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Chapter 11

International Debt

Summary

The international debt markets are a major source of finance for government, financial

institutions and corporations. While all major global financial centres attract foreignborrowers, the euromarkets and the US markets predominate as providers of short-,medium- and longer-term debt finance.

The euromarkets originated from the preference of the then USSR to holdUS outside the jurisdiction of the US authorities. !owever, the continued growth ofthe euromarkets has been prompted b" the fact that the" can normall" offer higherdeposit rates of return and lower borrowing rates than are available in domestic debtmarkets. #n addition, the euromarkets are attractive to borrowers because of the widerange of lenders and instruments available$ that is, the" provide greater depth andli%uidit", and facilitate funding diversification.

&uromarket transactions occur in a number of financial centres around theworld. ' euromarket transaction is characterised b" the currenc" and countr" in whichthe debt is issued. ' euromarket transaction is predominantl" denominated in acurrenc" other than the currenc" of the countr" in which the debt is issued. Theeuromarkets are categorised as the eurocurrenc" market, the euronote market and theeurobond market.

The eurocurrenc" market involves intermediated finance, and includes short-term bank advances, stand-b" facilities and medium- to longer-term bank loans.Short-term bank loans are full"-drawn advances similar to those available in adomestic market, but the" are denominated in a currenc" other than the currenc" ofthe bank lender. The rate of interest attached to a facilit" is determined b" reference to

an indicator rate such as (#)*R or S#)*R, and is t"picall" reset ever" three or si+months, in line with changes in one of these rates. Usuall" the rate will be set at amargin a number of basis points above the indicator rate. ' short-term loan ma"have a revolving credit arrangement attached. ' stand-b" facilit" is a contingenc" lineof credit that is established with a financial institution. ' borrower will usuall" onl"draw on a stand-b" facilit" in time of tight li%uidit". (onger-term bank loans aret"picall" s"ndicated loans because of the sie of the debt issue, therefore a s"ndicateof banks will all commit funds to the loan. 's there is no formal secondar" market inindividual term loans, %uasi-securitisation innovations have developed that allowcertain sell-down provisions. These include novation, subparticipation, andtransferable loan certificates.

The euronote market incorporates the short- to medium-term direct debtmarkets. 't the shorter end of the maturit" spectrum is the promissor" note. 's with

promissor" notes issued within domestic markets, these securities are also discountsecurities. !owever, there are two main t"pes of promissor" notes, or commercial

paper, issued in the euromarkets/ the note issuance facilit" 0#1 and eurocommercialpaper &23. The distinguishing feature of an 0#1 is that it incorporates anunderwriting agreement, whereas &23 does not have such a feature. The price of an

0#1 or &23 is calculated using the discount securit" formula from 2hapter 4, but it isimportant to note that the euromarkets adopt the 567-da" "ear convention. 'nothersecurit" issued into the euronote market is the medium-term note 8T0. The 8T0 isan unsecured bearer securit" that pa"s a periodic interest coupon that ma" be fi+ed or

based on a variable indicator rate. The 8T0 facilit" is ver" fle+ible and ma" include arange of maturities, currencies of denomination, and fi+ed and floating rate coupons.

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The 8T0 program is often periodicall" issued in tranches into a number of differentcountries. The structure of each tranche can var" to meet the specific needs of theissuer and investors.

The longer-term direct finance market is known as the eurobond market.Straight bonds are fi+ed-interest bonds that pa" a regular coupon for the life of the

bond, with the face value repaid at maturit". The maturit" of the bond is t"picall"between three and twelve "ears, the most common currenc" of denomination is theUS, and US=7 million is the minimum issue that would justif" incurring theestablishment and servicing costs involved in the issue. 3arties associated with aeurobond issue include the lead manager, co-managers, the management group,underwriters, pa"ing agents, and market makers. The price of a straight bond is the

present value of its future cash flows. &urobonds issued with adjustable coupons areknown as floating rate notes 1R0s$ the" become %uite popular during periods ofrelativel" high and volatile interest rates. The 1R0 enables the periodic repricing ofthe interest rate in order to reflect current market "ields. 2onvertible eurobonds are

bonds that ma" be converted into e%uit" or some other securit" of the issuer. ' bond

ma" also be sold with a warrant that provides the holder with the right to purchaseother nominated securities at a specified price and dates. The warrant ma" beattached to the host bond, or it ma" be naked. Since the bu"ers of eurobonds tend to

be individuals rather than institutions, onl" the best-rated borrowers can e+pect to besuccessful in this market.

