1. Certificate for Introduction to Securities & Investment (Cert.ISI)
32cis
Certificate for Introduction to Securities & Investment (Cert.ISI)
Unit 1
Lesson 32:
Corporate bond variations
Domestic
Foreign
Eurobond
Asset-backed securities

2. Corporate bond variations
Investment banks are continually trying to devise new financial instruments aimed at meeting the financing needs of issuers and the income needs of investors. This is called “financial engineering”.
This has resulted in a large variety of corporate debt being issued and traded
Medium-term notes
Standard corporate bonds with maturities ranging from nine months to five years
But the term has also be applied to securities with maturities as long as 30 years
Offered to investors continually over a period of time by an agent of the issuer, instead of being issued in a single, underwritten tranche
Medium-term notes originated in the USA, with the aim of filling the funding gap between commercial paper and long-term bonds.

3. Corporate bond variations
More financial engineering…
Floating rate notes (FRNs)
The rate of interest is variable, because it is linked to a benchmark rate in the money markets
The interest rate on most FRNs is linked to LIBOR – the London InterBank Offered Rate
LIBOR is the rate of interest at which banks will lend to each other in London, and is used world-wide as the basis for financial instrument cash-flows
The FRN will pay the benchmark interest rate plus an agreed margin on top
This margin is known as the spread
The Chicago Mercantile Exchange's Eurodollar contracts are based on three-month US dollar LIBOR rates. They are the world's most heavily traded short term interest rate futures contracts and extend up to 10 years. Shorter maturities trade on the Singapore Exchange in Asian time.
Libor:
Derivatives based on LIBOR are now traded on exchanges such as LIFFE and the Chicago Mercantile Exchange as well as over-the-counter. The rates are also used as the basis for many types of lending, from syndicated and commercial lending, to calculating rates on residential mortgages.

4. Corporate bond variations
When is a bond not a bond? When is a share not a share? When it is a Permanent Interest Bearing Share (PIBS) !
PIBS are only issued in the UK sterling market. PIBS are special shares issued by building societies that pay a fixed rate of interest. They cannot be sold back to the society but can be bought and sold on the stock exchange, which means the price varies.
PIBS carry a fixed coupon
In this aspect, they are different from ordinary shares, where the dividend can vary from year to year, and more like a bond
PIBS are irredeemable
In this aspect they differ from other corporate bonds, and are more like a share

5. Domestic bonds and foreign bonds
Bonds can also be categorised geographically – domestic or foreign
Domestic bonds
Issued by a domestic issuer into the domestic market, e.g.
UK company issuing bonds, denominated in sterling, to UK investors
Foreign bonds
Issued by an overseas entity into a domestic market denominated in the domestic currency, e.g.
German company issuing a sterling bond to UK Investors
British company issuing a US dollar-denominated bond to US investors
Eurobonds
Foreign bonds originally issued in European markets and denominated in US dollars
Nowadays, eurobonds can be issued in markets outside Europe
Eurobonds can also now be issued in currencies other than US dollars
However, the defining characteristics of a eurobond is that it is always denominated in a currency different from the financial centre (or centres) in which it is issued to investors

6. Eurobonds
Eurobonds are large international bond issues, often made by governments and multinational companies
The Eurobond market is the world’s largest market for longer-term capital. Most of its activity is concentrated in London
The Eurobond market started in 1963 but grew exponentially in the early 1970s to accommodate the re-cycling of Opec US dollar revenues from oil sales
At that time, US financial institutions were restricted on the amount of interest they could pay on US dollar deposits
Oil exporters placed their US dollars on deposit with financial institutions in Europe: the eurodollar market took off
Companies and governments issued bonds in Europe, tapping the plentiful supply of US dollars
Opec net oil export revenues

7. Eurobonds
The Eurobond market has been in existence for nearly 50 years.
The first Eurobond was issued on behalf of the Italian motorway operator, Autostrade, in July 1963
Terms: US$15m, 5½%, 1972/78
Guaranteed by Italian state-owned industrial and financial holding company, IRI
IRI actually diverted the proceeds of the issue to another company it owned, steel producer, Finsider

8. Characteristics of eurobonds
Most Eurobonds are issued as conventional bonds (also known as “straights”)
Fixed nominal value
Fixed coupon
Known redemption date
Default risk:
Eurobonds issued by companies often do not provide any security to the investors
However nearly all eurobonds have a credit rating from a recognised credit rating agency
Seniority risk:
Eurobond issuers usually include a “negative pledge” clause in the bond prospectus. This prevents the issuer from subsequently making any secured bond issues, or issues which confer greater “seniority” (i.e. the right to be paid out first in the event of the issuer going into liquidation) – unless the same level of security is given to the existing bondholders.

9. Versatility of eurobonds
Eurobonds have also been issued as floating rate notes, zero coupon bonds, convertible bonds and dual-currency bonds. There are no set rules: if it suits the issuer and the investors are still willing to lend the money, virtually any feature can be used.
The versatility of the eurobond market makes it much more attractive to issuers than their domestic bond markets
A choice of innovative products to meet more exactly the borrower’s needs
The ability to reach potential lenders internationally rather than just domestically
Anonymity to investors, as eurobonds are issued in bearer form
Interest paid gross (i.e. with no tax deduction) to investors
Lower funding costs, due to the competitive nature and greater liquidity of the market
Ability to make bond issues at short notice
Less regulation and disclosure

10. Asset-backed securities
Asset-backed securities is the term given to bonds which bundle together financial assets which – on their own – would be too small or too illiquid to be traded in the market
Mortgages
A large number of mortgages can be pooled together and sold as a single investment asset
Although each individual mortgage will have a different interest rate and a different maturity date, in aggregate they will have a blended interest rate and maturity date
The banks that originally provided the mortgage to the home-buyer are still responsible for servicing the debt (i.e. collecting the monthly payments)
Credit card receivables

11. Asset-backed securities
Asset-backed securities (ABS) have become a controversial asset class
One of the principal causes of the Credit Crunch was the collapse of the US “sub-prime” housing loan market.
Sub-prime loans are loans made to borrowers with poor credit histories or with insufficient income to meet the monthly payments comfortably
By the beginning of 2007, the US housing market was falling. A large number of sub-prime borrowers found it impossible to renew their loans on the same terms as before.
This triggered defaults on a huge number of mortgages, which had been pooled together and sold on to investors as asset-backed securities.
Many investment grade mortgage-backed securities were found to contain sub-prime housing loans, causing a collapse in confidence in the whole ABS asset class