International Debt Financing

FINA6222 Selected Topics in Finance: International Finance

CUHK Business School

Week 4
Lesson Outline
• Sources of funds for MNCs
• Overview of international bond markets
• Types of international bond instruments
• Eurobond market
• International bank loans

1
Global Sources of Funds for MNCs
• Sources of funds for international firms
• Internal – retained earnings
• External – debt/equity/loans/hybrids
• Loans
• All 3 can be raised domestically or internationally
• MNC foreign affiliates can also raise money from within the MNC

2
Financing Mix Around the World
• Firms use different capital structures globally
• Internal capital generally utilized first
• Equity and bond markets dominate the US
• Bond market dominates in Japan
• Loans dominate in Europe

3
Long-Term Capital for MNCs

4
Centralized Debt Denomination

5
Decentralized Debt Denomination

6
Why Source Debt Internationally?
• Evidence suggests credit spreads differ across countries
• Differing perceptions of credit risk
• Diversify funding sources
• Cyclical differences – credit spreads tend to be countercyclical (widens in
recessions)
• Can borrow in countries with low interest rates and invest in countries with high
interest rates while hedging currency risk carry trade

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Comparing the Costs of Debt
• Compare apples to apples
• Similar amounts
• Maturity
• Cash flow patterns (same currency as well)
• 𝐴𝑛𝑛𝑢𝑎𝑙 𝑦𝑖𝑒𝑙𝑑 = (1 − 𝑆𝑒𝑚𝑖𝑎𝑛𝑛𝑢𝑎𝑙 𝑦𝑖𝑒𝑙𝑑)! − 1 term structure yield curve

• Interest rate structure

• The All-in-Cost Principle (AIC) YTM

• The discount rate or internal rate of return that equates the PV of all future interest rate and
principal payments to the net proceeds
• Solve for 𝑖 in 𝑃𝑟𝑜𝑐𝑒𝑒𝑑𝑠 = ∑$ !
!"# 𝐶𝑜𝑢𝑝𝑜𝑛/(1 + 𝑖) + 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙/(1 + 𝑖)
$

• 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑙𝑜𝑎𝑛 = 𝑅𝑖𝑠𝑘 𝑓𝑟𝑒𝑒 𝑟𝑎𝑡𝑒 + 𝐶𝑟𝑒𝑑𝑖𝑡 𝑠𝑝𝑟𝑒𝑎𝑑 + 𝑇𝑟𝑎𝑛𝑠𝑎𝑐𝑡𝑖𝑜𝑛 𝑐𝑜𝑠𝑡

• Credit rating: based on current information of risk of default
• Moody’s and Standard & Poor’s; European Rating Agency (Eurorating); Japan Credit Rating Agency
(JCR)
• Ratings schemes differ across agencies moral hazard in credit ratings, banker pays rating angency to raise the rating

8
Overview of World’s Bond Markets
• Domestic bonds are issued by a borrower domiciled within a country,
denominated in the currency of that country, and traded within the country.
• International bonds include foreign bonds and Eurobonds.
• At the end of June 2018, the face value of bonds (long-term original maturity
notes) outstanding in the world was approximately $114,449.9 billion.

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Foreign Bonds and Eurobonds
• International bond market encompasses two basic market segments: foreign bonds
and Eurobonds
• A foreign bond is offered by a foreign borrower to investors in a national capital market and
denominated in that nation’s currency.
• Example: German MNC issuing dollar-denominated bonds to US investors.
• A Eurobond issue is denominated in a particular currency but sold to investors in national
capital markets other than the country that issued the denominating currency.
• Example: Dutch borrower issuing dollar-denominated bonds to investors in the United
Kingdom, Switzerland, and the Netherlands.

10
Bearer Bonds and Registered Bonds
• Eurobonds are usually bearer bonds, bonds in which ownership is demonstrated
through possession of the bond
• Issuer does not keep any records indicating who is the current owner of the bond.
• Bearer bonds are very attractive to investors desiring privacy and anonymity, one reason for
this being that they enable tax evasion.

• Registered bonds, on the other hand, are bonds whose ownership is demonstrated
by associating the buyer’s name with the bond in the issuer’s records

11
Security Regulations
• Foreign bonds must meet the security regulations of the country in which they are
issued
• As such, Yankee bonds must meet the same regulations as US domestic bonds.
• Many foreign borrowers find this level of regulation burdensome and prefer to
raise U.S. dollars in the Eurobond market
• Transactional restrictions prohibit offers and sales of Eurobonds in the United
States or to US investors during a 40-day restriction period that allows for the
security to become seasoned in the secondary market

12
Global Bonds
• A global bond issue is a very large bond issue that would be difficult to sell in any
one country or region of the world
• Global bond issues were first offered in 1989.
• Simultaneously sold and subsequently traded in major markets worldwide.
• Most have been denominated in the US dollar.
• Portion of a US dollar global bond sold by a US (foreign) borrower in the United States is
classified as a domestic (Yankee) bond and the portion sold elsewhere is a Eurodollar bond.

