FINS3616 Lecture Notes - Lecture 7: Yield Spread, Bond Market, Risk Premium
6 – International Debt and Equity Financing
Global sources of funds for international firms
• Sources of funds for international firms
Internal – retained earnings
External – debt/equity/hybrids
(a) Loans
• All 3 can be raised domestically and internationally
• MNC foreign affiliates can also raise money from within MNC
Equity, intracompany debt, funds from sister affiliates
Financing mix around the world
• Firms use different capital structures – internal capital generally utilised first
• Equity and bond markets dominate the U.S.
• Bond market dominates in Japan
• Loans dominate in Europe
Characteristics of debt instruments
• Currency of denomination
If a purely domestic firm issues debt denominated in a foreign currency, can
affect how much they must repay; can match their revenue base though
• Maturity – structure borrowing so that large principal payments are not clustered
Match maturities of assets (accounts receivable and inventory) with short-term
debt and finance fixed assets (investments) with long-term debt
• Nature of their interest payments – fixed or floating rate debt
• Tradability
• International character – domestic v international
Centralised versus decentralised debt denomination
• Centralised – oo i $s headuates ue
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• Decentralised – borrow in different currencies of subsidiaries
Serves as balance-sheet (natural) hedge – balance foreign assets/ liabilities
Is issuing debt in low-interest rate countries a good idea?
• If UIRP holds, cost should be same as domestic loan
Assuming you believe this then issuing debt in low-interest countries is not a
good idea – for the same cost you nor assume forex risk
• If UI‘P doest hold, the low-interest country loan is cheaper
Forex can help – if currency that loan is denominated in depreciates you pay less
of the principal back
• Credit spreads
Risk premium paid above the risk-free rate
(a) Can differ across countries offering savings
Tax differentials can offer incentives to take on debt in different markets
Characteristics of debt instruments cont.
• Debt portfolios – can diversify across currencies just like diversifying across stocks
• Maturity – since 2000, many companies started to issue very long-dated debt
Some as long as 100 years – Walt Dises dued “leepig Beauties
Some are perpetuities
When to choose floating rate debt?
• Depends on expected future short-term rates
Term structure of interest rates – costs can and usually do differ across maturities
Expectations hypothesis
(a) Governs relationship between long rates and expected short rates
(b) Long-term interest rates are a weighted average of the current short-term
rate and expected future short-term rates
i. Holds well in U.K., but not U.S.
(c) Breakeven rate: rate that the market expects for future short-term borrowing
Tradability of debt
• Intermediated and direct debt
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Financial disintermediation – corporate borrowing takes the form of a tradable
security issued in the public market rather than a non-tradable loan provided by
a financial institution
• Private placements
Regulated by Securities Act of 1993 (in U.S.)
Must be sold to a limited number of large and sophisticated investors
Investors must have access to substantial financial information regarding the
company
Investors must purchase the securities for their own investment portfolios (not
for resale) and must be capable of sustaining any losses
The international character of debt
• Domestic bonds – bonds issues and traded in domestic market (country is country of
currency denomination)
• International bonds – bonds traded outside the country of the issuer
Foreign bonds: issued in domestic market by a foreign borrower (e.g. U.S.
company issuing A$ bond in Australia)
(a) Denominated in domestic currency
(b) Market to domestic residents
(c) Regulated by domestic authorities
Eurobond – mature in less than 10 years (usually 5)
(a) Denominated in one or more currencies
(b) Traded in external markets outside the borders of the countries issuing the
currencies
Size and structure of the world bond market
• Government bond market – most important in most countries
• Domestic bond markets
Regulated by domestic governments
(a) Required filing for issuances > $1.5m (U.S.)
(b) New public issues must be approved (Japan)
Usually annual coupons
• International bond markets
Geeall egulated issues goeet, ot ooes
Eurobonds – issued simultaneously in capital markets of several nations
(a) Need not comply with regulatory restrictions that apply to domestic issuers
International bond market
• Primary market for Eurobonds:
Borrower contacts an investment bank to serve as lead manager
(a) Bank contacts co-managers to serve in a syndicate to share risk
• Secondary market for Eurobonds – the above bonds sold to other investors; over the
counter market
• Global bonds – bond sold simultaneously in domestic and Eurobond market
Lower borrowing costs by approximately 20 basis points
• Dragon bonds – Eurobond targeted at Asian market
Types of debt instruments in international bond market
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Document Summary
Global sources of funds for international firms: sources of funds for international firms. External debt/equity/hybrids (a) loans: all 3 can be raised domestically and internationally, mnc foreign affiliates can also raise money from within mnc. Equity, intracompany debt, funds from sister affiliates. Financing mix around the world: firms use different capital structures internal capital generally utilised first, equity and bond markets dominate the u. s, bond market dominates in japan, loans dominate in europe. Characteristics of debt instruments: currency of denomination. If a purely domestic firm issues debt denominated in a foreign currency, can affect how much they must repay; can match their revenue base though: maturity structure borrowing so that large principal payments are not clustered. Match maturities of assets (accounts receivable and inventory) with short-term debt and finance fixed assets (investments) with long-term debt: nature of their interest payments fixed or floating rate debt, tradability.
