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The Global Capital Market
Prof. Ian Giddy
New York University
Copyright ©1996 Ian H. Giddy The Global capital Market 2
The International Capital Market
International bank financing Eurobonds, foreign bonds and global
bonds “A Day in the Life”
The secondary marketThe primary market
Structured financing
Copyright ©1996 Ian H. Giddy The Global capital Market 3
Short-Term Financing: Evolution
INTERMEDIATED
DIRECT
ENHANCED
BANK LOANS
COMMERCIAL PAPER
BANK L/Cs
Copyright ©1996 Ian H. Giddy The Global capital Market 8
Alternative Sources ofShort-Term Financing
FINANCINGFINANCING
DEBT EQUITYDOMESTIC
LOANS
DOMESTIC
LOANSEUROMARKET
LOANS
EUROMARKET
LOANSSYNDICATED
EUROCREDITS
SYNDICATED
EUROCREDITSNOTE ISSUANCE
FACILITIES
NOTE ISSUANCE
FACILITIESEUROCOMMERCIAL
PAPER
EUROCOMMERCIAL
PAPER
Copyright ©1996 Ian H. Giddy The Global capital Market 9
A RevolverThe Bigfoot Group
£115,000,000equivalent
Committed Revolving Facility
Arranged by
Credit Suisse First Boston Limited
Underwriting Banks
ABN-AMRO N.V. Banque Indosuez Crédit LyonnaisDeutsche Bank Fuji International Finance Limited Banque Paribas
Samuel Montague & Co. Limited County Bank KredietbankBanque Bruxelles Lambert S.A. Citibank Crédit Suisse
Sumitomo Finance International Westdeutsche Landesbank Girozentraleo Finance International Westdeutsche Landesbank
Tender Panel Members
ABN-AMRO N.V. Indosuez Crédit Lyonnais CIBC LimitedDeutsche Bank Fuji International Finance Limited Banque ParibasLTCB International Limited J.P. Morgan County Bank Kredietbank
Banque Bruxelles Lambert S.A. Citibank Crédit Suisse Commerzbank Merrill Lynch Capital Markets Sumitomo Finance International
Salomon Brothers International Westdeutsche Landesbank Girozentrale
Tender Panel and Facility Agent
Credit Suisse First Boston Limited
RUF Structure:ArrangerUnderwriting
banksTender
panelAgent
Copyright ©1996 Ian H. Giddy The Global capital Market 10
RUF Stuff
Need lots of money fast?
Have trouble accessing CP market?
Arrange syndicated
creditYES
Confident of always being able
to access the short-term market?
Arrange Euronote
programYES
Arrange RUF or MOF:
Underwritten Euronote program
Need funds? Don’t issue paperNO
Cannot sell paper at L+10bp? Borrow from banksYES
Issue Euronotes or other paper
Copyright ©1996 Ian H. Giddy The Global capital Market 11
Alternative Sources ofLong-Term Financing
FINANCINGFINANCING
DEBT EQUITY
Bank credits - syndicated
lending and facilities Bonds
Domestic, foreign, EuroPublic, privateStructured, such as principle-indexed notes
Medium-term notes Asset-backed financing and leasing Project financing
Copyright ©1996 Ian H. Giddy The Global capital Market 12
Long-Term Financing: Evolution
INTERMEDIATED
DIRECT
ENHANCED
BANK TERM LOANS
PUBLIC BONDS
BANK-GUARANTEED BONDS
Copyright ©1996 Ian H. Giddy The Global capital Market 13
The Global Bond Market
Domestic bonds Foreign bond
(Issued within country of currency, by non-resident issuers)
Eurobonds(Issued and sold in a jurisdiction outside the
country of the currency of denomination) Global Bonds(Issued in the domestic and the Eurobond
markets simultaneously)
Copyright ©1996 Ian H. Giddy The Global capital Market 14
The Global Bond Market
Domestic bonds Foreign bond
(Issued within country of currency, by non-resident issuers)
Eurobonds(Issued and sold in a jurisdiction outside the
country of the currency of denomination) Global Bonds(Issued in the domestic and the Eurobond
markets simultaneously)
Copyright ©1996 Ian H. Giddy The Global capital Market 15
International Bond Markets are Linked
Issuers and investors compare terms in the domestic and Eurobond markets, which are linked across currencies via currency swaps
