A large part of running a company – as well as a government – is the process of securing sufficient amounts of capital to carry out operations. One particular route via which this capital can be secured is via foreign bonds. Continue reading to learn more about the same.
Defining Foreign Bonds
A foreign bond can be defined as a bond that has been issued by a company or government agency that has operations in one country but is offered to investors located in foreign countries. These bonds are made available to these investors in the currencies that prevail in their countries. Take, for instance, a company that is located in India issues bonds and offers them to investors located in Canada in Canadian Dollars.
Examining the Scope of Foreign Bonds
Foreign bonds create a channel for borrowers to access new capital markets and also allow them to get their hands on foreign currency. In the process of doing so, it also gives investors the opportunity to invest in foreign companies in their local currency. Investors are often drawn to foreign bonds as they allow them to diversify their portfolios and invest in foreign content without having to deal with the exchange rate.
Types of Foreign Bonds
Listed below are some of the different kinds of foreign bonds.
These foreign bonds are U.S. dollar-denominated bonds that are issued by foreign borrowers within the American bond markets. The issuers of these bonds are ordinarily foreign governments or entities, supranational, and corporate borrowers with high ratings. There are certain traits associated with Yankee bonds. Take for instance the requirement by the SEC to ensure that international bond issues are regulated and to ensure that documents are completely disclosed with all details provided. Issuers of Yankee bonds are required to adopt American accounting practices and are required to be rated by American credit rating agencies as opposed to foreign ones. An American domestic underwriting syndicate sponsors these bonds and must be registered by the Securities and Exchange Board of India prior to being sold in the American domestic market. So far, Reliance Industries Ltd. has had the most success with Yankee bonds and has secured a USD 50 million Yankee Bond issue for 50 years.
These foreign bonds are issued in domestic Japanese markets by borrowers who aren’t Japanese. Borrowers are required to have at least a minimum investment grade rating (i.e., A) and are supranational. The time frame for the maturity of these bonds ranges between 3 to 20 years. While supranational and their entities are given priority, sovereigns along with quality private corporations may also be permitted to issue Samurai bonds. If they happen to have Japanese trade links, they are likely to be given more priority as well. The settlement and administrative procedures associated with these registered bonds are expensive.
These foreign bonds are available in the UK domestic securities market and are sterling denominated. The time frame needed for maturity ranges from 5 years to 25 years or greater.
Risks Associated with Foreign Bonds
While investors are often eager to invest in foreign bonds, they must remember they carry with them the following risks.
Interest Rate Risk
Foreign bonds bring with them an interest rate risk. This means that when interest rates rise, the resale value or market price of these bonds declines. Take for instance an investor who owns a 10-year bond that pays 4 percent only to find that the interest rate has risen to 5 percent. Only a handful of investors would be willing to take on a foreign bond without a price cut to offset the difference in income.
When you purchase a bond at a predetermined interest rate it implies that the inherent value of the bond is tethered to the amount of inflation that might be taken away from its yield. Should an investor purchase a bond with a 5 percent interest rate at a time when inflation is 3 percent, the investor’s real payout amounts to the net difference which is 2 percent.
This risk serves as an implicit risk tethered to all foreign bonds. In order to understand this better consider the following example. Consider a foreign bond that yields 7 percent in a European currency which when converted into Indian rupees results in the yield falling to 2 percent owing to exchange rate differences.
Prior to investing in foreign bonds, it is crucial that investors take into account the government responsible for issuing the bonds and consider whether it is stable or not. Furthermore, they must take into account the laws surrounding the bond’s issuance and the court system that prevails. Falling under political risks associated with foreign bonds is the potential issue of issuing countries being unable to cover the debt associated with foreign bonds they issued. Owing to this very fact investors could potentially lose some, if not all, of their principal and interest.
Prior to investing in foreign bonds, it is important to do adequate research about those responsible for issuing them.