Copyright 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared

Copyright 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and PhillipsSlides prepared by Peter Phillips

11-1

Chapter 11

International debt

markets


11-2

Learning objectives

• Examine the use of international debt markets as a source of funding

• Describe the role of euromarkets and US capital markets

• Distinguish between eurocurrency, euronote and eurobond markets

• Consider US debt markets and securities

• Explain the role of credit rating agencies


11-3

11.1 The euromarkets

11.2 Eurocurrency market

11.3 Euronote market

11.4 Eurobond market

11.5 Markets in the USA

11.6 Credit rating agencies

11.7 Summary

Chapter organisation


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11.1 The euromarkets• International debt markets

– Are used by: financial institutions, who are the largest borrowers governments and corporations

– Attract investors as they: provide a deep and liquid market allow higher investment returns are a form of portfolio diversification

– Have grown in importance owing to deregulation of FX markets

– Accessible to borrowers with a strong financial reputation and a very good credit rating (cont.)


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11.1 The euromarkets (cont.)

• International debt markets (cont.)

– Consist of large unregulated money and capital markets– Major centres in London, the Middle East and Asia– USD is the dominant currency– Euro-zone is the domestic market for countries adopting the

euro currency– Debt securities denominated in euros have grown as the

predictability, liquidity and volatility of the euro consolidate

(cont.)


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• Euromarkets

– Initially evolved to enable countries to hold USD outside of the US, e.g. USSR

– Although euromarkets originated in Europe, euromarket transactions can occur in any nation-state of the world

‘Euro’ means ‘outside’

– A euromarket transaction is conducted in a foreign country but not in its currency

– Growth in euromarket transactions is driven mainly by interest rate factors; i.e. lower borrowing and higher lending rates

(cont.)


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• Euromarkets (cont.)

– Provide intermediated and direct finance over a range of terms to maturity and are categorised as follows:

Eurocurrency markets• Provide intermediated bank finance

Euronote markets• Provide short-term direct finance

Eurobond markets• Provide medium- to long-term direct finance


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11.2 Eurocurrency Market





11.7 Summary


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11.2 Eurocurrency market

• The major forms of eurocurrency facilities discussed are:– short-term bank advances– standby arrangements– medium- to long-term eurocurrency loans

(cont.)


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11.2 Eurocurrency market (cont.)

• Short-term bank advances

– Similar to term loans or fully drawn advances– Term determined and full amount drawn down on approval– Commitment fee may be charged if advance not drawn

down immediately after approval– May be extended by ‘revolving credit’, where a mixture of

currencies can be chosen at each rollover (to match borrower’s currency inflows)

– LIBOR typically used as indicator or reference rate

(cont.)


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• Eurocurrency standby facilities

– A source of ‘back-up’ funds to meet short-term cash shortfalls

– Funds more likely to be available offshore in periods of tight domestic liquidity

– Short-term finance (up to two years)– Interest charge and commitment fee apply

(cont.)


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• Medium- to long-term eurocurrency bank loans

– Loan size about USD3–100 million– Larger loans may involve a syndicate of banks– Term is typically five to 10 years– Loans usually fully drawn down at commencement of loan

unless an availability period is arranged, which attracts a commitment fee

– Interest rate normally above LIBOR and fixed for a period of one to 12 months, plus other fees apply


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11.7 Summary


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• Active market for short-term promissory notes or commercial paper

• Euronotes take several forms, two of which are:1. euronote issuance facility (NIF)

2. eurocommercial paper (ECP)

• Demystified in that these securities are fundamentally the same as domestic money-market and capital-market securities

(cont.)


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11.3 Euronote market (cont.)

• Euronote issuance facility (NIF)

– A short-term unconditional bearer promissory note drawn by the borrower in borrower’s name

– Underwriting banks guarantee funds at issue and convert funding into medium term through a rollover facility

– The instrument Discount security Maturity usually 30 to 180 days Bearer securities in denominations of USD 100 000 to

500 000

(cont.)


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• Euronote issuance facility (NIF) (cont.)

– Structure A syndicate of banks underwrite the facility to a specified

amount and discount rate, thus providing certainty for borrower

– Selling procedures Usually sold by a tender process, inviting members of a tender

panel to tender prices for the notes Tender panel composed of up to 25 financial institutions,

including some of the underwriters Issuer may specify a rate (posted rate), which is the yield at

which the issuer is willing to sell a security

(cont.)


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• Euronote issuance facility (NIF) (cont.)