BONDMARKETSWITHINCOUNTRYOFCURRENCY
BONDMARKETSOUTSIDECOUNTRYOFCURRENCY
CurrencySwaps
Long-datedForwardExchange
Domestic US
- Gov't- Corporate
ForeignBonds
"Yankee"
DomesticJapanese
- Gov't- Corporate
ForeignBonds
"Samurai"
EurodollarBond Market
EuroyenBond Market
Copyright ©1996 Ian H. Giddy The Global capital Market 16
Foreign Bonds
A foreign bond is a bond issued in a host country's financial market, in the host country's currency, by a foreign borrower
The three largest foreign bond markets are Japan, Switzerland, and the U.S., representing issuance of about $40 billion in bonds annually
Copyright ©1996 Ian H. Giddy The Global capital Market 17
Private Placements and Rule 144A
The private placement exemption from registration and disclosure is extended to Eurobonds as long as the U.S. investors meet the following requirements:They are large and sophisticatedThere are only a few investorsThey have access to information and analysis similar
to that which would ordinarily be contained in a registered offering prospectus
They are capable of sustaining the risk of losses, andThey intend to purchase the bonds for their own
investment portfolios, and not for resale.
Copyright ©1996 Ian H. Giddy The Global capital Market 18
Characteristics of Eurobonds
Issued outside country of currency Not subject to domestic registration or disclosure
requirements In most cases take form of private placements Placed through syndicates in many countries who sell
principally to nonresidents Bonds are structured so as to be free of withholding tax Bearer form
But... Eurobonds usually influenced de facto by government
and banks of country of currency
Copyright ©1996 Ian H. Giddy The Global capital Market 19
Global Bonds
Copyright ©1996 Ian H. Giddy The Global capital Market 20
Key Dates in the Issuance of a Eurobond
Issuance need oropportunity identified
Announcement ofEurobond issue
Offering day:Eurobond issued
Closing day:Eurobonds delivered,
Issuer gets money
Issuerdiscussesdeal withleadmanager
Syndicateformed,bonds"presold"prior tofinal terms
Finalterms,bonds soldby sellinggroup toinvestors
Copyright ©1996 Ian H. Giddy The Global capital Market 21
Key Players in the Issuance of a Eurobond
MANAGERSUNDER-
WRITERS
SELLING
GROUP
Copyright ©1996 Ian H. Giddy The Global capital Market 22
Who Gets What
Fees, percent Fees, amount Net pricePrice paid by investor (in theory) 101.50
Price paid by member of selling group 60% 0.90 100.60
Price paid by member
of underwriting group 60%+20% 0.90+0.30 100.30
Price paid by managers
(plus "praecipium" paid to lead manager) 60%+20%+20% 0.90+0.30+0.30 100.00
Copyright ©1996 Ian H. Giddy The Global capital Market 23
Pricing Eurobonds in the Secondary Market What "spread to Treasury" should it yield
relative to similar bonds--credit risk, duration and liquidity--trading in the secondary market?
Use the desired yield to maturity to find its present value at the next coupon date.
Find today's present value of that amount, including the coupon to be paid
Actual price is quoted as "clean price," meaning not counting accrued interest
Copyright ©1996 Ian H. Giddy The Global capital Market 24
The Eurobond Secondary Market
Copyright ©1996 Ian H. Giddy The Global capital Market 25
Eurobond Secondary Market Quotations
Examine the straight bonds listedWhat determines the yields?The bid-offer spreads?Does this differ by currency?
Can you explain the pricing
of the floating rate notes?
Copyright ©1996 Ian H. Giddy The Global capital Market 26
A Day in the Lifeof the Eurobond Market
Examine the dealsWhy were each done in that particular form?What determines the pricing?
Can you break the hybrids into their component parts?
