“ International Finance and Payments ”

1. Academy of Economic Studies Faculty of International Business and Economics “International Finance and Payments” Lecture IX “International Bond Market” Lect. Cristian PĂUN Email: cpaun@ase.ro URL: http://www.finint.ase.ro

2. International Bond Market General Situation Types of Bonds

3. International Bond Market Situation by Issuing Institutions Romanian Experience on International Bond Market

4. International Bond Market

5. Step IV Step I Beneficiary Lead Manager Bank Coordination and/or guarantee group Co - managers Step II Step III Underwritting Group Step VI Selling group Private Investors Step VI Private Investors Tombstone Bond Issuing Mechanism - IPO

6. IPO description: • Step 1: Contacting a lead manager bank and this bank will create the coordinating group (if the amount is too important) • Step 2: Creating the Underwriting group that will sign up for 70% from the total bond’s quantity with the condition of including the unsold bonds in their own portfolio; • Step 3: Creating the Selling group that will try to sell in advance the remaining 30% from the total bonds; • Step 4: Selling the bonds to private investors • Step 5: Listing the bonds on capital markets, starting the secondary market, closing operation (tombstone) If the private investors will be not interested for IPO of bonds: • Redesigning the bonds conditions (issuing price, call price) • Road Show (promoting the IPO at the level of private investors) • Guarantee for IPO granted by lead bank (the unsubscribed bonds will be included in its own portfolio)

7. Bond Definition - Bond = a security that is issued in connection with a specific borrowing arrangement • Bond indenture = the contract between the issuer and the borrower • Main elements of the contract: • Face value • Coupon rate • Issuing price • Bond premium - Bond classification: - T-Bonds - Municipal Bonds - Corporate Bonds

8. Types of Corporate Bonds • Call Provisions on Corporate Bonds: • allows the issuer to repurchase the bond at a specific call price before the maturity • The call price is above par value according with maturity (it falls as time passes); • Usually offers a higher coupons rates then noncallable bonds. • Convertible Bonds: • Give to the bondholders an option to exchange each bond for a specified number of shares of common stock of the firm; • The Conversion Rate = Number of Bonds / Number of Stock • The Conversion Premium = Bond Par Value x Number of Bonds – Current Stock Price x Number of Stock

9. Types of Corporate Bonds • 3. Puttable Bonds: • Allows the bond holder to extend or to sell bond at a specific date (call date) • The holder is interest to extend the bond life when the bond current yield exceeds current market yields; • When the coupon rate is too low the holder will reduce the holding period • 4. Floating Rate Note: • Make interest payments that are tied to some measure of current market rate (T-Bill rate adjusted with 4%) • Major risk: changes in the company’s financial strength (if the financial situation will be worse the price of the bond would fall because the investor’s will require a greater yield premium than the security can offer).

10. Innovation in the Bond Market • Reverse Floater Bonds: the coupon rate falls when the general interest rates rises (the benefit of the investors is double when the rates falls – higher price and higher interest rate); • Asset - Backed Bonds: - issuing a bond with a coupon rate connected to the financial performance of several firms from the same group (example: Walt Disney, David Bowie) • Catastrophe Bonds: - issuing a bond with a final payment that depended on whether there a catastrophe will be produced (example: Electrolux and a possible earthquake in Japan). • Indexed Bonds: - make payments that are tied to a general price index or a particular commodity price (example: Mexico issued a bond tied to the price of oil).

11. Indexed Bonds: Example Nominal Return=(Interest+Price Appreciation)/Initial Price Real Return=(1+Nominal Return)/(1+Inflation)

12. Bond Value and Bond Price

13. Bond Yields – Yield to Maturity YTM = 6 % Bond Yields – Current Yield

14. Bond Yields – Yield to Call YTM = 6.23 %

15. Determinants of Bond Safety • Coverage Ratios: ratios of company to fixed costs • Times – interest – earned ratio (EBIT/Interest Obligations) • Fixed Charge Coverage Ratio (EBIT/(Interest+Lease) • 2. Leverage Ratio (Debt-to-Equity Ratio) • 3. Liquidity Ratios: • Current Ratios = Current Assets / Current Liabilities • Quick Ratios = (Current Assets – Inventories) / Current Liabilities • 4. Profitability Ratios • ROA = EBIT / Total Asset • 5. Cash Flow to Debt Ratio (Cash Flow to Outstanding Debt)

16. Financial Ratios by Rating Classes Source: Bodie, Kane, Marcus “Investment”, page 437, McGraw-Hill Irwin, 2003