13
Types of Instruments
• Straight fixed-rate issues
• Euro-medium-term notes
• Floating-rate notes
• Equity-related bonds
• Dual-currency bonds

14
Characteristics of International Bond
Instruments

15
Straight Fixed-Rate Issues
• Straight fixed-rate bonds have a specified maturity date and fixed coupon
payments
• Unlike many domestic bonds, which make semiannual coupon payments, coupon interest on
Eurobonds is typically paid annually.
• Vast majority of new international bond offerings in any year are straight fixed-rate issues.
• Euro, U.S. dollar, British pound sterling, and Japanese yen have been the most common
currencies denominating straight fixed-rate bonds in recent years.

16
Euro-Medium-Term Notes
• Euro-medium-term notes (Euro-MTNs) are (typically) fixed-rate notes issued
by a corporation with maturities ranging from less than a year to about 10 years
• Euro-MTNs have a fixed maturity and pay coupon interest on periodic dates.
• Unlike a bond issue, in which the entire issue is brought to market at once, a Euro-MTN issue
is partially sold on a continuous basis through an issuance facility that allows the borrower to
obtain funds only as needed on a flexible basis.
• First introduced in 1986.

17
Floating-Rate Notes
• Floating-rate notes (FRNs) are typically medium-term bonds with coupon
payments indexed to some reference rate
• Common reference rates are either three-month or six-month U.S. dollar LIBOR.
• Coupon payments on FRNs are usually quarterly or semiannual and in accord with the
reference rate
• First introduced in 1970.
• Attractive option for investors with a strong need to preserve the principal value of the
investment should they need to liquidate the investment prior to the maturity of the bonds.

18
Equity-Related Bonds
• There are two types of equity-related bonds:
1. A convertible bond issue allows the investor to exchange the bond for a
predetermined straight fixed-rate bond value.
• Floor-value of a convertible bond is its straight fixed-rate bond value
2. Bonds with equity warrants can be viewed as straight fixed-rate bonds with
the addition of a call option (or warrant) feature.
• Warrant entitles the bondholder to purchase a certain number of equity shares in the issuer
at a pre-stated price over a predetermined period of time.

19
Dual-Currency Bonds
• A dual-currency bond is a straight fixed-rate bond issued in one currency that
pays coupon interest in that same currency
• Coupon interest is frequently at a higher rate than comparable straight fixed-rate bonds.
• Amount of the dollar principal repayment at maturity is set at inception; frequently, the amount
allows for some appreciation in the exchange rate of the stronger currency.
• Japanese firms have been big issuers of dual-currency bonds.

20
Outstanding International Bonds (in USD
billions)

21
International Bond Market Credit Ratings
• Fitch Ratings, Moody’s Investors Service, and S&P Global Ratings (S&P) have
for years provided credit ratings on domestic and international bonds and their
issuers
• Ratings are based on an analysis of current information regarding the likelihood of default and
the specifics of the debt obligation.
• Ratings reflect both creditworthiness and exchange rate uncertainty.

22
S&P’s Sovereign Rating Framework

23
Eurobond Market Structure and Practices
• Primary market
• A borrower deciding to raise funds by issuing Eurobonds to the investing public will contact
an investment banker and ask it to serve as the lead manager (that is, bookrunner) of an
underwriting syndicate that will bring the bonds to market.
• Lead manager may invite co-managers to form a managing group to help negotiate terms
with the borrower, ascertain market conditions, and manage the issuance.
• Managing group, with other banks, will serve as underwriters, committing their own capital
to buy the issue from the borrower at a discount from the issue price.
• Discount, or underwriting spread, is usually 2% to 2.5%.
• Selling group will sell bonds to the investing public.

24
Eurobond Market Structure and Practices
• Secondary market
• Eurobonds initially purchased in the primary market from a member of the selling group
may be resold prior to their maturities to other investors in the secondary market.
• Secondary market for Eurobonds is an OTC market with principal trading in London.
• Comprises market makers and brokers connected by an array of telecommunications
equipment.
• Market makers stand ready to buy or sell for their own account by quoting two-way bid and
ask prices, and they can trade directly with one another, through a broker, or with retail
customers.
• Bid-ask spread represents the only profit to market makers.

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International Bank Loans: Eurocredits
revolting credit facility

• Longer term loans in Eurobank market

• Types of Eurocredits
• Term loan – loan with a fixed maturity for a fixed amount
• Credit line – allows borrower to withdraw as a loan any amount of money up to a fixed
limit
• Syndicates – group of banks that share risk
• Lead bank negotiates with borrower over terms
• Participating banks – banks that provide funding
• Paying agent – the bank that receives the service payments from the borrower and
distributes them to participating banks

26
International Bank Loans: Eurocredits
• Fees and Borrowing Costs
• Periodic costs – interest
• Interest rate (e.g., LIBOR + 1.5%)
• Commitment fee (0.25% - 0.75%) on unused portion of credit
• Agent fee
• Upfront cost – 1% - 2.5% of total; deducted from principal

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International Bank Loans: Euronote
• Euro-commercial paper and other short-term paper
• Medium-term notes – maturities from 9 months – 10 years
• Notes can be offered continuously
• Can be issued in small denominations
• Lower costs than a Eurobond issue
• Not underwritten
• Amounts/timing of sales are not disclosed – allows for discretion
• NIF/SNIF/RUF – syndicates of banks committed to distribute or purchase a
borrower’s Euronotes with maturities of 1,3,6, or 12 months.

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