Copyright ©1996 Ian H. Giddy The Global capital Market 27
A Day in the Life...
NEW INTER NA TIONAL BO ND ISSUES
Bo rrowerBo rrower Amou nt m .Amou nt m . Cou pon %Cou pon % Pr icePr ice Mat ur ityMat ur ity FeesFees Boo k ru nn erBoo k ru nn er
Celworks Trust 1990-1¶ (b) US$250 9 1/4 99.80 1998 1 7/8-1 5/8 Credit Suisse
Marui Corp* US$500 (4 3/ 8) 100 1995 2 1/4-1 1/2 Nomura
Holderbank (a) US$150 9 3/4 101 1994 1 3/8-1 CSFB
Battle Mountaingold US$100 7 1/2 100 2006 2 1/2-1 1/2 Merrill Lynch
SN CF FFr750 9 1/4 98.55 1997 1 7/8-1 1/4 CCF
Viennische Stadtsbank (a) L100bn 13 101 3/8 1994 1 3/8-7/8 BN L
Eurofima (a ) P ta10bn 12 5/8 101 1/8 1996 1 5/8-1 Deutsche Bank
Ir ish Bldg Soc . (a ) ¥15bn 7.4 101 5/8 1995 1 5/8-1 1/8 IBJ
Bank of Montreal (c ) ¥2.8bn 7 1/4 101 1/8 1993 1 1/8-5/8 Nippon Credit
¶Final te rms. *With equity warrants. Private placement. Convertible. (a) Non-callable. (b) Callable at par af ter 5 years. I f call notexercised, bond pays 50bp over Libor in last year . (c) Redemption linked to Nikkei stock index .
NEW INTER NA TIONAL BO ND ISSUES
Bo rrowerBo rrower Amou nt m .Amou nt m . Cou pon %Cou pon % Pr icePr ice Mat ur ityMat ur ity FeesFees Boo k ru nn erBoo k ru nn er
Celworks Trust 1990-1¶ (b) US$250 9 1/4 99.80 1998 1 7/8-1 5/8 Credit Suisse
Marui Corp* US$500 (4 3/ 8) 100 1995 2 1/4-1 1/2 Nomura
Holderbank (a) US$150 9 3/4 101 1994 1 3/8-1 CSFB
Battle Mountaingold US$100 7 1/2 100 2006 2 1/2-1 1/2 Merrill Lynch
SN CF FFr750 9 1/4 98.55 1997 1 7/8-1 1/4 CCF
Viennische Stadtsbank (a) L100bn 13 101 3/8 1994 1 3/8-7/8 BN L
Eurofima (a ) P ta10bn 12 5/8 101 1/8 1996 1 5/8-1 Deutsche Bank
Ir ish Bldg Soc . (a ) ¥15bn 7.4 101 5/8 1995 1 5/8-1 1/8 IBJ
Bank of Montreal (c ) ¥2.8bn 7 1/4 101 1/8 1993 1 1/8-5/8 Nippon Credit
¶Final te rms. *With equity warrants. Private placement. Convertible. (a) Non-callable. (b) Callable at par af ter 5 years. I f call notexercised, bond pays 50bp over Libor in last year . (c) Redemption linked to Nikkei stock index .
Copyright ©1996 Ian H. Giddy The Global capital Market 28
Asset-Backed Eurobonds
Legal risk:Legal structure: sale of assets to separate
subsidiary that issued ABS.
Default risk:Overcollateralization dictated by rating
agenciesReplenishment of collateralThird-party garantees.
Prepayment risk:Early redemption caused by “spread trigger”.
