Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 11-1 Chapter 11 International Debt Markets

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 11-2 Learning Objectives Examine the use of international debt markets as a source of funding Describe the role of euromarkets and US capital markets Distinguish between eurocurrency, euronote and eurobond markets Consider US debt markets and securities Explain the role of credit rating agencies Describe the parties borrowing in these markets

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 11-3 Chapter Organisation 11.1 The Euromarkets 11.2Eurocurrency Market 11.3Euronote Market 11.4Eurobond Market 11.5Markets in the United States 11.6Credit Rating Agencies 11.7Summary

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger The Euromarkets International debt markets –Are used by  Financial institutions, who are the largest borrowers  Governments and corporations –Attract investors as they  Provide a deep and liquid market  Allow higher investment returns  Are a form of portfolio diversification –Have grown in importance due to deregulation of FX markets –Accessible to borrowers with a strong financial reputation and a very good credit rating

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger The Euromarkets (cont.) International debt markets (cont.) –Consist of large unregulated money and capital markets –Major centres in London, the Middle East and Asia –USD is the dominant currency –Euro-zone is the domestic market for countries adopting the euro currency –Debt securities denominated in euros have grown as the predictability, liquidity and volatility of the euro consolidates

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger The Euromarkets (cont.) Euro markets –Initially evolved to enable countries to hold USD outside of the US, e.g. USSR –Although euromarkets originated in Europe, euromarket transactions can occur in any nation-state of the world  ‘Euro’ means ‘outside’ –A euromarket transaction is conducted in a foreign country but not in its currency –Growth in euromarket transactions are driven mainly by interest rate factors, i.e lower borrowing and higher lending rates

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger The Euromarkets (cont.) Euro markets (cont.) –Provide intermediated and direct finance over a range of terms to maturity and are categorised as follows:  Eurocurrency markets Provide intermediated bank finance  Euronote markets Provide short-term direct finance  Eurobond markets Provide medium- to long-term direct finance

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 11-8 Chapter Organisation 11.1 The Euromarkets 11.2Eurocurrency Market 11.3Euronote Market 11.4Eurobond Market 11.5Markets in the United States 11.6Credit Rating Agencies 11.7Summary

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Eurocurrency Market The major forms of eurocurrency facilities discussed are –Short-term bank advances –Stand-by arrangements –Medium- to long-term eurocurrency loans

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Eurocurrency Market (cont.) Short-term bank advances –Similar to term loans or fully-drawn advances –Term determined, and full amount drawn-down on approval –Commitment fee may be charged if advance not drawn- down immediately after approval –May be extended by ‘revolving credit’, where a mixture of currencies can be chosen at each rollover (to match borrower’s currency inflows) –LIBOR typically used as indicator or reference rate

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Eurocurrency Market (cont.) Eurocurrency stand-by facilities –A source of ‘back-up’ funds to meet short-term cash shortfalls –Funds more likely to be available offshore in periods of tight domestic liquidity –Short-term finance (up to two years) –Interest charge and commitment fee apply

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Eurocurrency Market (cont.) Medium- to long-term eurocurrency bank loans –Loan size about USD3–100 million –Larger loans may involve a syndicate of banks –Term is typically 5 to 10 years –Loans usually fully drawn-down at commencement of loan unless an availability period is arranged, which attracts a commitment fee –Interest rate normally above LIBOR and fixed for a period of 1 to 12 months, plus other fees apply

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Chapter Organisation 11.1 The Euromarkets 11.2Eurocurrency Market 11.3Euronote Market 11.4Eurobond Market 11.5Markets in the United States 11.6Credit Rating Agencies 11.7Summary Summary

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Euronote Market Active market for short-term promissory notes or commercial paper Euronotes take several forms, two of which are –Euronote issuance facility (NIF) –Eurocommercial paper (ECP) Demystified in that these securities are fundamentally the same as domestic money- market and capital-market securities

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Euronote Market (cont.) Euronote issuance facility (NIF) –A short-term unconditional bearer promissory note drawn by the borrower in borrower’s name –Underwriting banks guarantee funds at issue and convert funding into medium term through a rollover facility –The instrument  Discount security  Maturity usually 30 to 180 days  Bearer securities in denominations of USD to

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Euronote Market (cont.) Euronote issuance facility (NIF) (cont.) –Structure  Typically a syndicate of banks underwrite the facility to a specified amount and discount rate, thus providing certainty for borrower –Selling procedures  Usually sold by a tender process, inviting members of a tender panel to tender prices for the notes  Tender panel composed of up to 25 financial institutions, including some of the underwriters  Issuer may specify a rate (posted rate), which is the yield at which the issuer is willing to sell a security