The US capital markets are an important source of funds, particularl" forborrowers that do not have a credit rating high enough to gain access to theeuromarkets. While the US market is fairl" tightl" regulated, there are certaine+emptions that enable easier access. These include certain commercial paper issues,

private placements and Rule

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their own words and provide an e+ample. *n the other hand, a post-graduate studentma" be re%uired to provide much greater depth of anal"sis and discussion.

1. Briefly outline the fators that led to the development of the euromar!ets.

"#plain why the euromar!ets ontinued to e#pand even after the original auses

for its development eased.

the euromarkets incorporate both mone" markets and capital markets within the

major centres around the world

a euromarket transaction is a financial transaction carried out b" a local borrower

in another countr", but not in the currenc" of that countr"

includes the eurocurrenc" market, the euronote market and the eurobond market

the dominant currenc" is the US, but euromarket transactions are carried out in

all major currencies

the initial boost to the suppl" of US being held outside the US' was provided b"

the USSR, which withdrew its US deposits from US banks in the cold warenvironment of the

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the term of the advance is set and the full amount is generall" drawn-down on

approval

a commitment fee is charged to the borrower if the advance is not drawn shortl"

after approval

the repa"ment of principal and interest normall" takes place as a lump sum at the

end of the term of the loan, with no provisions for earl" repa"ment

the short-term advance can be e+tended to provide a revolving credit arrangement

the borrower can normall" choose a mi+ture of currencies at each roll over

this allows the compan" to tailor the currenc" mi+ of the facilit", and thus of its

repa"ment commitments, to match the e+pected currenc" inflows from itsbusiness transactions. This minimises its e+posure to foreign e+changemovements

the interest reference rate is usuall" the rate at which banks in the market offer

funds to each other, for e+ample, (#)*R or S#)*R

borrowing in the eurocurrenc" markets ma" provide lower interest costs, enable

foreign e+change risk management, and provides funding diversification

&urocurrenc" stand-b" facilities/

a back-up source of funds to be used in the event of an unanticipated need for

short-term funding

the euromarkets is a reliable source of li%uidit" funding

t"picall", stand-b" facilities will be needed during periods of tight li%uidit", and if

the facilit" is arranged with a local supplier of funds there is the risk that thesupplier will also be subject to li%uidit" constraints at the ver" time that the

borrower needs to draw against the facilit"

stand-b" facilities are not intended b" the lender to be used as a source of ongoingfinance. rawings ma" be limited for a fi+ed term of, for e+ample, a few monthsthrough the period for which the facilit" has been arranged$ alternativel", therema" be a re%uirement that the facilit" remain unused for a specified number ofmonths per "ear

the charges associated with the stand-b" facilit" include both a commitment fee

and an interest charge on the funds that are drawn

since the facilit" will be drawn in periods of cash flow problems, the lender will

charge a higher risk premium than would be charged on a regular, full" drawnadvance

(. Ban!s in the eurourreny mar!ets provide longer%term loans. Desribe

the ommon features of suh loans. )utline the tehniques that have been

introdued by lenders in order to add to the liquidity of their longer%term loans.

&hat impat have these developments had* from the point of view of the

borrower'

2ommon features of a eurocurrenc" term loan include/

the minimum sie of a term loan is likel" to fall in the range of B5 million to B=

million

a single lender ma" be prepared to fund up to B=7 million to B

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where a s"ndicate is arranged, the lead manager takes the primar" responsibilit"

for arranging the transaction, structuring the facilit", negotiating the price andterms of the loan, and organising the participation of other banks

the lead bank ma" also underwrite the whole facilit"

where the facilit" is large, it is likel" that the lead bank will appoint co-managers

co-managers assume some of the administrative responsibilities, and also advise

on which banks to include as participating banks

participating banks are those that have little or no role in the negotiation of terms,