– Parties involved in NIF issue Arranger, lead manger, co-managers and senior managers,

facility agent, tender panel agent, issuing and paying agent

– Fees Additional to NIF issue and rollover fees: include establishment

fees for the arranger, managers and underwriter; commitment fee and take-up fees to underwriters; and agency fees for administration

Approximately 50 basis points (0.50%) in equivalent annual costs

(cont.)


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• Eurocommercial paper (ECP)

– Arrangement where P-notes are issued into euromarkets that are not underwritten

– Developed owing to changes in needs of: borrowers—high credit ratings and a history of successful

issues, sought cheaper funds by dispensing with underwriters financial institutions—underwriting NIF issues sought to avoid

imposed capital adequacy requirements of off-balance-sheet exposures

(cont.)


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• Eurocommercial paper (ECP) (cont.)

– Typically more than USD250 million– Issued in tranches to test market’s reaction and to match

borrower’s cash needs– Usually less than six dealing institutions (spread

geographically and involving different institutional forms) to avoid fragmentation of facility

(cont.)


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• Calculating the price of NIF and ECP– Discount security formulae (from Chapter 9) but with market convention of a

360-day year


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11.7 Summary


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• Eurobond market is the equivalent of a domestic capital market

• Two main long-term coupon debt securities issued in the euromarket considered here:1. Euro medium-term notes

2. Eurobonds, including straight bonds and floating rate notes

(cont.)


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11.4 Eurobond market (cont.)

1. Euro medium-term notes (MTN)

– Emerged from the US equivalent market– Unsecured, non-homogenous bearer securities paying

periodic coupon, issued in tranches Maturities up to 15 years, average about three years Coupons can be a fixed or variable interest rate expressed as a

margin above a specified indicator rate MTNs are not homogenous and can include a range of

maturities, currencies and fixed and floating coupons

– Dealers With issuers, determine amount of facility and maturities Act as agents for the issuer and seek investors Promote secondary market by quoting two-way prices

(cont.)


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Euro medium-term notes (MTN) (cont.)

– Issues Primary issue on a periodic or continuous (daily) basis To remove concerns of fragmentation of notes, two other

distribution techniques used• 1. MTN tap approach—involves dividing facility

into a number of tranches, each with a specified minimum and maximum dollar amount, and identical maturity and coupon

• 2. Serial offering technique—involves setting the maturity and coupon terms when facility is established. Facility may have several series of notes, each with different characteristics

(cont.)


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2. Eurobonds

– Bond markets consist of three broad market groups i Domestic bonds

• Bonds issued into a local market, in the local currency, by a local company

ii Foreign bonds• Bonds issued into a foreign market, in the local currency of that

market

iii Eurobonds• Bonds issued into a foreign market, but not in the currency of that

market• Traded on global markets and may escape local market listing and

trading regulations• Underwritten by a multinational syndicate of banks

(cont.)


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• Issue and trading of eurobonds

– Eurobonds are sold in a multistage process organised by an international bank called the lead manager

– Lead manager creates a management group by inviting five to 30 banks to be co-managers

Management group prepares the bond issue, sets final conditions of the bond, selects underwriters and usually subscribes to a large portion of the issue

– 30 to 300 underwriters are invited to participate based on their regional placement power

(cont.)


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• Issue and trading of eurobonds (cont.)


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• Types of eurobonds

– Eurobond markets continue to develop with new types of instruments and issuing techniques arising from time to time

– Two classes of bonds considered here:

1. Straight (fixed coupon)

2. Floating rate notes

(cont.)


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• Types of eurobonds (cont.)

1. Straight (fixed coupon) A fixed-interest bond paying periodic coupons; principal

repayable at maturity Issuers and investors

• Issuers—high credit rating and a household name• Investors include retail and institutional investors

Amount and currency of denomination• Fixed costs of issue constrain minimum size of issue to at least

USD50 million, average about USD500 million• Main currency USD, but also yen, euro and pound sterling

(cont.)


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Interest rate (coupon)• Fixed coupon set at issue generally paid annually in arrears• Coupons detached from bonds and presented to issuer’s paying

agent for payment on due date

Maturity• Usually a specified maturity date (mostly three to 12 years), with

no option for issuer or investor to lengthen or shorten life of bond• Usually principal payable in full on maturity (bullet repayment,

although a partly amortised repayment structure possible)

(cont.)


