What is a Eurobond?
Companies can use bonds to raise funds from investors who, in turn, receive interest payments pre-determinedly. Bonds can be used domestically and internationally.
However, the main difference is that companies can receive funds in a currency different than they usually use through international bonds.
There are three types of bonds, two being international bonds.
Domestic bondsare bonds issued inside the country's borders by a local business, whileforeign bondsare issued in a particular country by a foreign borrower.
A Eurobondis a debt instrument of a fixed income denominated in a currency different than that of the local country where the bond has been issued. They are also known as external bonds since companies issue these bonds offshore and raisecapitalusing different currencies.
The currency of the issuance is named the Eurobond. For instance, a bond issued and denominated by the US dollar would be called a Eurodollar bond. Another bond denominated by the Chinese currency (Yen) would be called the Euroyen bond.
To guarantee the purchase of the entire bond, a global association (syndicate) of monetary institutions would handle the transaction in the borrower's name.
The term “Eurobond” doesn’t mean the bond was issued in Europe or by the Euro currency. Instead, the bond can be issued outside the borders of the currency’s home country.
The flexibility of these external bonds is the critical difference. Companies issuing these bonds can choose the country they are giving them to. Their decisions would be made based on economic and regulatory fundamentals such as
- Interest rates
- Economic cycle
- Market size and growth
External bonds provide lowpar valueor face value, making them a low-cost investment and highly tempting for investors. Also, these bonds have high liquidity, which can be converted into cash within onefiscal year.
Example Of Eurobond
Assume an American corporation wants to start a business in Canada and needs a massive amount of the local currency (Canadian dollars) to make its new business come to life.
Since the company lacks the amounts of Canadian dollars needed, they considered borrowing the funds from Canada. However, it seemed a bit costly to do so.
The company then studied the foreign market and realized an enormous quantity of Canadians in a certain country, say, Australia. The company then issues Canadian-dollar-denominated external bonds in the Australian market.
Investors with a surplus of Canadian dollars in their bank accounts might decide to invest in these bonds.
Thus, the firm can now get its funds and open its business in Canada with fewer costs than it would have incurred if it directly issued the bonds in the Canadian market.
History Of Eurobonds
Eurobonds were created and centered in London, with Luxembourg also a significant center. Since then, external bonds have expanded and are traded globally, with Singapore and Tokyo as essential markets.
These bonds were first created to avoid specific financial regulations imposed by the US government on bankers. Investing in US dollars in London helped them run away from these regulations.
London was glad to be the home of this finance sector and accepted the business with open arms.
They were first issued in 1963 by an Italian railroad company calledAutostrade. The company issued 60,000 bearer bonds at $250 per bond, accounting for a total value of $15M.
These bonds had a coupon rate of 5.5% paid annually. The issuance was made to London bankers and paid in Luxembourg to reduce tax bills.
These external bonds were significant for Europeans since they helped them get their hands on safe dollar-denominated investments.
The maturity of these bonds is between 5 to 15 years, with most of the bonds having a maturity date of fewer than ten years. Additionally, a single bond of this type can be valued at more than a billion dollars.
Essentially emerging as a tool to avoid financial regulations imposed on banks by the US government, the Eurobond market has grown to an estimated $24.8B, according toCMDPortal.
Types Of Eurobonds
1. Straight bond
A straight bond is issued with a specified interest rate and maturity date. They can also be issued using variable rates.
Additionally, they may have a 6-month interval of fixed rates based upon theLIBORfor deposits in the bond’s currency.
2. Convertible external bonds
These are issued with specific interest rates and maturity dates. The main difference here is that they can be transformed into equity shares of the issuer’s company with a price set at the time of the issuance.
3. Medium-term external bonds
These short-term bonds are usually issued with a maturity date of 3 to 8 years. They have a less formal issuing procedure than that of large bonds. Moreover, these bonds can have fixed or variable interest rates.
4. Bonds with warrants
These external bonds are issued with warrants. The warrant is an option to buy common shares of the issuing company at a given price during a specified period.
Unless the prices of the common shares exceed the exercise price, warrants pay no dividends, lack voting rights, and are useless upon the expiration date.
5. Multiple currency bonds
Grant the investor the right to receive payments and the principal in whatever currency is agreed on at the issuance date. Of course, the bondholder chooses between two or more currencies at a predetermined exchange rate.
Benefits Of Eurobonds
These bonds grant both investors and issuers various benefits. Regarding the issuers:
| The flexibility of companies to choose the country to issue bonds. |
| Lower interest rates become an option |
| Protection against currency risk or forex risk |
| The issuer chooses various maturity date options |
| International bond trade that goes beyond national borders |
1. The flexibility of companies to choose whatever country to invest in.
These bonds allow companies to choose the country to issue bonds in according to economic and financial fundamentals. These decisions would be affected by interest rates, economic cycles, and market size.
2. Lower interest rate options
Issuing bonds to countries with lower interest rates allows companies to raise capital with minimal interest payments.
3. Protection against currency risk
Using these bonds, the issuer and the borrower agree on a fixed exchange rate. Thus, protecting the issuer against currency risk.
4. The issuer chooses various maturity date options.
External bonds can provide maturity dates from 5 years up to 30 years. Yet, most bonds are set to less than ten years.
5. International bond trade goes beyond national borders.
These bonds pull different investors from nations around the world. Thus, diversifying the markets that the companies engage in.
Issuers aren’t the only beneficiaries when using these bonds. Investors also claim valuable advantages such as engaging in foreign investment in their home country. Also, investors can use these bonds to diversify their portfolios, effectively decreasing risk.
As mentioned earlier, these bonds are also relatively cheap as they have low par value and deliver high liquidity.
External bonds can also be more liquid if the bond is denominated in a foreign currency and issued in a strong country (economically).
Eurobonds Vs. foreign bonds
Foreign bonds are long-term bonds issued in a domestic country by a foreign company. The bonds would be denominated in the domestic currency and follow regulations imposed by the government.
Even though both types of bonds are regarded as international bonds, they are known to be different types of investments. People confuse these two terms since foreign bonds were created much earlier than Eurobonds.
When talking about foreign bonds, investors do not have to worry about exchanging currencies since the bonds are issued in the domestic country’s currency. Thus, it enables investors to diversify their portfolios without the need for draining calculations and exchange rates.
Monetary institutions also underwrite foreign bonds, making these investments safer for beginners. However, due to their low risk, these bonds yield low rates of return and, in some cases, provide negative rates of return during economic recessions.
But, How Can You Maximize Your Bond Investments?
The first thing that should be considered when asking this question is the length of time you hold the bond. The longer you have a bond, the more yield will be received.
When holding a 10-year bond, the yield would be much higher than a 1-year bond since you would be holding your money for extended periods.
However, if interest rates rise, then prices of bonds go down since other issued bonds would be traded at a higher interest rate, thus paying more money. This would make currently held bonds equal to less than other trading bonds.
But holding bonds until they mature would still grant the investor the face value of the bonds, plus whatever interest payments the investor would receive. The only drawback would be if the issuer failed to meet its obligations.
Evaluating foreign and external bonds and studying what better suits your current portfolio will help you make appropriate investment decisions. Along with a financial expert’s advice, your portfolio would be something you can be proud of.
