Explain various types of Bond used in International Market.
Answers
Types of Bonds in International Bond Market
◆ Domestic Bonds
Issued locally by a domestic borrower
Usually denominated in the local currency.
A US dollar bond issued in the USA by a US company
◆ Foreign Bonds
Issued on local market by a foreign borrower
Usually denominated in domestic currency
Issue and Trading – Under supervision of domestic market authority
A US dollar bond issued in the USA by a Non-US company is a foreign bond
◆ Euro Bonds
Underwritten by Multinational Syndicate of Banks
Placed in countries other than one in whose currency the bond is denominated
◆ Zero Coupon Bonds
Do not pay interest payments (also known as coupon payments)
Purchased at a Discount
◆ Fixed Rate Bond
A Fixed-rate bond is a security that pays a fixed amount of interest (coupon rate) on the face value of the bond periodically (often every six months or annually) to the owner until maturity date.
Example: Companhia Vale do Rio Doce (CVRD) issued straight coupon Eurobonds
ü Date of issue: January 2004
ü Amount: USD 500 million
ü Maturity: January 2034 (30 years).
ü Issue price: 100%
ü Coupon: 8.25% payable annually
ü YTM: 8.35% (Brazil’s government bonds traded at YTM 9.02% at the time)
◆ Floating Rate Bond
· Floating rate bonds pay coupon based on some reference interest rate, such as LIBOR.
· Unlike coupon bonds, floating rate notes do not carry a fixed nominal interest rate.
· The coupon payments are linked to the movement in a reference interest rate (frequently money market rates, such as the LIBOR) to which they are adjusted at specific intervals, typically on each coupon date for the next coupon period.
· The coupon of a floating rate bond is frequently defined as the sum of the reference interest rate and a spread of x basis points.
· Floating rate bonds may be viewed as zero coupon bonds with a face value equaling the sum of the forthcoming coupon payment and the principal because their regular interest rate adjustments guarantee interest payments in line with market conditions
◆ Convertible Bond
It is a type of bond which can be converted into shares of common stock in the issuing company or cash of equal value, at an agreed-upon price.
It is a hybrid security with debt- and equity-like features.
◆ Warrants
A warrant is an option a firm issues that permits the owner to buy from the firm a certain number of shares at a specified price.
Warrants often come into existence as a result of a bond issue i.e. they are usually attached to bond issues as “sweeteners”.
● Restriction on Rates
· Cap: Upper Limit
· Floor: Lower Limit
· Collar: Both upper and lower limit
● Inverse or Reverse Floaters
· While a floating rate bond’s coupon normally moves in the same direction as the reference rate, there are floating rate bonds whose coupon moves in the opposite direction from the reference rate.
· These securities are called inverse floaters or reverse floaters.
· In contrast to a standard floating rate bonds, an investor benefits from the reverse floater amid falling interest rates.
◆ Step Up Bonds
· Bond with a coupon that increases, usually at regular intervals, while the bond is outstanding.
◆ Step Down Bonds
· Bonds that have coupons that decrease over time: the initial coupons are high, while the subsequent ones gradually decrease in value.
◆ Call Provision
If the bond’s indenture contains a call feature or call provision, the issuer retains the right to retire the debt, fully or partially, before the scheduled maturity date.
When call provision is exercised by the firm there is a reinvestment risk. Therefore, call provision is unattractive for the investors
◆ Put Provision
Bonds can also carry put provision, which allows the investor to sell the bonds back to the issuer at a date specified when the bonds are sold to the investor.