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Listing• Eurobond market has no specific physical location• Secondary market dealings occur through market-makers in a

number of world financial centres• Eurobonds may be listed on the Luxembourg, London or

Singapore exchanges, in compliance with disclosure standards and to ensure periodic public quotation, but few if any transactions

Participants• In addition to lead and co-mangers, and underwriting and selling

groups, trustee and paying agents are involved

Costs• Commission of 1.5% to 2.5% of issue price and direct costs

(cont.)


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– 2. Floating rate notes (FRNs)

A bearer bond with a variable coupon rate based on an indicator interest rate, generally LIBOR

• Coupon rate reset periodically (usually six monthly) and therefore the price remains relatively stable

• Issue amount typically USD100 million, but can be more than USD500 million

• Maturities ranging from five to 20 years• FRNs often have a call option, and may also have a put option

(cont.)


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• Calculating the price of fixed-interest euromarket securities– Formula is the same as fixed-interest security formula 10.7

in Chapter 10

kiniAi

iCP )(1)(1

n)(11


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11.7 Summary


11-35


• US markets accessible to more international borrowers than euromarkets because of the lower required investment grade credit rating, i.e. BBB and AA respectively

• Important available US securities– Commercial paper (USCP)– US foreign (Yankee) bonds– American depository receipts (ADRs)

• The US market is highly innovative and has other products not discussed here

(cont.)


11-36

11.5 Markets in the USA (cont.)

• Commercial paper (USCP)

– Short-term promissory note; i.e. discount security– Average maturity less than 45 days– Denominations of USD$100 000– Some issues are supported by credit enhancements such as

a bank letter of credit, or security over the assets of the issuer

– Issue by public offer or private placement without requirement for official SEC registration

(cont.)


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• US foreign (Yankee) bonds

– A debt security issued by a foreign borrower into the US market

– Denominated in USD– Issued for up to 20 years– Straight bond—fixed interest periodic coupon, principal

repayable at maturity Yankee bond—a variation issued as a floating rate note with

interest coupons based on an indicator rate Junk bond—issue of securities with a credit rating less than

investment-grade BBB

(cont.)


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• American depository receipts (ADRs)

– A security issued by a US depository bank and supported by a depository share

– The depository share represents one or more ordinary shares of a foreign issuer listed on the foreign company’s home stock exchange

– Allows foreign companies to raise capital in US market without needing to meet SEC listing requirements


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11.7 Summary

Copyright 2009 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Institutions, Instruments and Markets 6e by VineySlides prepared by Anthony Stanger

11-39


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• An organisation specialising in assessing the credit quality associated with financial obligations, e.g. S&P (Standard & Poor’s)

• The rating methodology develops a profile balancing business risk, financial risk and environmental risk factors

• S&P provide:– long-term credit ratings (AAA to D), with BBB and above

being ‘investment grade’– short-term credit ratings (A-1 to D)– a rating of a corporation overall

(cont.)


11-41

11.6 Credit rating agencies (cont.)

• S&P provide (cont.):

– issue-specific credit ratings on the creditworthiness of an obligor with respect to a specific financial obligation

– credit ratings of specific issues into international markets include the following:

• Country risk—risk of changes in the laws of a foreign country affecting financial transactions

• Sovereign risk—risk of a foreign government defaulting on its obligations

• Foreign exchange risk— risk of the value of one currency, relative to another, changing

(cont.)


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11.6 Credit rating agencies (cont.)

• Credit ratings agencies have been accorded a lot of attention over the past several years

• First, credit ratings agencies were criticised heavily for providing favourable ratings on securitised mortgage products that later turned ‘toxic

• Second, as the GFC became a sovereign debt crisis, the ratings accorded to different countries (especially Greece, Spain and Italy) attracted much interest

• Commentators and investors have been most interested in much-publicised ratings ‘downgrades’ of various countries


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11.7 Summary


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11.7 Summary

• International debt markets are attractive to both investors and borrowers

• Major eurocurrency facilities include short-term bank advances, standby facilities and medium- to long-term bank loans, and are attractive because of:– the lower cost of borrowing– their creating a natural hedge– the size of the eurocurrency market

• The euronote market is a market for short-term direct debt markets

(cont.)


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11.7 Summary (cont.)

• Main security is the P-note (commercial paper) with two main facilities, NIF and ECP

• The eurobond market is a market for the issue of bonds in a currency other than the currency of the market of issue, and it includes MTNs, straight (fixed coupon) bonds and floating rate notes

• Debt markets in the US include commercial paper (USCP), US foreign (Yankee) bonds and American depository receipts (ADRs)

• Credit rating agencies assess the credit quality of a firm and/or its financial obligations

Documents

Copyright 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared