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Brady Bonds

Brady Bonds. Jose A. Boza David Marquez Elton Festari Rahul Bakshi. Presentation Outline. Brady Bond Introduction Citibank Requirements Mexican Bond Calculations Venezuela Bond Calculations Costa Rica Bond Calculations Country Risk Using Brady Bonds Recommendations Questions.

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Brady Bonds

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  1. Brady Bonds Jose A. Boza David Marquez Elton Festari Rahul Bakshi

  2. Presentation Outline • Brady Bond Introduction • Citibank Requirements • Mexican Bond Calculations • Venezuela Bond Calculations • Costa Rica Bond Calculations • Country Risk Using Brady Bonds • Recommendations • Questions

  3. Brady Bonds • Securities that have resulted from the exchange of commercial bank loans, sometimes defaulted loans, into new bonds. • Purpose – To replace the sovereign debt of developing countries (debt service reduction agreement). • Par – loans exchanged for fixed rate bonds, issued with below-market interest rates (issued at face value) • Discount – floating rate bonds, issued with market interest rates (issued below face value).

  4. Citibank Requirements • Should company buy Mexican par or discount bonds? • Should company buy Venezuelan par or discount bonds? • Fair opening price for Costa Rican bonds • Should Citibank sell its Mexican bonds in 1996? • How can Citibank hedge its Mexican exposure?

  5. Mexico Bonds – 1990 Issue • Bond characteristics • 30 year maturity • 30-yr US treasury bond collateral for face value • 3 coupon payments (18 months) collateral

  6. Mexico Bonds – 1990 Issue • Par bonds • Fixed coupon of 6.25 % • Discount bonds • LIBOR plus 13/16 %

  7. Mexico Bond Calculations • Data required • YTM U.S. – 7.925% • YTM Mexico – 15% • LIBOR – 8.5% • Default probability for Mexico – 5.5%

  8. Mexico Bond Calculations • Par bond NPV • P = $38.08

  9. Mexico Bond Calculations • Discount bond NPV • P = $51.77 Recommendation: Buy Par bonds.

  10. Venezuela Bonds – 1990 Issue • Bond characteristics • 30 year maturity • 30-yr US treasury bond collateral for face value • 2.3 (14 months) coupon payments collateral

  11. Venezuela Bonds – 1990 Issue • Par bonds • Fixed coupon of 6.75 % • Discount bonds • LIBOR plus 13/16 %

  12. Venezuela Bond Calculations • Data required. • YTM U.S. – 7.925% • YTM Venezuela – 14% • LIBOR – 8.5% • Default probability Venezuela – 5%

  13. Venezuela Bond Calculations • Par bond NPV • P = $40.52

  14. Venezuela Bond Calculations • Discount bond NPV • P = $52.06 Recommendation: Buy Par Bonds.

  15. Costa Rica Bonds – 1990 Issue • Bond characteristics – Principal Series A • 20 year maturity • No collateral for face value • 3 coupon payments collateral

  16. Costa Rica Bond Calculations • Data required. • YTM U.S. – 7% • YTM Costa Rica – 12.5% • Default probability Costa Rica – 5%

  17. Costa Rica Bond Calculations • Bond NPV • P = $32.45

  18. 1996 – Sell Mexican Bonds? • Ability to sell at $71.50 • Valuation (NPV) at $58.69 • D = [(1 + ytm) / ytm] - [(1 + ytm) + yrs * (i - ytm)] / [i * [(1 + ytm) ^yrs - 1] + i] • Duration – Less than 6 years (5.93) • Duration = the average (cash-weighted) term-to-maturity of a bond. • Yes, sell.

  19. Mexican Par Bonds Useful Diversification Tool? • US Rate DVBP – The price rise (fall) of the bond for a 100 basis point shift downward in the US yield curve. • DVBP for Mexican Par Bonds = 8.48 • High negative correlation b/t US and Mexican Par Brady Bonds • Yes, good diversification tool.

  20. Method to Determine Country Risk • State Variable – Provides an estimate of country risk embedded in the bond – higher state value, the lower risk of the bond. • State Variable for Mexican Brady Bonds - .001210. • SD = .11895 (relatively high) • YTM(Brady Bond) – YTM(Risk Free) = Country Risk

  21. Hedging USD 600 Million of Mexican Brady par Bonds • Options: • Put Options on Mexican Stock Exchange • Put Options on CME’s options for Mexican par Brady Bonds

  22. Forward Looking – Mexico’s Country Risk • Mexico has industries growing in TeleCom and Media • Growing correlation with US Economy • Some political risks with upcoming elections in 2002 • Ability for economic growth in 2002 and 2003 • Retiring Brady Bonds and replacing with US $1.5bn 30-yr bond at 9% (frees up US Treasury assets held by Mexico)

  23. QUESTIONS?

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