1. The Global Capital Market
Prof. Ian Giddy
New York University

2. The International Capital Market
International bank financing
Eurobonds, foreign bonds and global bonds
“A Day in the Life”
The secondary market
The primary market
Structured financing

3. Short-Term Financing: Evolution
DIRECT
COMMERCIAL PAPER
ENHANCED
BANK L/Cs
INTERMEDIATED
BANK LOANS

4. Alternative Sources of Short-Term Financing
DEBT
EQUITY
Alternative Sources of Short-Term Financing
DOMESTIC
LOANS

5. Alternative Sources of Short-Term Financing
DEBT
EQUITY
Alternative Sources of Short-Term Financing
DOMESTIC
LOANS
EUROMARKET
LOANS

6. Alternative Sources of Short-Term Financing
DEBT
EQUITY
Alternative Sources of Short-Term Financing
DOMESTIC
LOANS
EUROMARKET
LOANS
SYNDICATED
EUROCREDITS

7. Alternative Sources of Short-Term Financing
DEBT
EQUITY
Alternative Sources of Short-Term Financing
DOMESTIC
LOANS
EUROMARKET
LOANS
SYNDICATED
EUROCREDITS
NOTE ISSUANCE
FACILITIES

8. Alternative Sources of Short-Term Financing
DEBT
EQUITY
Alternative Sources of Short-Term Financing
DOMESTIC
LOANS
EUROMARKET
LOANS
SYNDICATED
EUROCREDITS
NOTE ISSUANCE
FACILITIES
EUROCOMMERCIAL
PAPER

9. A Revolver RUF Structure: Arranger Underwriting banks Tender panel
Agent

10. RUF Stuff Need lots of money fast? Arrange syndicated
Have trouble accessing CP market?
Arrange syndicated
credit
YES
Confident of always being able
to access the short-term market?
Arrange Euronote
program
YES
Arrange RUF or MOF:
Underwritten Euronote program
Need funds?
Don’t issue paper NO
Cannot sell paper at L+10bp?
Borrow from banks
YES
Issue Euronotes or other paper

11. Alternative Sources of Long-Term Financing
Bank credits - syndicated
lending and facilities
Bonds
Domestic, foreign, Euro
Public, private
Structured, such as principle-indexed notes
Medium-term notes
Asset-backed financing and leasing
Project financing
DEBT
EQUITY

12. Long-Term Financing: Evolution
DIRECT
PUBLIC BONDS
ENHANCED
BANK-GUARANTEED BONDS
INTERMEDIATED
BANK TERM LOANS

13. The Global Bond Market Domestic bonds Foreign bond Eurobonds
(Issued within country of currency, by non-resident issuers)
Eurobonds
(Issued and sold in a jurisdiction outside the country of the currency of denomination)
Global Bonds
(Issued in the domestic and the Eurobond markets simultaneously)

14. The Global Bond Market Domestic bonds Foreign bond Eurobonds
(Issued within country of currency, by non-resident issuers)
Eurobonds
(Issued and sold in a jurisdiction outside the country of the currency of denomination)
Global Bonds
(Issued in the domestic and the Eurobond markets simultaneously)

15. International Bond Markets are Linked
Issuers and investors compare terms in the domestic and Eurobond markets, which are linked across currencies via currency swaps
Domestic US
Domestic
BOND
Japanese
MARKETS -
Gov't
WITHIN -
Corporate -
Gov't
COUNTRY -
Corporate OF
Foreign
CURRENCY
Bonds
Foreign
"Yankee"
Bonds
"Samurai"
Currency
Swaps
BOND
MARKETS
OUTSIDE
Eurodollar
Euroyen
COUNTRY
Bond Market
Bond Market OF
CURRENCY
Long-dated
Forward
Exchange

16. Foreign Bonds
A foreign bond is a bond issued in a host country's financial market, in the host country's currency, by a foreign borrower
The three largest foreign bond markets are Japan, Switzerland, and the U.S., representing issuance of about $40 billion in bonds annually

17. Private Placements and Rule 144A
The private placement exemption from registration and disclosure is extended to Eurobonds as long as the U.S. investors meet the following requirements:
They are large and sophisticated
There are only a few investors
They have access to information and analysis similar to that which would ordinarily be contained in a registered offering prospectus
They are capable of sustaining the risk of losses, and
They intend to purchase the bonds for their own investment portfolios, and not for resale.

