CHAPTER 7 INTERNATIONAL BOND MARKET
SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER
QUESTIONS AND PROBLEMS
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
Answer: The major types of international bond instruments and their distinguishing characteristics are as
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
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