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Western University
Business Administration
Business Administration 4440Q/R/S/T
Brad Bisho

CHAPTER 7 INTERNATIONAL BOND MARKET SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS QUESTIONS 1. Describe the difference between foreign bonds and Eurobonds. Why do Eurobonds make up the lion’s share of the international bond market? Answer: The two major segments of the international bond market are foreign bonds and Eurobonds. A foreign bond issue is offered by a foreign borrower to investors in a national capital market and denominated in that nation’s currency. For example, if the Province of Saskatchewan issued a bond in New York with interest and principal denominated in US dollars, that would be a foreign bond. A Eurobond issue, on the other hand is denominated in a particular currency but sold to investors in national capital markets other than the country of the denominating currency of the bond. So, for example, if the Province of Saskatchewan issued a bond in with interest and principal denominated in US dollars and that bond was underwritten and sold in London, that would be a Eurobond. Eurobonds make up over 80 percent of the international bond market. The two major reasons for this stem from the fact that the US dollar is the currency most frequently sought in international bond financing. First, Eurodollar bonds can be brought to market more quickly than Yankee bonds because they are not offered to U.S. investors and thus do not have to meet the strict SEC registration requirements. Second, Eurobonds are typically bearer bonds that provide anonymity to the owner and thus allow a means for evading taxes on the interest received. Because of this feature, investors are generally willing to accept a lower yield on Eurodollar bonds in comparison to registered Yankee bonds of comparable terms, where ownership is recorded. For borrowers the lower yield means a lower cost of debt service. IM-1 2. Briefly define each of the major types of international bond market instruments, noting their distinguishing characteristics. Answer: The major types of international bond instruments and their distinguishing characteristics are as follows: Straight fixed-rate bond issues have a designated maturity date at which the principal of the bond issue is promised to be repaid. During the life of the bond, fixed coupon payments that are some percentage rate of the face value are paid as interest to the bondholders. This is the major international bond type. Straight fixed-rate Eurobonds are typically bearer bonds and pay coupon interest annually. Floating-rate notes (FRNs) are typically medium-term bonds with their coupon payments indexed to some reference rate. Common reference rates are either three-month or six-month U.S. dollar LIBOR. Coupon payments on FRNs are usually quarterly or semi-annual, and in accord with the reference rate. A convertible bond issue allows the investor to exchange the bond for a pre-determined number of equity shares of the issuer. The floor value of a convertible bond is its straight fixed-rate bond value. Convertibles usually sell at a premium above the larger of their straight debt value and their conversion value. Additionally, investors are usually willing to accept a lower coupon rate of interest than the comparable straight fixed coupon bond rate because they find the call feature attractive. Bonds with equity warrants can be viewed as a straight fixed-rate bond with the addition of a call option (or warrant) feature. The warrant entitles the bondholder to purchase a certain number of equity shares in the issuer at a pre-stated price over a pre-determined period of time. Zero coupon bonds are sold at a discount from face value and do not pay any coupon interest over their life. At maturity the investor receives the full face value. Another form of zero coupon bonds are stripped bonds. A stripped bond is a zero coupon bond that results from stripping the coupons and principal from a coupon bond. The result is a series of zero coupon bonds represented by the individual coupon and principal payments. A dual-currency bond is a straight fixed-rate bond issued in one currency and pays coupon interest in that same currency. At maturity, hover, the principal is repaid in a second currency. Coupon interest is frequently at a higher rate than comparable straight fixed-rate bonds. The amount of the dollar principal repayment at maturity is set at inception; frequently, the amount allows for some appreciation in the IM-2 exchange rate of the stronger currency. From the investor’s perspective, a dual currency bond includes a long-term forward contract. Composite currency bonds are denominated in a currency basket, such as in SDR, instead of a single currency. They are frequently called currency cocktail bonds. They are typically straight fixed-rate bonds. The currency composite is a portfolio of currencies: when some currencies are depreciating others may be appreciating, thus yielding lower variability overall. 3. Why do most international bonds have high Moody’s or Standard & Poor’s credit ratings? Answer: Moody’s Investors Service and Standard & Poor’s provide credit ratings on most international bond issues. It has been noted that a disproportionate share of international bonds have high credit ratings. The evidence suggests that a logical reason for this is that the Eurobond market is only accessible to firms that have good credit ratings to begin with. 4. What factors do Standard & Poors analyze in determining the credit rating it assigns a sovereign government? Answer: In rating a sovereign government, S&P’s analysis centers around an examination of the degree of political risk and economic risk. In assessing political risk, S & P examines the stability of the political system, the social environment, and international relations with other the countries. Factors examined in assessing economic risk include the sovereign’s external financial position, balance of payments flexibility, economic structure and growth, management of the economy, and economic prospects. The rating assigned a sovereign is particularly important because it usually represents the ceiling for ratings S&P will assign an obligation o
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