International Bond Markets
What are “International Bond Markets”?
In addition to domestic or local bond markets, there are also thriving international bond markets. An increasing number of companies are seeking to borrow internationally and there are many investors who purchase bonds from foreign issuers.
An international bond is defined as a bond issued in a country that is not the domestic country of the issuer. Such bonds can be classified into three broad types – eurobonds, foreign bonds, and global bonds. International bonds are exposed to inflation, interest rate, default, downgrade, currency and liquidity risks, plus market volatility.
There are varied instruments in international bond markets, such as fixed rate bonds, floating rate bonds, convertible bonds, fixed-rate with equity warrants, and zero-coupon bonds.
Key Learning Points
- An international bond is issued in a different country to the domestic country of the issuer
- Most international bonds are corporate bonds
- There are three broad types of international bonds: eurobonds, foreign bonds, and global bonds
- Exchange rate risk is one of the major risks investors face while investing in such bonds
Types of International Bonds
Eurobonds: these are bonds that are denominated in a foreign currency i.e. a currency other than that of the country in which it is issued. A bond denominated in Japanese Yen and issued in the UK, or a bond denominated in US dollars and issued in France or the UK are all examples of Eurobonds. London is the preeminent market for Eurobonds and other types of bonds.
Eurobonds account for approximately 30% of the global bond market. Such bonds can be issued with fixed or floating interest rates. These bonds typically have medium to long term maturities. The issuer can choose between a significant range of maturities – usually 3, 5, 7, and 10 years – although some eurobonds have maturities ranging from 15 to 30 years. Eurobonds denominated in dollars (known as Eurodollars) are the largest component of the Eurobond market.
Foreign bonds: these are bonds that are denominated in the currency of the country where they are issued and where the issuer is not a resident of that country. For example, a yen-denominated bond sold by a non-Japanese issuer (such as a French company) in Japan, or a US dollar denominated bond sold by a German company in the US. Examples of such bonds are also known as Samurai and Yankee bonds respectively.
Global bonds: these are bonds that are denominated in a foreign currency i.e. a currency that is different from the domestic currency of the country in which the bond is issued. For example, a German company issuing a Japanese yen-denominated bond in London, or a German company issuing bonds denominated in the US dollar and offering it to investors in both the US and Japan.
International Bond Markets – Advantages and Disadvantages
Investing in the international bond markets can help investors to diversify their portfolio, gain exposure to foreign markets, get high returns (in return for higher risk, relative to domestic bonds), and can be useful for hedging. However such bonds can add exposure to the additional risk of currency fluctuations (i.e. exchange rate risk), country risk and their liquidity is often low when compared to domestic bonds. Further, the transaction costs of international bonds tend to be higher relative to domestic bonds.
Currency Fluctuations, International Bonds and Total Returns
The total rate of return on an international bond can be affected by currency fluctuations. A depreciation (appreciation) in the foreign currency in which the international bond is denominated will result in lowering (increasing) total returns on such a bond. Given below is an example of currency depreciation.
Example: Currency Depreciation of the US Dollar (Foreign Currency)
Assume that a UK based investor purchases a one-year US dollar denominated bond with a $12,000 par value. It is trading at par, has a one year maturity and coupon of 3% (annual). At the time of purchase, the exchange rate was $1=£1.7. Consequently, this investor paid £20,400 for the US$ denominated bond. By the time the bond matured, the USD depreciated against the GBP i.e $1=£1.4.
Therefore, the UK based investor received only £16,800 upon converting the maturity proceeds after one year. So, the loss arising from currency fluctuations (i.e. depreciation of the USD) was £3,600. However, this loss was reduced to some extent, due to the coupon payment of $360. Therefore, upon conversion, the net loss from this investment amounted to – £3,600 + £504 = £3,096 ($360 = £504). The UK investor lost 15.18% on the initial investment of £20,400 (refer to the calculation below).