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Euronote Market (cont.) Euronote issuance facility (NIF) (cont.) –Parties involved in NIF issue  Arranger, lead manger, co-managers and senior managers, facility agent, tender panel agent, issuing and paying agent –Fees  Additional to NIF issue and rollover fees, include establishment fees for the arranger, managers and underwritter; commitment fee and take-up fees to underwriters; and agency fees for administration  Approximately 50 basis points (0.50%) in equivalent annual costs

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Euronote Market (cont.) Eurocommercial paper (ECP) –Arrangement where P-notes are issued into euromarkets that are not underwritten –Developed due to changes in needs of  Borrowers: high credit ratings and a history of successful issues, sought cheaper funds by dispensing with underwriters  Financial institutions: underwriting NIF issues sought to avoid imposed capital adequacy requirements of off- balance-sheet exposures

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Euronote Market (cont.) Eurocommercial paper (ECP) (cont.) –Typically more than USD250 million –Issued in tranches to test market’s reaction and to match borrower’s cash needs –Usually less than 6 dealing institutions (spread geographically and involving different institutional forms) to avoid fragmentation of facility

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Euronote Market (cont.) Calculating the price of NIF and ECP –Discount security formulae (from Chapter 9) but with market convention of a 360-day year (11.1)

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Chapter Organisation 11.1 The Euromarkets 11.2Eurocurrency Market 11.3Euronote Market 11.4Eurobond Market 11.5Markets in the United States 11.6Credit Rating Agencies 11.7Summary Summary

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Eurobond Market Eurobond market is the equivalent of a domestic capital market Two main long-term coupon debt securities issued in the euromarket considered here –Euro medium-term notes –Eurobonds, including straight bonds and floating rate notes

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Eurobond Market (cont.) Euro medium-term notes (MTN) –Emerged from the US equivalent market –Unsecured, non-homogenous bearer securities paying periodic coupon, issued in tranches  Maturities up to 15 years, average about 3 years  Coupons can be a fixed or variable interest rate expressed as a margin above a specified indicator rate  MTNs are not homogenous and can include a range of maturities, currencies and fixed and floating coupons –Dealers  With issuers, determine amount of facility and maturities  Act as agents for the issuer and seek investors  Promote secondary market by quoting two-way prices

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Eurobond Market (cont.) Euro medium-term note (MTN) (cont.) –Issues  Primary issue on a periodic or continuous (daily) basis  To remove concerns of fragmentation of notes, two other distribution techniques used MTN tap approach—involves dividing facility into a number of tranches, each with a specified minimum and maximum dollar amount, and identical maturity and coupon Serial offering technique—involves setting the maturity and coupon terms when facility is established. Facility may have several series of notes, each with different characteristics

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Eurobond Market (cont.) Eurobonds –Bond markets consist of 3 broad market groups  Domestic bonds Bonds issued into a local market, in the local currency, by a local company  Foreign bonds Bonds issued into a foreign market, in the local currency of that market  Eurobonds Bonds issued into a foreign market, but not in the currency of that market Traded on global markets and may escape local market listing and trading regulations Underwritten by a multinational syndicate of banks

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Eurobond Market (cont.) Issue and trading of eurobonds –Eurobonds are sold in a multi-stage process organised by an international bank called the lead manager –Lead manager creates a management group by inviting 5 to 30 banks to be co-managers  Management group prepares the bond issue, sets final conditions of the bond, selects underwriters and usually subscribes to a large portion of the issue –30 to 300 underwriters are invited to participate based on their regional placement power

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Eurobond Market (cont.) Issue and trading of eurobonds (cont.)

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Eurobond Market (cont.) Types of eurobonds –Eurobond markets continue to develop with new types of instruments and issuing techniques arising from time to time –Two classes of bonds considered here  Straight (fixed coupon)  Floating rate notes

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Eurobond Market (cont.) Types of eurobonds (cont.) –Straight (fixed coupon)  A fixed-interest bond paying periodic coupons; principal repayable at maturity  Issuers and investors Issuers—high credit rating and a household name Investors include retail and institutional investors  Amount and currency of denomination Fixed costs of issue constrain minimum size of issue to at least USD50 million, average about USD500 million Main currency USD, but also yen, euro and pound sterling

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Eurobond Market (cont.) Types of eurobonds (cont.)  Interest rate (coupon) Fixed coupon set at issue generally paid annually in arrears Coupons detached from bonds and presented to issuer’s paying agent for payment on due date  Maturity Usually a specified maturity date (mostly 3 to 12 years), with no option for issuer or investor to lengthen or shorten life of bond Usually principal payable in full on maturity (bullet repayment, although a partly amortised repayment structure possible)

