INTERNATIONAL FINANCE:

SESSION 8:

International
Debt Financing

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1
 Chapter 11

International
Debt Financing

adapted by Uwe Walz

Slides prepared by
April Knill, Ph.D., Florida State University
 Multinational Corporation
Sources of Long-Term Capital

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 Debt Financing
Centralized Model

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 Debt Financing
Decentralized Model

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 Is issuing debt in low-interest
countries a good idea?
If UIRP holds, the cost should be the same as a
domestic loan

If UIRP does not hold, loan may be cheaper!

The price for cheap is FX risk
Troubling if FX risk correlates positively with business risk

Credit spreads
Risk premium paid above the risk-free rate
Can differ across countries offering savings
Tax differentials can offer incentives to take on debt in
different markets

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 Is short-term debt cheaper?
Suppose the yield curve is upward sloping

Expectations Hypothesis
Governs relationship between long rates and expected
short rates
Breakeven rate = the rate that the market expects for
future short-term borrowing
Long-term interest rates are a weighted average of the
current short-term rate and expected future short-term
rates
Holds well in U.K.
Doesnt hold as well in U.S.

In general it is better to match duration of assets

with duration of liabilities

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 The international character of debt

Domestic bonds: issued and traded in domestic

(home currency) market

International bonds bonds traded outside the

country of the issuer

Foreign Bonds: issued in domestic market by a foreign

borrower (Ex. U.S. company issuing -bond in Japan)
Denominated in domestic currency
Marketed to domestic residents
Regulated by domestic authorities

Eurobond: issued in national market in different currency

(Ex. Dutch borrower issues $-bonds in UK & Netherlands)
Denominated in one or more currencies
Traded in external markets outside the borders of the countries issuing the
currencies

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 The Size and Structure of the World Bond
Market (in billions of $)

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 WSJ Size of U.S. Bond and
Equity Markets

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 The Internationalization of the World Bond
Market

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 Domestic bond markets

Regulated by domestic governments

Required filing for issuances > $1.5 million (U.S.)

New public issues must be approved by MOF (Japan)

US: Owner of bonds is registered

Most other countries: not registered (bearer bonds)

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 Bearer Bonds and Registered
Bonds
Bearer Bonds are bonds with no registered
owner
Offer anonymity
Same risk of loss as currency

Registered Bonds: the owners name is

registered with the issuer

U.S. security laws require Yankee bonds sold to

U.S. citizens to be registered.
Yankee bonds = foreign bond issued in US
Equivalently called Samurai bonds in Japan and
Bulldogs in the UK

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 National Security Registrations

Yankee bonds must meet the requirements of

the SEC, just like U.S. domestic bonds.

Many borrowers find this level of regulation

burdensome and prefer to raise U.S. dollars in
the Eurobond market.
Eurobonds sold in the primary market in the United
States may not be sold to U.S. citizens.

Of course, a U.S. citizen could buy a Eurobond on the

secondary market.
Eurobonds are typically bearer bonds

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 Currency of denomination

Dollar has been the dominant currency

Euro is now the dominant currency

Also pound, yen and Swiss franc

Dual-currency bond
Issued and paying currency in one currency but paying
back principal in another
Interest rate often higher
Combination between straight bond and long-term forward
contract
Whether it is a good investment depends on movement of
forex rate

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 Currency of Issuance in the International
Bond Market (September 2010,
outstanding amounts, billions of $)

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 International Bank Loans

The Eurocredit Market

Longer term loans in Eurobank market
Term loan: fixed maturity for a fixed amount
Credit line: allows borrower to withdraw as a loan any
amount of money up to a fixed limit

The Euronote Market

Distinction between loan and bond market is blurred
Special case: Euro Medium term notes
Maturities from 9 months 10 years
Typically offered continuously
Can be issued in small denominations
Lower costs than a Eurobond issue
Not underwritten

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 Comparing the Costs of Debt

Compare apples to apples, i.e. instruments with

Similar amounts
Same Maturity
Same Currency
Same interest rate structure

Typical adjustments:
Fixed rate Eurbonds pay coupon once a year, whereas US bonds
pay coupon semi-annually
Solution: Annual yield = (1-Semiannual yield)2 1

Comparison between domestic and foreign bond

Solution: hedge exchange rate risk

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 The All-in-Cost Principle (AIC)

The discount rate (IRR) that equates the PV of all future

interest rate and principal payments to the net proceeds

Net proceeds: proceeds of issue net of transaction costs

Coupon payments = interest rate of loan

C C C + FV
Net proceeds = + 2
+... + n
(1+ i) (1+ i) (1+ i)

Solve for i in Proceeds: this is the AIC

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 Example: Eurobond by GE

Suppose GE issues a bond with FV of 2m

Bond characteristics:
Maturity is 5 years
Price is 995.18 per 1,000 FV
Coupon is 5.125%
Fees are 0.275%

What is the all-in-cost of the bond issue?