but act merel" as providers of funds to the borrower

an agent bank acts on behalf of the s"ndicate in the administration of the loan

the term of the facilit" is commonl" between five and ten "ears

the interest rate is normall" at a margin above (#)*R, with the interest period

usuall" nominated b" the borrower

fees include establishment fee, participation fees, legal fees, annual commitment

fees, and fees pa"able to the agent bank for its administration of the loan

amortised, interest onl" and deferred repa"ment loans are all available

(i%uidit" and sell-down provisions/

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euronote market transactions are short- to medium-term debt instruments issued

directl" into the markets

0#1 and &23 are both euronote instruments$ the" are promissor" notes issued b" a

borrower into overseas markets, in a currenc" other than the currenc" of thecountr" in which the paper is issued

Similarities between a 0#1 and &23/

promissor" notes C commonl" referred to as commercial paper

drawn issued b" a borrower in its own name one-name paper

discount securities C sold for less than the face value which is pa"able at maturit"

issued with maturities ranging from 57 to

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8T0s ma" be issued on a periodic or continuous basis

#n order to alla" concerns that the fle+ibilit" of the 8T0 issue ma" lead to afragmented stock of notes and reduce li%uidit" in the secondar" market, two otherdistribution techni%ues are commonl" attached to issues/

the tap approach - involves the division of the full facilit" into a number oftranches, each with a specified minimum and ma+imum dollar amount and withnotes within the tranche having identical maturit" and coupons. ' new tranche,comprised of notes of a different coupon and maturit", ma" not be offered to themarket until the minimum amount of the first tranche has been sold

the serial offering techni%ue - under which the maturit" and coupon characteristics

of the notes are determined at the time of the establishment of the facilit". Thefacilit" ma" have a number of series of notes, the characteristics of the notes beingdifferent between the series. Though there is not the minimum9ma+imumconstraint of the tap tranche s"stem, the establishment of the series also limits the

diversit" of the notes issued, and facilitates a reasonabl" deep secondar" market

7. &hat harateristis of a bond enable it to be labelled as a eurobond* as

opposed to a domesti bond or a foreign bond' Define and provide e#amples of

eah of these types of bonds.

a bond is a long-term debt securit" issued directl" into the capital markets and

pa"ing a defined interest coupon. The coupon ma" be based on a fi+ed or variableinterest rate. The face value is repa"able at maturit"

bond markets comprise three broad market groupings/ domestic bonds, foreign

bonds and eurobonds

domestic bonds - these are bonds issued in a specific countr", b" a borrower fromthat countr", and denominated in the currenc" of that countr"

for e+ample, an 'ustralian compan" issues a bond into the local 'ustralian bond

market that is denominated in 'U

foreign bonds - these are bonds issued b" a borrower in a countr" other than the

borrower?s own countr", and denominated in the currenc" of the countr" in whichthe bond is issued. 1oreign bond issues, and their secondar" market trading, areconducted under the supervision and regulation of the authorities of the countr" inwhich the bond is issued

for e+ample, a US issue b" an 'ustralian corporation, placed in the domestic

US' market, would be identified as a foreign bond issue foreign bonds often have %uite colourful names. )onds placed in the US' are

known as Eankee bonds and those issued in Fapan are known as Samurai bonds

eurobonds - these are bonds, generall" underwritten b" a multinational s"ndicate

of banks, and placed in countries other than the countr" of the currenc" in whichthe issue is denominated. These bonds are not marketed on a single, specific,national bond market. Therefore, the" are not subject to the listing or tradingre%uirements imposed b" national authorities

for e+ample, an 'ustralian corporation issuing US denominated bonds in an

overseas location other than the US'

a straight eurobond pa"s a fi+ed coupon rate$ a floating rate note pa"s a variablecoupon

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8. 4s an aount manager with an investment ban!* you have been

approahed by one of your orporate lients to advise on issuing bonds into the

eurobond mar!et. Briefly outline to your lient the proesses and parties

involved in the issue of a eurobond.