Copyright ©1996 Ian H. Giddy The Global capital Market 29
Equity-Linked Eurobonds
Eurobonds with warrantsMarui
Convertible EurobondsBattle Mountaingold
Index-linked EurobondsBank of Montreal
Copyright ©1996 Ian H. Giddy The Global capital Market 30
Equity Financing Choices
Equity
Warrants Conver-tibles
ADRs Common
Copyright ©1996 Ian H. Giddy The Global capital Market 31
Values and Market Premium
ConversionValue
StraightBond Value
Market ValueMarket Premium
Value
of
Convertible
Bond
($) 0
Price Per Share of Common Stock
Copyright ©1996 Ian H. Giddy The Global capital Market 32
Values and Warrant Premium
TheoreticalValue
Market ValueMarket Premium
Value
of
Warrant
($)
0Price Per Share of Common Stock ($)
1994, HarperCollins PublishersCopyright
Copyright ©1996 Ian H. Giddy The Global capital Market 33
“Hybrid” Features of A Bond Issue
Conversion Feature - compound option
Warrants - two instruments Index-linked bonds Call Feature
Bond value = straight bond value - call value
These are all example of hybrid bonds and should be priced by decomposition
Copyright ©1996 Ian H. Giddy The Global capital Market 34
International Equity Markets and Portfolio Diversification No well-accepted international version of the capital
asset pricing model. The benefits of diversification globally are empirical
issues. The empirical case for international diversification has
two components. Establish the riskiness of foreign investment, and the extent to
which combining a foreign with a domestic portfolio reduces risk.
Even if it reduces risk, does foreign investment also reduce expected return?
Then what we have to do is make sure we understand how international diversification is best achieved.
Copyright ©1996 Ian H. Giddy The Global capital Market 35
Portfolio Return and Risk
Portfolio return:
where wi are the weights of each asset in the portfolio. (Expected return is simply the weighted sum of the individual asset returns.)
Portfolio variance:
When i = j, the term wiwjFiFjDij becomes wi2Fi
2.
E(R ) = w E(R )pi=1
n
i i
P2
i=1
n
j=1
n
i j i j ij = w w
Copyright ©1996 Ian H. Giddy The Global capital Market 36
The Minimum-Variance Frontier of Risky Assets
Efficient frontier
Individual assets
Global minimum-variance portfolio
E(r)
Copyright ©1996 Ian H. Giddy The Global capital Market 37
Optimal Overall Portfolio
Indifference curve
Opportunity set
CALE(r)
P
Optimal complete portfolio
Copyright ©1996 Ian H. Giddy The Global capital Market 38
The Global Efficient Frontier
10 15 20 25 30 5
5
10
15
20
25
30
STOCKSANDBONDS
STOCKSONLY
EAFESTOCKS& BONDS
EAFE STOCKS
WORLD STOCKS & BONDS
WORLD STOCKS
US STOCKS & BONDSUS STOCKS
US BONDS
AVERAGE RETURN% PA
RISK, % PA
Copyright ©1996 Ian H. Giddy The Global capital Market 39
Evidence Suggests Index Funds are Not for the International Investor For the international investor the capitalization-
weighted portfolio may not be the optimal one. The reason is market segmentation. The world stock market is not efficient yet, the evidence suggests, at least not in the "mean-variance efficiency" sense that is required by the CAPM.
Because of real exchange risk (deviations from PPP), what is the optimal portfolio for an investor in one country may not be the optimal portfolio for an investor in another, even if there were a single risk-free asset acceptable to both.
Studies confirm these propositions
Copyright ©1996 Ian H. Giddy The Global capital Market 40
International Portfolio Optimization: Passive vs Active Portfolios
(Let the proportions of all possible assets vary until the optimal proportions are found.)
The results of
letting the
computer
find the best
proportions for
various levels
of return:
0.1
0.11
0.12
0.13
0.14
0.15
0.16
0.17
0.18
0.19
0.2
0.21
0.22
0.23
0.05 0.1 0.15 0.2 0.25 0.3 0.35
RETURN
RISK(STANDARD DEVIATION)
Same risk as 100% USA,but higher return
100% USA portfolio
100% Japan
Minimum riskportfolio Market capitalization
weighted portfolio
Copyright ©1996 Ian H. Giddy The Global capital Market 41
Obstacles to International Investment Might Include:
Information barriers. Political and capital control risks. Foreign exchange risks. Restrictions on foreign investment and
control. Taxation. Higher costs.
