Finance

Eurobonds Dual currency bonds Floating Rate Notes

Eurobonds. A major source of borrowing at Eurocurrency market is through the issue of international bonds known as Eurobonds. Most Eurobonds are bearer securities. Most of the bonds are denominated in US dollars, issued in denominations of USD 10,000. The average maturity of Eurobonds is about 5 to 6 years, although it is normal to find issues with maturity up to 15 years.

Types of Eurobonds

There are four main types of Eurobonds:

(i) Straight or fixed rate bonds;

(ii) Convertible bonds;

(iii) Currency option or dual currency bonds;

(iv) Floating Rate Notes (FRNs)

(i) Straight or fixed rate bonds. These are fixed interest-bearing securities, the interest normally payable at yearly intervals. Interest is payable on the basis of interest year of 360 days. Maturities range from 3 to 25 years. Maturity common is up to 15 years. Bonds may provide right of redemption to the borrowers before maturity by offering an agio (premium).

There are no withholding taxes on interest earned on Eurobonds. Though the interest rate is fixed, the actual yield from the investment depends upon the price paid by the investor. Bond prices are influenced by the level of short-term interest rates and the degree of liquidity in the market. Price fluctuations can produce capital gain or loss to the investor when he disposes of the bond in the secondary market. Price fluctuations often lead to switch between bonds in the secondary market and between bonds and other instruments.

(ii) Convertible bonds. These are also fixed interest-bearing securities. The investor has the option to convert them into equity share of the borrowing company. The conversion will be done at a stipulated price for the share and during a stipulated period. The conversion price is normally kept higher than the market price for the equity shares on the date of bond issue.

The rate of interest on convertible bonds is lower than that offered on a comparable straight bond. This is because the investor will profit from a rise in the share price.

The attraction of convertible bonds to the investors is that in addition to fixed income on their investment they stand to participate in the capital growth of the company. Further some of the bonds are issued in a currency other than the currency in which the shares of the company are denominated. This provides an opportunity to diversify the currency risk.

(iii) Currency option or dual currency bonds. These are similar to straight bonds with the difference that it is issued in one currency with option to take payment of interest and principal in a second currency. Normally option bonds are issued in sterling and provide for payment in dollar or Deutsche mark.

The rate at which the conversion of currency takes place depends upon the terms of issue. Some bonds fix the rate of conversion at the time of issue itself. But recent issues provide for floating rates for conversion. The rate of conversion in such case is the spot rate quoted in the market three business days before each payment is due for interest and principal.

(iv) Floating Rate Notes (FRNs). The FRNs are similar to straight bonds in respect of maturity and denomination. But the specialty of the FRNs is that the interest payable is varying in accordance with the market conditions unlike the fixed rate payable on a straight bond. Interest on FRNs is payable at a spread over the LIBOR, which is normally 1/4%. The rate of interest is adjusted every six months depending upon the ruling LIBOR.

Many bonds also provide for a minimum interest clause in case the LIBOR falls below a certain level. The advantage of FRNs is that they provide the investor with the facility of investing for long term and also benefit from movement in short-term rates.

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