18. Characteristics of Eurobonds
Issued outside country of currency
Not subject to domestic registration or disclosure requirements
In most cases take form of private placements
Placed through syndicates in many countries who sell principally to nonresidents
Bonds are structured so as to be free of withholding tax
Bearer form
But...
Eurobonds usually influenced de facto by government and banks of country of currency

19. Global Bonds

20. Key Dates in the Issuance of a Eurobond

21. Key Players in the Issuance of a Eurobond
MANAGERS
SELLING
GROUP
UNDER-
WRITERS

22. Who Gets What Fees, percent Fees, amount Net price
Price paid by investor (in theory)
Price paid by member of selling group 60%
Price paid by member
of underwriting group 60%+20%
Price paid by managers
(plus "praecipium" paid to lead manager) 60%+20%+20%

23. Pricing Eurobonds in the Secondary Market
What "spread to Treasury" should it yield relative to similar bonds--credit risk, duration and liquidity--trading in the secondary market?
Use the desired yield to maturity to find its present value at the next coupon date.
Find today's present value of that amount, including the coupon to be paid
Actual price is quoted as "clean price," meaning not counting accrued interest

24. The Eurobond Secondary Market

25. Eurobond Secondary Market Quotations
Examine the straight bonds listed
What determines the yields?
The bid-offer spreads?
Does this differ by currency?
Can you explain the pricing
of the floating rate notes?

26. A Day in the Life of the Eurobond Market
Examine the deals
Why were each done in that particular form?
What determines the pricing?
Can you break the hybrids into their component parts?

27. A Day in the Life...

28. Asset-Backed Eurobonds
Legal risk:
Legal structure: sale of assets to separate subsidiary that issued ABS.
Default risk:
Overcollateralization dictated by rating agencies
Replenishment of collateral
Third-party garantees.
Prepayment risk:
Early redemption caused by “spread trigger”.

29. Equity-Linked Eurobonds
Eurobonds with warrants
Marui
Convertible Eurobonds
Battle Mountaingold
Index-linked Eurobonds
Bank of Montreal

30. Equity Financing Choices
Conver-tibles
Warrants
Equity
ADRs
Common

31. Values and Market Premium
Conversion
Value
Straight
Bond Value V a l u e o f C n v r t i b B d
($) 0
Market
Value
Market Premium
Price Per Share of Common Stock

32. Values and Warrant Premium
1994, HarperCollins Publishers
Copyright
Values and Warrant Premium V a l u e o f W r n t
($)
Market
Value
Market Premium
Theoretical
Value
Price Per Share of Common Stock ($)

33. “Hybrid” Features of A Bond Issue
Conversion Feature - compound option
Warrants - two instruments
Index-linked bonds
Call Feature
Bond value = straight bond value - call value
These are all example of hybrid bonds and should be priced by decomposition

34. International Equity Markets and Portfolio Diversification
No well-accepted international version of the capital asset pricing model.
The benefits of diversification globally are empirical issues.
The empirical case for international diversification has two components.
Establish the riskiness of foreign investment, and the extent to which combining a foreign with a domestic portfolio reduces risk.
Even if it reduces risk, does foreign investment also reduce expected return?
Then what we have to do is make sure we understand how international diversification is best achieved.

35. Portfolio Return and Risk
where wi are the weights of each asset in the portfolio. (Expected return is simply the weighted sum of the individual asset returns.)
Portfolio variance:
When i = j, the term wiwjFiFjDij becomes wi2Fi2.

36. The Minimum-Variance Frontier of Risky Assets
Efficient frontier
Individual assets
Global minimum-variance portfolio

37. Optimal Overall Portfolio
Indifference curve
CAL
Opportunity set P
Optimal complete portfolio

38. The Global Efficient Frontier

39. Evidence Suggests Index Funds are Not for the International Investor
For the international investor the capitalization-weighted portfolio may not be the optimal one. The reason is market segmentation. The world stock market is not efficient yet, the evidence suggests, at least not in the "mean-variance efficiency" sense that is required by the CAPM.
Because of real exchange risk (deviations from PPP), what is the optimal portfolio for an investor in one country may not be the optimal portfolio for an investor in another, even if there were a single risk-free asset acceptable to both.
Studies confirm these propositions

40. International Portfolio Optimization: Passive vs Active Portfolios
(Let the proportions of all possible assets vary until the optimal proportions are found.)
The results of
letting the
computer
find the best
proportions for
various levels
of return:

41. Obstacles to International Investment Might Include:
Information barriers.
Political and capital control risks.
Foreign exchange risks.
Restrictions on foreign investment and control.
Taxation.
Higher costs.