Copyright ©1996 Ian H. Giddy The Global capital Market 42
Conclusion:
The international equity market is imperfect
Hence there may be advantages to international equity issuance
How should companies achieve this?
Financing withStructured Securities
Prof. Ian Giddy
New York University
Copyright ©1996 Ian H. Giddy The Global capital Market 44
Principles of Innovation Through Financial Engineering
Bundling and unbundling basic instruments Exploiting market imperfections (sometimes
temporary) Creating value added for investor and issuer
by tailoring securities to their particular needs
Key: For the innovation to work, it must provide value added to both issuer and investor.
Copyright ©1996 Ian H. Giddy The Global capital Market 46
Anatomy of a Deal
Issuer:Looking for large amounts of floating-rate
USD and DEM funding for its loan porfolio.Wants low-cost funds: target CP-.10Is not too concerned about specific timing
of issue, amount or maturityIs willing to consider hybrid structures.
Copyright ©1996 Ian H. Giddy The Global capital Market 47
Anatomy of a Deal
Investor:Has distinctive preference for high grade
investmentsLooking for investments that will improve
portfolio returns relative to relevant indexesInvests in both floating rate and fixed rate
sterling and dollar securitiesCan buy options to hedge portfolio but
cannot sell options
Copyright ©1996 Ian H. Giddy The Global capital Market 48
Anatomy of a Deal
Intermediary:Has experience and technical and legal
background in structure financeHas active swap and option trading and
positioning capabilitiesHas clients looking for caps and other forms
of interest rate protection.
Copyright ©1996 Ian H. Giddy The Global capital Market 49
The Deal
1 Initiate medium term note programme for the borrower, allowing for a variety of currencies, maturities and special structures
2 Structuring a MTN in such a way as to meet the investor’s needs and constraints
3 Line up all potential counterparties and negociate numbers acceptable to all sides
4 Upon issuer’s and investor’s approval, place the securities
Copyright ©1996 Ian H. Giddy The Global capital Market 50
The Deal / 2
5 For the issuer, swap and strip the issue into the form of funding that he requires
6 Offer a degree of liquidity to the issuer by standing willing to buy back the securities at a later date.
Copyright ©1996 Ian H. Giddy The Global capital Market 51
The Issue
Issuer: Deutsche Bank AG Amount: US$ 40 Million Coupon:
First three years: semi-annual
LIBOR + 3/8% p.a., paid semi-annually
Last 5 years: 8.35% Price: 100 Maturity: February 10, 2000 Call: Issuer may redeem the notes in full at par on
February 10, 1995 Fees: 30 bp Arranger: Credit Swiss First Boston
Copyright ©1996 Ian H. Giddy The Global capital Market 56
The Deal in Detail
SCOTTISH
LIFE
CSFB
DEUTSCHE
Deutsche sells 3-year floating rate note paying LIBOR - 3/8%
For an additional 3/4% p.a., Deutsche buys three-year put option on 5-
year fixed-rate 8.35% note to SL in 3 years
For 1% p.a., Deutsche sells CSFB a swaption (the right to pay fixed 8.35% for 5 years in 3 years)
CLIENT
CSFB sells the swaption to a corporate client seeking to hedge its funding cost against a rate rise
Copyright ©1996 Ian H. Giddy The Global capital Market 57
What’s Really Going On?
Note: Issuer has agreed to pay an above-market rate
on both the floating rate note and the fixed rate bond segment of the issue
FRN portion: .75 % above normal cost
Fixed portion: .50% above normal cost Issuer has in effect purchased the right to pay a
fixed rate of 8.35% on a five-year bond to be issued in three years time.
Copyright ©1996 Ian H. Giddy The Global capital Market 58
Motivations for Issuing Hybrids Bonds
Company has a view There are constraints on what the
company can issue The company can arbitrage to save
money Always ask: given my goal, is there an
alternative way of achieving the same effect (e.g., using derivatives?)
Copyright ©1996 Ian H. Giddy The Global capital Market 59
The International Capital Market
International bank financing Eurobonds, foreign bonds and global
bonds “A Day in the Life”
The secondary marketThe primary market
Structured financing