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Foreign Bonds: Your AAA Way to

Security, Income and All the Power

of Foreign Currencies in a Single

Investment

By Te World Currency Watch Research eam

Tese days, there are many interesting opportunities or investing in oreign currencies, rom long-term currency EFs to short-term Forex trades. In act, there are so many ways to invest in oreigncurrencies that its easy to orget one o the saest, long-term strategies: Te oreign currency bond.

Few currency investments oer you the security and long-term income potential o a oreigncurrency bond. Tese widely available oreign investment opportunities are easy to buy, incredibly

liquid, and theyre even relatively easy to predict compared to other assets. Some even protect youagainst currency risk.

Best o all, these bonds are oten at their best when an economy is headed or a downturn, makingthem a perect investment or todays turbulent economic outlook.

What is a Foreign Currency Bond?

In short, a oreign bond is any government-issued debt, in its local currency. However, any bondavailable on your own domestic markets denominated in a oreign currency also alls into thiscategory.

Since the rst oreign currency bonds were issued in the mid 1950s, the rapid development o theworld bond market has allowed issuers to raise capital outside o their own domestic markets whileproviding a wealth o opportunities to the average investor.

As you probably know, a bond is one o the most basic, cut-and-dried investments in the markets.Its simply a loan with interest. Only instead o taking out a loan yoursel, youre loaning your assetsto either a company or country that has to pay you back with interest when your bond matures. Youessentially become the creditor, instead o the borrower.

When you purchase a bond, it has a maturity date and a coupon rate. Ater you buy the bond,youre paid the coupon rate (a percentage o what you originally paid or the bond) annually on

specic coupon dates.Usually these payments come twice a year. Once your bond matures, you are repaid the bonds

principal or the ace value and the transaction is over. Tis is a very general example, but itdemonstrates the undamentals o bond investing.

So or instance, say you bought a three-year reasury note in the United States at the most recentrates. At best, you would make between 23% annual yield on your investment.

So twice a year on your coupon date you would receive a 1% to 1.5% return. Not bad


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right? Well, in a year when annual infation is expected to hit the neighborhood o 5%, a paltry 2%to 3% wont help you build up your portolio. In act, at these rates, you would produce a negativeyield and lose 2-3% o your original investment value.

But thats why oreign bonds are such a protable alternative.

Foreign bonds allow you to capitalize on the global economic climate and maximize the value oyour bond investments.

I you bought that same three-year bond in another country, you can secure an even highercoupon rate (as high as 3% to 4% depending on the country). Plus, you can earn extra prots romany currency appreciation o the local currency rising against the U.S. dollar.

Lets look at an example.

Riding High on the Australian Dollar

In August 2008 a three-year Australian bond yielded 5%. Lets assume you invested $5,000 U.S.

dollars in this three-year bond.

o invest in an Australian dollar bond, you rst need to call your broker. Most brokers can handleoreign bonds, but make sure to ask about ees, etc.

Te next thing you need is the local currency. So your broker will convert your U.S. dollars intoAustralian dollars. Lets say the exchange rate on AUD/USD is $0.86. (Tat means you get oneAustralian dollar or every US$0.86.)

o nd out how much youre paying (in Australian dollars), simply divide 5,000 by 0.86 =A$5,813.95.

**Its important at this point to note the dierence in coupon dates on oreign and domesticbonds. While many American bonds split their coupon payment between two dates over the courseo the year, most oreign bonds pay their coupon all at once, on a single coupon date. Be sure toaccount or this minor dierence when deciding where and how much youll invest.**

At your request, your broker will invest in a bond paying a set interest rate or a set term itcould be one, three, or ve years, or example: Say you decided to buy a three-year Australian bondthat pays 5%.

Ten ater three years, you decide to sell your mature bond. I the Australian dollar has risenin value versus the U.S. dollar, you would gain extra prots on the appreciation. Lets just say theexchange rate has jumped to .96 or every one U.S. dollar.

So the U.S. dollar is now worth .96 Aussie cents, you receive your initial A$5,813.95 x .96 =US$5.581.39. Tats an extra US$580 just rom currency appreciation alonenot counting youryield.

In essence, you earned prots twicei the Australian dollar appreciates against the U.S. dollar.


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Keep an Eye on the Yields

I mentioned earlier that bond perormance is relatively easy to predict. Tough its almostimpossible to predict the perormance o some o your more volatile investments, bond perormancegenerally remains stable and consistent in the long-run. And the yield curve is your key tounderstanding and predicting bond returns.

A Sample Yield Curve or T-Bills

A yield curve is a chart displaying the relationship between interest rates and maturity dates obonds with similar credit quality. Te yield curve helps orecast what economic activity will aectyour bonds price going orward.