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Eurobond Market (cont.) Types of eurobonds (cont.)  Listing Eurobond market has no specific physical location Secondary market dealings occur through market-makers in a number of world financial centres Eurobonds may be listed on the Luxembourg, London or Singapore exchanges, in compliance with disclosure standards and to ensure periodic public quotation, but few if any transactions  Participants In addition to lead and co-mangers, and underwriting and selling groups, trustee and paying agents are involved  Costs Commission of 1.5% to 2.5% of issue price and direct costs

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Eurobond Market (cont.) Types of eurobonds (cont.) –Floating rate notes (FRNs)  A bearer bond with a variable coupon rate based on an indicator interest rate, generally LIBOR Coupon rate reset periodically (usually six monthly) and therefore the price remains relatively stable Issue amount typically USD100 million, but can be more than USD500 million Maturities ranging from 5 to 20 years FRNs often have a call option, and may also have a put option

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Eurobond Market (cont.) Calculating the price of fixed-interest euromarket securities –Formula is the same as fixed-interest security formula 10.7 in Chapter 10 (11.2)

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Chapter Organisation 11.1 The Euromarkets 11.2Eurocurrency Market 11.3Euronote Market 11.4Eurobond Market 11.5Markets in the United States 11.6Credit Rating Agencies 11.7Summary Summary

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Markets in the United States US markets accessible to more international borrowers than euromarkets because of the lower required investment grade credit rating i.e. BBB and AA respectively Important available US securities –Commercial paper (USCP) –US foreign (Yankee) bonds –American depository receipts (ADRs) The US market is highly innovative and has other products not discussed here

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Markets in the United States (cont.) Commercial paper (USCP) –Short-term promissory note i.e. discount security –Average maturity less than 45 days –Denomination in USD$ –Some issues are supported by credit enhancements such as a bank letter of credit, or security over the assets of the issuer –Issue by public offer or private placement without requirement for official SEC registration

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Markets in the United States (cont.) US foreign (Yankee) bonds –A debt security issued by a foreign borrower into the US market –Denominated in USD –Issued for up to 20 years –Straight bond – fixed interest periodic coupon, principal repayable at maturity  Yankee bond—a variation issued as a floating rate note with interest coupons based on an indicator rate  Junk bond—issue of securities with a credit rating less than investment-grade BBB

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Markets in the United States (cont.) American depository receipts (ADRs) –A security issued by a US depository bank and supported by a depository share –The depository share represents one or more ordinary shares of a foreign issuer listed on the foreign company’s home stock exchange –Allows foreign companies to raise capital in US market without needing to meet SEC listing requirements

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Chapter Organisation 11.1 The Euromarkets 11.2Eurocurrency Market 11.3Euronote Market 11.4Eurobond Market 11.5Markets in the United States 11.6Credit Rating Agencies 11.7Summary

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Credit Rating Agencies –An organisation specialising in assessing the credit quality associated with financial obligations, e.g. S&P (Standard & Poor’s) –The rating methodology develops a profile balancing business risk, financial risk and environmental risk factors –S&P provide  Long-term credit ratings (AAA to D), with BBB and above being ‘investment grade’  Short-term credit ratings (A-1 to D)  A rating of a corporation overall

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Credit Rating Agencies (cont.) –S&P provide (cont.)  Issue-specific credit ratings on the credit worthiness of an obligor with respect to a specific financial obligation  Credit ratings of specific issues into international markets include Country risk—risk that changes in the laws of a foreign currency affect financial transactions Sovereign risk—risk that a foreign government will default on its obligations Foreign exchange risk— risk that the value of one currency, relative to another, will change

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Chapter Organisation 11.1 The Euromarkets 11.2Eurocurrency Market 11.3Euronote Market 11.4Eurobond Market 11.5Markets in the United States 11.6Credit Rating Agencies 11.7Summary

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Summary International debt markets are attractive to both investors and borrowers Major eurocurrency facilities include short-term bank advances, stand-by facilities and medium- to long-term bank loans, and are attractive for –The lower cost of borrowing –Creating a natural hedge –The size of the eurocurrency market The euronote market is a market for short-term direct debt markets Main security is the P-note (commercial paper) with two main facilities, NIF and ECP

Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger Summary (cont.) The eurobond market is a market for the issue of bonds in a currency other than the currency of the market of issue, and it includes MTNs, straight (fixed coupon) bonds and floating rate notes Debt markets in the US include commercial paper (USCP), US foreign (Yankee) bonds and American depository receipt (ADRs) Credit rating agencies assess the credit quality of a firm and/or its financial obligations