Definition of Bond Markets

Bonds can be defined as negotiable debt instruments with original maturity in excess of one year. The domestic bond markets are dominated by the respective governments. For instance, the US treasury is the largest issuer of bonds in the world. When a non-resident issuer issues bonds in the domestic market of a country (currency), it is known of that currency is known as a Eurobond.

Thus, for instance, when Reliance Industries issues a USD bond in the US capital market, it is a foreign dollar bond. If the bond issue is made in London, it is a Eurodollar bond. Public, registered issues of foreign bonds in the domestic markets of various countries have acquired trade names such as Yankee Bonds (US), Bulldog Bonds (UK), Samurai Bonds (Japan), Matador Bonds (Spain) etc.

Bonds may be registered or in bearer form. The procedures for transfer of ownership or exchange between bondholders are different for the two categories.

The traditional bond is the straight bond. It is a debt instrument with a fixed maturity period, a fixed coupon which is a fixed periodic payment usually expressed as percentage of the face value, and repayment of the face value at maturity. The market price at which such a security is bought by an investor either in the primary market (a new issue) or in the secondary market.

A very large number of variants of the straight bond have evolved over time to suit varying needs of borrowers and investors. The familiar variants are: Floating Rate Notes (FRN): It is a bond with varying coupon. Periodically every six months, the interest rate payable for the next six months is set with reference to a market index such as LIBOR.

Zero coupon bonds (“Zeros”) and Deep Discount Bonds which do pay a coupon but are at a rate below the market rate for a corresponding straight bond. Bulk of the return to the investor is in the form of capital gains.

Sinking fund bonds were a device, often used by small risky companies, to assure the investors that they will get their money back.

Some other bonds like Callable bonds, Puttable bonds and Convertible bonds. Each of these contains an option granted either by the issuer to the investor (convertibles, puttable) or vice-versa (callable). The value of the option is captured by adjusting the coupon which tends to be lower for convertibles and puttable bonds and higher for a callable bond compared to a straight bond with identical features.

Some bonds contain embedded currency or commodity options. For instance, the coupon payments and / or the redemption amount may be linked to an exchange rate or the price of a commodity such as oil. Redemption may be in any one of two or more currencies at the option of the investor. Dual currency bonds have coupon payments in one currency and redemption in another.

Warrants are an option sold with a bond which gives the holder the right to purchase a financial asset at a stated price. The asset may be a further bond, equity shares or a foreign currency. The warrant may be permanently attached to the bond or detachable and separately tradeable.

The largest international bond market is the Eurobond market which is said to have originated in 1963 with an issue of Eurodollar bonds by Autostrade, an Italian borrower.

Eurobond markets in all currencies except yen are quite free from any regulation by the respective governments. The euroyen bond market, which really came into existence as late as 1984, is closely controlled and monitored by the Japanese Ministry of Finance.

Straight bonds in the eurobond market are priced with reference to a benchmark, typically treasury issues. Thus, a eurodollar bond will be priced to yield a YTM (Yield-to- Maturity). The straight bonds segment is accessible only to highly rated borrowers.

Many eurobonds are listed on stock exchanges in Europe. This requires that certain financial reports be made available to the exchanges on a regular basis. However, secondary market trading in eurobonds is almost entirely over-the-counter by telephone between dealers.

Flotation costs of eurobond issues are generally higher than costs associated with syndicated eurocredits.

Among the national capital markets, the US market is the largest in the world. It is complemented by the world’s largest and most active derivative markets, both OTC and exchange-traded. It provides a wide spectrum of funding avenues.

From a non-resident borrower’s point of view, the most prestigious funding avenue is public issue of Yankee Bonds. These are dollar denominated bonds issued by foreign borrowers. It is the largest and most active market in the world but potential borrowers must meet very stringent disclosure, dual rating and other listing requirements, option features like call and put can be incorporated and there are no restrictions on the size of the issue, maturity and so forth.

Medium-term Notes (MTNs) represent a medium-term, non-underwritten, fixed interest rate source of funding. This form of funding originated in the US capital market and was introduced to the euro market – Euro Medium Term Notes (EMTNs) – during the ’80s. It was a part of the disintermediation process in which borrowers were approaching investors directly rather than going through the bank loan route.