42. Conclusion:
The international equity market is imperfect
Hence there may be advantages to international equity issuance
How should companies achieve this?

43. Financing with Structured Securities
Prof. Ian Giddy
New York University

44. Principles of Innovation Through Financial Engineering
Bundling and unbundling basic instruments
Exploiting market imperfections (sometimes temporary)
Creating value added for investor and issuer by tailoring securities to their particular needs
Key: For the innovation to work, it must provide value added to both issuer and investor.

45. Anatomy of a Deal

46. Anatomy of a Deal Issuer:
Looking for large amounts of floating-rate USD and DEM funding for its loan porfolio.
Wants low-cost funds: target CP-.10
Is not too concerned about specific timing of issue, amount or maturity
Is willing to consider hybrid structures.

47. Anatomy of a Deal Investor:
Has distinctive preference for high grade investments
Looking for investments that will improve portfolio returns relative to relevant indexes
Invests in both floating rate and fixed rate sterling and dollar securities
Can buy options to hedge portfolio but cannot sell options

48. Anatomy of a Deal Intermediary:
Has experience and technical and legal background in structure finance
Has active swap and option trading and positioning capabilities
Has clients looking for caps and other forms of interest rate protection.

49. The Deal
Initiate medium term note programme for the borrower, allowing for a variety of currencies, maturities and special structures
Structuring a MTN in such a way as to meet the investor’s needs and constraints
Line up all potential counterparties and negociate numbers acceptable to all sides
Upon issuer’s and investor’s approval, place the securities

50. The Deal / 2
For the issuer, swap and strip the issue into the form of funding that he requires
Offer a degree of liquidity to the issuer by standing willing to buy back the securities at a later date.

51. The Issue Issuer: Deutsche Bank AG Amount: US$ 40 Million Coupon:
First three years: semi-annual
LIBOR + 3/8% p.a., paid semi-annually
Last 5 years: 8.35%
Price: 100
Maturity: February 10, 2000
Call: Issuer may redeem the notes in full at par on February 10, 1995
Fees: 30 bp
Arranger: Credit Swiss First Boston

52. The Parties in the Deal
DEUTSCHE
SCOTTISH
LIFE
CSFB

53. The Deal in Detail SCOTTISH DEUTSCHE LIFE CSFB
Deutsche sells 3-year floating rate note paying LIBOR - 3/8%
SCOTTISH
LIFE
CSFB

54. The Deal in Detail SCOTTISH DEUTSCHE LIFE CSFB
Deutsche sells 3-year floating rate note paying LIBOR - 3/8%
SCOTTISH
LIFE
For an additional 3/4% p.a., Deutsche buys three- year put option on 5-year fixed-rate 8.35% note to SL in 3 years
CSFB

55. The Deal in Detail SCOTTISH DEUTSCHE LIFE CSFB
Deutsche sells 3-year floating rate note paying LIBOR - 3/8%
SCOTTISH
LIFE
For an additional 3/4% p.a., Deutsche buys three- year put option on 5-year fixed-rate 8.35% note to SL in 3 years
For 1% p.a., Deutsche sells CSFB a swaption (the right to pay fixed 8.35% for 5 years in 3 years)
CSFB

56. The Deal in Detail DEUTSCHE SCOTTISH LIFE CSFB CLIENT
Deutsche sells 3-year floating rate note paying LIBOR - 3/8%
SCOTTISH
LIFE
For an additional 3/4% p.a., Deutsche buys three- year put option on 5-year fixed-rate 8.35% note to SL in 3 years
For 1% p.a., Deutsche sells CSFB a swaption (the right to pay fixed 8.35% for 5 years in 3 years)
CSFB
CSFB sells the swaption to a corporate client seeking to hedge its funding cost against a rate rise
CLIENT

57. What’s Really Going On? Note:
Issuer has agreed to pay an above-market rate on both the floating rate note and the fixed rate bond segment of the issue
FRN portion: .75 % above normal cost
Fixed portion: .50% above normal cost
Issuer has in effect purchased the right to pay a fixed rate of 8.35% on a five-year bond to be issued in three years time.

58. Motivations for Issuing Hybrids Bonds
Company has a view
There are constraints on what the company can issue
The company can arbitrage to save money
Always ask: given my goal, is there an alternative way of achieving the same effect (e.g., using derivatives?)

59. The International Capital Market
International bank financing
Eurobonds, foreign bonds and global bonds
“A Day in the Life”
The secondary market
The primary market
Structured financing

60. END