Non-US Bonds Chapter 9

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

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

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)

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)

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

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] = = 5.91%  BEQ always less than Eurodollar bond’s YTM convert BEQ of US bond to annual-pay basis

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

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

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

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

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.

Pfandbriefe Market German mortgage-bond market  largest asset in European bond market and 6 th 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

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