Money may be raised internationally by bond issues and by bank loans. This is done in domestic as well as international markets. The difference is that in international markets the money may come in a currency which is different from that normally used by the borrower. The characteristic feature of the international bond market is that bonds are always sold outside the country of the borrower. There are three types of bond, of which two are international bonds. A domestic bond is a bond issued in a country by a resident of that country. A foreign bond is a bond issued in a particular country by a foreign borrower. Eurobonds are bonds underwritten and sold in more than one country.
A foreign bond may be defined as an international bond sold by a foreign borrower but denominated in the currency of the country in which it is placed. It is underwritten and sold by a national underwriting syndicate in the lending country. Thus, a US company might float a bond issue in the London capital market, underwritten by a British syndicate and denominated in sterling. The bond issue would be sold to investors in the UK capital market, where it would be quoted and traded. Foreign bonds issued outside the USA are called Yankee bonds, while foreign bonds issued in Japan are called Samurai bonds. Canadian entities are the major floaters of foreign bonds in the USA.
A Eurobond may be defined as an international bond underwritten by an international syndicate and sold in countries other than the country of the currency in which the issue is denominated. In the Eurobond market, the investor holds a claim directly on the borrower rather than on a financial institution. Eurobonds are generally issued by corporation and governments needing secure, long-term funds and are sold through a geographically diverse group of banks to investors around the world. Eurobonds are similar to domestic bonds in that they may be issued with fixed or floating interest rates.
Characteristics of Eurobonds
- The issuing technique takes the form of a placing rather than formal issuing, this avoids national regulations on new issues.
- Eurobonds are placed simultaneously in many countries through syndicates of underwriting banks which sell them to their investment clientele throughout the world.
- Unlike foreign bonds, Eurobonds are sold in countries other than that of the currency of denomination; thus dollar denominated Eurobonds are sold outside the U.S.A.
- The interest on Eurobonds is not subject to withholding tax.
Types of Eurobonds
There are a number of different types of Eurobond.
- A straight bond is one having a specified interest coupon and a specified maturity date. Straight bonds may be issued with a floating rate of interest. Such bonds may have their interest rate fixed at six-month intervals of a stated margin over the LIBOR for deposits in the currency of the bond. So, in the case of a Eurodollar bond, the interest rate may be based upon LIBOR for Eurodollar deposits.
- A convertible Eurobond is a bond having a specified interest coupon and maturity date, but it includes an option for the hold to convert its bonds into an equity share of the company at a conversion price set at the time of issue.
- Medium-term Euronotes are shorter-term Eurobonds with maturities ranging from three to eight years. Their issuing procedure is less formal than for large bonds. Interest rates on Euronotes can be fixed or variable. Medium-term Euro-notes are similar to medium-term roll-over Eurodollar credits. The difference is that in the Eurodollar market lenders hold a claim on a bank and not directly on the borrower.
Issue of Eurobonds
The issue of Eurobonds is normally undertaken by a consortium of international banks. A record of the transaction called a ‘tombstone’ is subsequently published in the financial press. Those banks whose names appear at the top of the tombstone have agreed to subscribe to the issue. At a second level, a much larger underwriting syndicate is mentioned. The banks in the managing syndicate will have made arrangements with a worldwide group of underwriters, mainly banks and security dealers. After arranging the participation of a number of underwriters, the managing syndicate will have made a firm offer to the borrower, which obtains the funds from the loan immediately. At a third level, the underwriting group usually arranges for the sale of the issue through an even larger selling group of banks, brokers and dealers.
Advantages of the Eurobonds
The Eurobond market possess a number of advantages for borrowers and investors.
The advantages of Eurobonds to borrowers are;
- The size and depth of the market are such that it has the capacity to absorb large and frequent issues.
- The Eurobond market has a freedom and flexibility not found in domestic markets.
- The cost of issue of Eurobonds, around 2.5 per cent of the face value of the issue.
- Maturities in the Eurobond market are suited to long-term funding requirements.
- A key feature of the Eurobond market is the development of a sound institutional framework for underwriting, distribution and placing of securities.
The advantages of Eurobonds to investors are;
- Eurobonds are issued in such a form that interest can be paid free of income or withholding taxes of the borrowing countries. Also, the bonds are issued in bearer form and are held outside the country of the investor, enabling the investor to evade domestic income tax.
- Issuers of Eurobonds have well reputation for credit worthiness.
- A special advantage to borrowers as well as lenders is provided by convertible Eurobonds. Holders of convertible debentures are given an option to exchange their bonds at a fixed price.
- The Eurobond market is active both as a primary and as a secondary market.