Definition of Eurobond Market

Eurobond Market

The last three decades have witnessed a fast growth of international bond market. Corporate sector can raise long-term funds through the issue of Eurobonds. Eurobonds are debt instruments denominated in a currency and issued outside the country of currency. Main borrowers in the Eurobond market are companies, MNC, state enterprises, Governments and International Organizations. Among the developing countries the main borrowers have been Argentina, Brazil, Chile, Hong Kong. Ivory Coast, Koreas, Malaysia, etc,. Lately India has also joined the list of borrowers.

Investment and institutions make investment in Eurobonds. Institutional investment comes from pension funds of west European nations, U.N. agencies, mutual funds of continental European banks and merchant bankers.

The Main currencies in which borrowings are made are U.S.$ Gilder, Candian dollar, French Franc, Swiss Franc and Japanese Yen.

Euro-bond is similar to domestic bonds/debentures sold in domestic capital market. Unlike domestic bond markets, Euro-bond market is free from official regulations; instead it is self-regulated by the Association of International Bond dealers. The prefix euro indicates that the bonds are sold outside the countries in whose currencies they are denominated.

Two kinds of bonds are floated in internal bond market.

Euro-bonds underwritten by an international syndicate and placed on the market of countries other than that of the currency in which the issue is made.

Foreign bonds issue on the market of a country and bought by non-residents in the currency of that country.

Foreign Bonds These are bonds issued by borrowers outside their domestic capital market underwritten by a firm that is situated in the foreign market. These bonds are denominated in the currency of the market in which they are issued. At times they may be denominated in another currency.

Thus a foreign bond is issued by foreign borrowers and is denominated in the currency of the country in which it is issued. U.S.A., Japan, Switzerland, Germany and U.K. allow foreign borrowers to raise money from their residents through the issue of foreign bonds.

Foreign bonds are referred to as traditional international bonds because they existed long before Eurobonds. Yankee bonds are foreign bonds issued in the United States. Foreign bonds issued in U.K. re called Bulldog bonds. Those issued in Japan are called Samurai bonds.

Immediately after the Second World War, USA was the primary market for foreign bonds. Due to interest Equalization Tax imposed in 1963 much of the dollar denominated bonds moved to the Eurobond market. The market trend is that borrowers prefer Euro market rather than the U.S. market.

Foreign organizations other than U.S. have extensively floated dollar bonds in the United States taking advantage of the well-developed capital market. US multinational raised substantial amounts of capital during 1970s by issuing bonds denominated in D-mark in Germany and bonds denominated in Swiss Francs in Switzerland.

Eurobond

A Eurobond is to be distinguished from a foreign bond in that it is denominated in a currency other than the currency of the country in which it is issued. Eurobonds are sold for international borrowers in several markets simultaneously by international group of banks.

The same causes, which led to the growth of Eurocurrency market, have also contributed to the development of Eurobond market. But the size and growth rate of this market are modest compared to Euro market. Yet, it has established itself as a major source of financing for multinational corporations. Besides MNCs, private enterprises, financial institutions, government and central banks and international financial institutions like the World Bank are the principal borrowers. They issue these bonds.

Institutional investors such as insurance companies, mutual funds, pension funds etc are the principal buyers/investors. Leading multinational bank and brokerage house also act as lenders. Since it is free from regulations that characterize the US Market, MNCs exploits the control-free environment. An international syndicate representing major European banks and European does underwriting of bond issue and foreign branches of US banks with participation from banks in other financial centers in Asia, the Middle East, and the Caribbean’s as well as large international securities firms.

Growth of Eurobond Market

The Eurobond market started flourishing due to some special advantages which are not available to either the domestic or foreign bond market. They are:

The Eurobond market like the Eurocurrency market is an offshore operation not subject to domestic regulations and controls. Domestic issues of bonds denominated in local currency are subject to several regulations. Eurobond issued is not subject to costly and time consuming registration procedures. In the USA securities exchange commission procedures are applicable both to the domestic and foreign bonds issued in United States. Disclosure requirements are less stringent to Eurobonds. Therefore many MNCs which do not which to disclose information resort to Eurobonds issue.

Eurobonds are issued in bearer form. This will facilitate their easy negotiation in the secondary market. These bonds are not available to US resident when issued. But they could purchase them after a cooling-off period.

Eurobond holders are not subject to income tax withholding on the interest received when they cash their interest coupons. But such withholding applies to non-resident investors in domestic and foreign bonds issued in USA. That is why, many U.S, MNCs use their subsidiaries to issue Eurobonds to reduce their borrowing cost.

Types of Bonds

There are different types of innovative bonds.

Straight Bonds: These bonds have fixed maturities. Interest payments are made at intervals of one year. These bonds are also issued on a perpetual basis. Bullet bonds provide repayment of the entire principal amount on a single maturity date. Full or partial redemption before fixed maturity date is also permitted.

Convertible Bonds: In addition to straight bonds convertible bonds or bonds attached with warrant are issued. Both these bonds can be converted into equity of the issuing company at a pre-specified conversion ratio.

Floating Rate Note: To overcome the risk arising out of volatility of interest rates bond s is also issued in the form of floating interest rate bonds. Since the interest rate can be adjusted according to the market rates, these bonds have become popular. Multinational financial institutions prefer to participate in this market rather than in syndicated Eurocurrency loans.

Multicurrency Bonds: Multiple currency bonds and currency cocktails are another innovation in bond issues. Multiple-currency bond entitles the holders to receive interest and principal in any of the specified currencies whose exchange rate are established at the outset. It is advantageous to the investor because he can ask for payment in the currency, which appreciated most. International bonds denominated in a currency cocktail, such as European Currency Unit (ECU), afford protection to the investor against exchange rate fluctuations.

Convertible Bonds: Another interesting variation of bond issue –dual or multiple currency bonds with the convertibility provision. For example a Swiss MNC may issue a Eurodollar bond that entitles the investor to convert into share of the company denominated in Italian inter lea at a specified conversion ratio. The fortune of the investor depends, among other things on the movement of US dollar/Swiss franc exchange rate.

The dual currency Eurobonds majority of which are yen/dollar bonds have been around for a few years. These bonds are denominated and serviced in Japanese Yen, but are redeemable in US dollar at the exchange rate fixed at the time of issue.

Bonds with Equity Warrants: Another innovation is the so-called ‘wedded warrants’, which were issued by a French company in 1985. These are 10-year bonds called after 5 years with warrants which give the holder the option to buy identical but non-callable bonds. For the first five years the warrants are ‘wedded’ to the original bonds. If the bondholder wants to exercise these warrants during this period, the holder must sell the original bonds back to the borrower. During the second 5 years period, the warrants are divorced from original bonds. Hence the bonds can be acquired for cash.

Zero coupons Bond: These bonds are sold at discount. Hence no interest is paid. Issues prefer them because they need not pay interest at periodical intervals. Investors especially from those countries which exempt capital gains or tax at lower rates find them attractive.

Despite all these innovations straight or fixed rate Eurobonds continue to account for a major share in bonds issue. Next come the floating rate bonds; convertible bonds and bonds with warrant account for a small portion of the total market.