Foreign bonds are all priced based on their yield to maturity percentages. Tereore, as a bondyield goes up, the bond price goes down, and vice versa.

Brazils Yield Curve Tells All

Its important to look at the yield curve, because you can discover a lower-yielding short-term bondmay actually pay more than a higher-yielding longer-term bond once you actor in infation.

ake a look at the graph above. Note that the three month yield is slightly higher than the oneyear yield! As you can see, there is no incentive outside o currency appreciation to go with thelonger-term choice.

In act, i youre bearish on the Brazilian real or you expect infation, you may nd that the returnswould be substantially better with the short-term bond.


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Tips or Buying Bonds

Search or bonds in a country thats experiencing rate cuts, a slower economy and other badnews or data.

Be sure to buy the highest quality AAA Sovereign bonds because they have the lowest risk o

deault.You want to buy bonds in a local market when a countrys economy has peaked and will slowdown or a period o time going orward.

I you buy a oreign bond just beore the economy slows down, then you essentially lock inyour yield to maturity. As the economy in the country slows, the interest rates drop makingyour higher yielding bonds more expensive, or valuable to the holder.

You can then decide to sell your oreign bonds at a prot, or continue to hold your higheryield bond to maturity.

Most oreign bonds sell in $1,000 increments with minimums much larger in dierent

markets.

A Note on Currency Risk and How to Protect your Investment

Currency risk is dened as how your investments value can fuctuate based on changes in thatcurrencys exchange rate. In this case, its the risk that the currency your bond is denominated in willlose value against the dollar.

Currency risk can aect any o your oreign-currency based investments, and its something youshould always consider when investing abroad.

Even though the dollar is on a steady decline and its a great time to diversiy your holdings, youwill always run the risk that your oreign currency-based investments can actually depreciate in valueover time.

However, some oreign currency bonds can actually protect you rom this risk in the short-term.Some banks and brokerages will allow you to purchase a oreign bond, and then sell or receiveinterest in the oreign currency. But then you can convert both your principal and your interest backto dollars when its most advantageous or you to do so.

For example, lets say that your euro-based bond reached maturity in August o 2008 (the areacircled in red on the chart below). Unortunately at the same time the dollar was making itsbiggest rally against the euro to date.


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Currency Risk Averted, Profts Preserved

I youre condent in the long-term potential o the euro, then you can hold the principal andinterest rom your bond in euro until the exchange rate is more avorable. In other words, wait orthe euro or rise again, and then convert your prots back when youll get the best return.

When the dollar bear market resumes which we think it will go into the later hal o 2009theundamentals will trump the ear and the euro should benet at the dollars expense.

Be sure to discuss this characteristic with your broker beore buying so that you can hedge againstcurrency risk.

The Best Foreign Bond to Buy This Year

Right now, the best bonds to buy are located in Norway.

A country with only 4.7 million people, Norways primary exports come rom natural resources,

including oil exploration and exports, sheries and hydroelectric power generation.

Over the last ew years, the clever Norwegians have developed an excellent model to careully andstrategically manage revenue orm these exports. Tey have transormed oil revenue into a nationalsocial und or the whole country.

Teir stringent scal management allows them to navigate the booms and bust cycles o oil pricessuccessully.

Because o this importance o oil exports, the Norwegian krones value tends to ollow the price ooil. And in the next ew years we expect oil prices to rise.

Heres why

Te massive U.S. decits will continue to push downward pressure in the U.S. dollar. As youknow, oil is priced in dollars all over the world. So a cheaper dollar will orce oils price higher.

But we are also a strong believer o the Peak Oil theory. As the Asian economies pick up speedin their growth rates in the coming months, demand will really ramp up, and the shortage on thesupply side will become apparent.

At the same time, production is declining in most major oil-producing countries in the world. Te


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worldwide demand or oil will simply outstrip supply, pushing prices o oil up.

Te Norwegian krone will be a big beneciary o that trend.

So here are two top credit quality Norwegian bonds:

Norwegian Rabobank with a coupon of 4.25%, maturing in 9/2/2014 (ISIN

XS0448022102). If youre looking for something with a shorter maturity, you can buy KSWbond paying a 3% coupon and maturing in 3/23/2012 (ISIN XS0418291174).

Both are government guaranteed bonds rated AAA and denominated in Norwegian krone.

A bond is one o the most basic, cut-and-dried investments in the markets. But by investing inoreign bonds, you can enjoy xed income and extra currency appreciation i the local currency risesversus the dollar. Add in the act that these bonds are highly-rated and government-backed, andyouve got a long-term, sae way to cash in on some o the most protable oreign currencies aroundthe world.

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ForeignBonds soverein