3arties to a eurobond issue/

a eurobond issue is organised b" an international bank called a lead manager

the lead manager arranges the issue$ discusses the issue and its s"ndication with

the issuer$ determines the appropriate institutions to include in various roles withinthe facilit", and invites their participation$ and prepares the facilit" documentation

the lead manager invites between five and 57 banks to act as co-managers$

together the" form the management group

the management group prepares the bond issue$ sets the final conditions of the

bond$ and selects the underwriters and selling groups. The management group will

usuall" subscribe to a large portion of the issue underwriters are invited to participate in the issue on the basis of their regional

placement power. Their number ma" var" from 57 to 577, and usuall" compriseinternational banks from all regions of the world. Together with the managementgroup, the underwriters guarantee final placement of the bonds at a set price

the selling group is responsible for selling the bonds to the public. #t consists of

managers, underwriters, and additional banks that have a good selling base. 'particular participant ma", at the one time, be manager, underwriter and seller

a separate fee is paid to compensate the participants for the particular services that

the" provide. Total fees pa"able ma" range from about

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often the clearing-houses of 2&&( or &uroclear are used in the settlement

process

the completion of a successful issue is marked b" the publication of an

advertisement in the international financial press. Since the advertisement marksthe end of the issue, it is referred to as a tombstone

after closing da", public secondar" market trading in the bonds begins. !owever,

trading actuall" takes place well before the closing da" - a gre" market

9. 4 highly rated finanial institution has deided to issue paper into both

the euronote mar!et and the eurobond mar!et. ,he ban! ma!es the following

issues:

"Cs maturing in ninety days with a fae value of ;SD$ per annum.&hat is the total amount of funds raised with eah issue'

-ote: you should loo! in the finanial press to asertain =IB)R. @owever*

assume for this question that =IB)R is urrently 2.98> per annum.0

Price of ECP issue/

+

=

maturit"toda"s

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US commercial paper US23 C a promissor" note, being a discount securit",

issued in the US mone" markets

placements of US23 with %ualified institutional investors, where there is no public

offering, to not re%uire official S&2 registration

&+empt private placement documentation and procedures include/

offering memorandum - contains a description of the US23, statement of use,

information on issuer, summar" financial statements, and supporting creditenhancements. ealers must suppl" an offering memorandum to each purchaser

offeree and purchaser limitations - offer and sales ma" onl" be made to %ualified

institutional investors

manner of offering - private placements cannot include an offer to the general

public, or an" advertising.

dealer agreement - the dealers must provide certain basic representations and

warranties, generall" under a standard agreement form. The dealer will beindemnified against misstatement, omission, or breach of representations andcovenants b" the issuer

issuing and pa"ing agent agreement - a standard agreement provided b" the

issuing and pa"ing agent, relating to the issuance, transfer, pa"ment andcancellation of the US23

denominations - an aggregate sale of US23 to an investor generall" must not be

less than US

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Shelf registration/

Eankee bonds re%uire registration with the S&2

Rule :

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a depositor" receipt is a securit" issued b" a US depositor" bank and is evidenced

b" a depositor" share

a depositor" share will represent one or more shares of a foreign issuer which are

listed on the foreign compan"?s local stock e+change

t"picall", a depositor" share will represent more than one share of the foreign

issuer, where the domestic share is trading at a price lower than that to which USinvestors are accustomed

an 'R program provides the opportunit" for a foreign compan", which

otherwise ma" not have been able to meet S&2 listing re%uirements, to access theUS capital market to raise funds

given the sie of the US capital markets, the 'R has become an important source

of funding for foreign companies

a depositor" bank acts as administrator, depositor", transfer agent, and registrar for

the program. The bank will assist with program structure and compliance issues,issue depositor" receipts, maintain records of registered holders, process transfers,

process dividend pa"ments and facilitate an orderl" market the 'R market is deep and li%uid. 'n 'R is attractive to US investors because

the issue is %uoted in US, and associated cash flows dividends or interestpa"ments are denominated in US and therefore are protected for foreigne+change risk. The issue is supported b" the underl"ing shares of the issuer, and issubject to US legal jurisdiction

'n 'R program ma" take one of a number of forms/ Level 1. Shares of the issuer compan", listed on its home e+change, are deposited

with a custodian bank in that countr". 'R securities are issued and traded in theUS over-the-counter market. These 'Rs are not listed on US e+changes and arenot registered for public offering. The same disclosure re%uirements appl" as forthe home countr".

