frequency has been higher on foreign currency denominated debt Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall.

Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall. EMERGING MARKET BONDS The financial markets of Latin America, Asia (except Japan), and eastern Europe are viewed as emerging markets Governments of emerging market countries issue Brady bonds, Eurobonds, and global bonds Brady bonds are basically bonds that represent a restructuring of nonperforming bank loans into marketable securities Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall.

THE EUROPEAN COVERED BONDS MARKET One of the largest sectors of the European market is the covered bonds market Covered bonds are issued by banks, and are collateralized by residential or commercial mortgage loans, or public sector loans Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall.

THE EUROPEAN COVERED BONDS MARKET (CONTINUED) The German mortgage-bond market, called the Pfandbriefe market, is the largest covered bonds market The sector of the Pfandbriefe market that has received the greatest interest from global institutional bond investors is the Jumbo Pfandbriefe sector, which has a minimum size requirement of 500 million Euros Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall. 19

Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall. Summary The global bond market can be classified into two markets: the internal or national bond market, which consists of a domestic bond market and a foreign bond market, and the external or international bond market (or Eurobond market) Sovereign debt is the obligation of a country’s central government Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall. 20

Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall. Summary (CONTINUED) Investors in the debt of governments of emerging countries are exposed to credit risk Governments of emerging market countries issue Brady bonds, Eurobonds, or global bonds At one time Brady bonds were a major part of the emerging bond market, but they are less important today Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall. 21

Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall. Summary (CONTINUED) Covered bonds are issued primarily in Europe by banks using predominately residential and mortgage loans as collateral This sector has become a major sector in the global bond market Although covered bonds are often compared to mortgage and asset-backed securities, there are differences in their credit protection and structure Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall. 22