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 Example: Eurobond by GE
Solution

Net proceeds:
2bn x [0.99518-0.00275] = 1,984.86m

Coupon payment
2bn x 0.05125 = 102.5m

AIC: use solver in Excel (i = 5.3%)

102.5 102.5 2102.5

1984.86 = + 2
+... +
(1+ i) (1+ i) (1+ i)5

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 Why source debt internationally?
Minimize the cost of debt

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 low interest rates and
invest in countries with high interest rates while
hedging currency risk
Tax loopholes

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 International Banking

Banks as MNCs
Merchant banks banks that perform both traditional
commercial banking and investment banking functions
Universal/Full-service banks banks that provide a wide
array of services, including securities activities
Globalization had fundamentally changed banking
around the world from localized to one of the most
global sectors in the world
Banking sector has become a larger part of many
economies perhaps too large (2007-2010 crisis has
taught us this)
Enables spillover of stress across borders

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Largest Banks Ranked by Market Capitalization

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 International Banking

Subsidiary and affiliate banks wholly or partly

owned by a parent bank, but is incorporated in
the foreign country where it is located

Affiliate is only partly owned but not controlled by a

foreign parent bank

Offshore banking centers

International banking facilities (IBF) a

separate set of asset/liability accounts
segregated on parent bank books but not
separate physically

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 International Banking

International banking regulation

Differences across countries, international regulations

could give one country an advantage

International capital adequacy: The 1988 Basel Accord

Banks must hold capital equal to at least 8% of a basket of
assets measured in different ways according to their riskiness

A new capital-adequacy framework on Basel II

Banks can follow Basel Accord framework for measuring risk
or use own models subject to strict requirements and
disclosure

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 International Banking

Basel III and the crisis

Crisis laid bare many deficiencies in the Basel II
Old framework underestimated risk because most
models overestimate the power of diversification to
reduce risk, especially in times of crisis
BIS and central banks/supervisory authorities have new
framework
Core capital is defined as retained earnings and common
shares
Reserves increased from 2% to 4.5%
Capital conservation buffer 2.5% of banks risk-weighted
assets
Local authorities require a countercyclical capital buffer,
which decreases (increases) in good (bad) times
Tracing/monitoring of liquidity funding
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 Global Debt Arrangers: 2016

Source: Thomson Reuter

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 Example: Cote DArgent

The private U.S. chocolate company Worsheys.

was acquired by a Swiss MNC Cote DArgent

The financial team at CDA is looking at three

financing possibilities

Which option is the cheapest one?

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 Example: Cote DArgent
Financing Options

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 Example: Cote DArgent
Solution Euro Eurobond

Net proceeds:
100m x [1-0.0125] = 98.75m

Coupon payment
100mn x 0.041 = 4.1

AIC: use solver in Excel (i = 4.38%)

4.1 4.1 104.1

98.75 = + 2
+... +
(1+ i) (1+ i) (1+ i)5

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 Example: Cote DArgent
Solution Yen Eurobond

Suppose FX(/) rates are as follows: S=140, F1=136.78,

F2=133.03, F3=128.87, F4=124.5 and F5=120.12

Net proceeds:
14bn x [101-0.009]140(/) = 100.1m

Coupon payment in Year 1

14bn x 0.01136.78(/) = 1.02m

AIC: use solver in Excel (i = 4.11%)

1.02 1.05 117.72

100.1 = + 2
+... +
(1+ i) (1+ i) (1+ i)5
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 Example: Cote DArgent
Solution Dual Currency Eurobond

Suppose FX(/) rates are as follows: S=140, F1=136.78,

F2=133.03, F3=128.87, F4=124.5 and F5=120.12

Net proceeds:
14bn x [0.98-0.009]140(/) = 97.1m

Coupon payment in Year 1

14bn x 0.02136.78(/) = 2.05m

AIC: use solver in Excel (i = 3.73%)

2.05 2.10 107.23

97.1 = + 2
+... +
(1+ i) (1+ i) (1+ i)5
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 Reasons for why the dual currency
bond is cheapest?

UIRP does not hold, so Japanese investors may

bet that Euro does not depreciate so much

Arbitrage is difficult

Transaction costs in long-term forward

contracts are high

Maybe bank makes cheap offer in order to

make profits on follow up projects

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 Choosing among debt financing options
EXERCISE

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