Level 2. Shares of the issuer compan", listed on its home e+change, are deposited

with a custodian bank in that countr". These 'Rs are listed on one or more USe+changes, such as the 0ew Eork Stock &+change, '8&K, or 0'S'L, but arenot sold as a public offering. There are e+tensive S&2 disclosure re%uirements.

Level . *ffer of new shares of the issuer compan", issued on its home e+change,

are deposited with a custodian bank in that countr". These 'Rs are listed on oneor more US e+changes and are sold as a registered public offering$ that is, the'R issue is registered with the S&2 for public offer to US investors, and must

meet e+tensive disclosure re%uirements. 1!!A"#e$ S%%%Private Placement &fferin$. 'n 'R facilit" ma" be established for

the private placement of new shares of the issuer in accordance with Rule

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a credit rating is the opinion of a credit rating agenc" of the creditworthiness of an

obligor, with respect to a debt issue or other financial obligation

a credit rating is not a recommendation to an investor, but rather a structured

assessment process that differentiates credit %ualit" between debt issuers

there are a number of major international credit rating agencies, including

Standard and 3oorIs, and 8ood"Is #nvestors Service

the objective is to provide a standard measure of credit risk

a rating agenc" issues both long-term and short-term credit ratings

S @ 3?s long-term ratings range from ''', reflecting the strongest credit %ualit",

to , the lowest. Ratings from '' to 222 ma" be modified b" the addition of aplus or minus sign to show relative standing within the major rating categories

debt issues with a rating of ))) and above are regarded as investment grade

short-term credit ratings range from '-< to , and also ma" include a plus or

minus sign

S @ 3 adds the s"mbol IrI to a credit rating where significant non-credit risk is

evident

while agencies will rate a corporation, most credit ratings are issue-specific

the importance to an investor of a credit rating is that it provides a standard

measure of risk. ' credit rating of ))) has the same meaning no matter whichcapital market it is issued. This assists with the pricing of investmentopportunities, particularl" in the international markets, where the investor ma" nothave full knowledge of the operations of a corporation

the importance to the issuer9borrower is that the credit rating is internationall"

accepted, therefore investors are more likel" to bu" securities that have a creditrating attached. There is a direct relationship between risk and return/ the higher

the credit rating, the lower the "ield the borrower needs to offer on the issue

12. 5ega Corporation proposes to raise additional debt finane to fund its

growing business operations. ,he ompany requests S to provide a redit

rating on the issue. Desribe the strutured redit rating proess used by the

redit rating ageny* inluding in your answer important issues that would be

inorporated in the redit ris! analysis.

The structured rating process involves/

preparation of financial statements, anal"stsI reports, and other relevant

information

issuer meetings, where management must address/

- the industr" environment and prospects- an overview of major business segments, including operating statistics and

comparisons with competitors and industr" norms- managementIs financial policies and performance goals- distinctive accounting practices- capital spending plans- financing alternatives and contingenc" plans

the S @ 3 rating committee conducts an anal"sis and s"nthesis of information and

compan" financial statements and

determines the credit rating communicates credit rating to issuer

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appeal process if necessar" - onl" if there is significant new information

disseminates the credit rating

conducts ongoing surveillance during the term of the issue

The rating methodolog" develops a profile that incorporates a balance betweenbusiness risk and financial risk. )usiness risk anal"sis includes/

issuer position in the industr"

marketing

cost efficienc"

technological e+pertise

management evaluation

c"clical characteristics

barriers to entr" or e+it

competition

1inancial risk anal"sis includes/

financial polic"

profitabilit"

capital structure of assets, debt, and e%uit"

cash flow projections and ratios

financial fle+ibilit"

off-balance-sheet financing

asset and liabilit" diversification, mi+ and li%uidit"

'dditional matters considered in an international rating anal"sis include/ market environment - econom", regulation, competition

information - e+tent of data, %ualit", timeliness, accounting standards,

comparabilit", and transparenc"

countr" risk - economic, business and social environment

sovereign risk - direct or indirect political interventions which affect the abilit" of

an issuer to meet offshore obligations. 'lso includes politicall" related events suchas strikes, riots, war and corruption

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