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 foreign
borrowers, 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 hold
USD outside the jurisdiction of the US authorities. However, the continued growth of
the euromarkets has been prompted by the fact that they can normally offer higher
deposit rates of return and lower borrowing rates than are available in domestic debt
markets. In addition, the euromarkets are attractive to borrowers because of the wide
range of lenders and instruments available; that is, they provide greater depth and
liquidity, and facilitate funding diversification.
Euromarket transactions occur in a number of financial centres around the
world. A euromarket transaction is characterised by the currency and country in which
the debt is issued. A euromarket transaction is predominantly denominated in a
currency other than the currency of the country in which the debt is issued. The
euromarkets are categorised as the eurocurrency market, the euronote market and the
eurobond market.
The eurocurrency market involves intermediated finance, and includes shortterm bank advances, stand-by facilities and medium- to longer-term bank loans.
Short-term bank loans are fully-drawn advances similar to those available in a
domestic market, but they are denominated in a currency other than the currency of
the bank lender. The rate of interest attached to a facility is determined by reference to
an indicator rate such as LIBOR or SIBOR, and is typically reset every three or six
months, in line with changes in one of these rates. Usually the rate will be set at a
margin (a number of basis points) above the indicator rate. A short-term loan may
have a revolving credit arrangement attached. A stand-by facility is a contingency line
of credit that is established with a financial institution. A borrower will usually only
draw on a stand-by facility in time of tight liquidity. Longer-term bank loans are
typically syndicated loans because of the size of the debt issue, therefore a syndicate
of banks will all commit funds to the loan. As there is no formal secondary market in
individual term loans, quasi-securitisation innovations have developed that allow
certain sell-down provisions. These include novation, subparticipation, and
transferable loan certificates.
The euronote market incorporates the short- to medium-term direct debt
markets. At the shorter end of the maturity spectrum is the promissory note. As with
promissory notes issued within domestic markets, these securities are also discount
securities. However, there are two main types of promissory notes, or commercial
paper, issued in the euromarkets: the note issuance facility (NIF) and eurocommercial
paper (ECP). The distinguishing feature of an NIF is that it incorporates an
underwriting agreement, whereas ECP does not have such a feature. The price of an
NIF or ECP is calculated using the discount security formula from Chapter 9, but it is
important to note that the euromarkets adopt the 360-day year convention. Another
security issued into the euronote market is the medium-term note (MTN). The MTN is
an unsecured bearer security that pays a periodic interest coupon that may be fixed or
based on a variable indicator rate. The MTN facility is very flexible and may include a
range of maturities, currencies of denomination, and fixed and floating rate coupons.
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The MTN program is often periodically issued in tranches into a number of different
countries. The structure of each tranche can vary to meet the specific needs of the
issuer and investors.
The longer-term direct finance market is known as the eurobond market.
Straight bonds are fixed-interest bonds that pay a regular coupon for the life of the
bond, with the face value repaid at maturity. The maturity of the bond is typically
between three and twelve years, the most common currency of denomination is the
USD, and USD50 million is the minimum issue that would justify incurring the
establishment and servicing costs involved in the issue. Parties associated with a
eurobond issue include the lead manager, co-managers, the management group,
underwriters, paying agents, and market makers. The price of a straight bond is the
present value of its future cash flows. Eurobonds issued with adjustable coupons are
known as floating rate notes (FRNs); they become quite popular during periods of
relatively high and volatile interest rates. The FRN enables the periodic repricing of
the interest rate in order to reflect current market yields. Convertible eurobonds are
bonds that may be converted into equity or some other security of the issuer. A bond
may also be sold with a warrant that provides the holder with the right to purchase
other nominated securities at a specified price and date(s). The warrant may be
attached to the host bond, or it may be naked. Since the buyers of eurobonds tend to
be individuals rather than institutions, only the best-rated borrowers can expect to be
successful in this market.
The US capital markets are an important source of funds, particularly for
borrowers that do not have a credit rating high enough to gain access to the
euromarkets. While the US market is fairly tightly regulated, there are certain
exemptions that enable easier access. These include certain commercial paper issues,
private placements and Rule 144A placements. Generally the exemption provisions
only allow the sale and resale of exempt securities to qualified institutional investors.
Securities issued into the US debt markets are fundamentally the same as those issued
elsewhere. The three main types of securities issued are commercial paper (USCP),
medium-term notes and bonds. Another form of issue is the American depositary
receipt (ADR). A depositary receipt is a security issued by a US depositary bank and
is evidenced by a depositary share. A depositary share will represent one or more
ordinary shares issued by the foreign company on its home exchange. On the basis of
the underlying shares, the ADR is issued and traded in the US markets, and again
provides a further source of funding for foreign companies.
Finally, the chapter considered the role of the credit rating agency in the
growth of debt markets. A credit rating is an opinion of the creditworthiness of an
issuer of debt and other financial obligations into the capital markets. International
credit rating agencies include Standard and Poors and Moodys Investors Service. S
& Ps long-term credit ratings range from AAA to C, depending on the credit quality
of the issuer. A credit rating of BBB and above is regarded as investment grade. The
chapter discussed the credit rating process and methodology and recognised the credit
rating as a standard measure of credit risk that, in part, facilitates access to the capital
markets by borrowers, and the efficient allocation of savings by lenders.
Review questions suggested answers
The following suggested answers incorporate the main points that should be
recognised by a student. An instructor should advise students of the depth of analysis
and discussion that is required for a particular question. For example, an
undergraduate student may only be required to briefly introduce points, explain in

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their own words and provide an example. On the other hand, a post-graduate student
may be required to provide much greater depth of analysis and discussion.
1.
Briefly outline the factors that led to the development of the euromarkets.
Explain why the euromarkets continued to expand even after the original causes
for its development ceased.

the euromarkets incorporate both money markets and capital markets within the
major centres around the world
a euromarket transaction is a financial transaction carried out by a local borrower
in another country, but not in the currency of that country
includes the eurocurrency market, the euronote market and the eurobond market
the dominant currency is the USD, but euromarket transactions are carried out in
all major currencies
the initial boost to the supply of USD being held outside the USA was provided by
the USSR, which withdrew its USD deposits from US banks in the cold war
environment of the 1950s and 1960s
the USSR wanted to have its funds outside the jurisdiction of the US authorities
but wanted to keep foreign currency deposits in USD because USD were, and still
are, the major currency of international trade and investment flows
the relocation of USSR funds provided the seeding from which the market grew.
Its growth depended upon deposits continuing to be attracted into the market
the euromarkets grew, partly motivated by other market participants who also
began depositing their USD earnings outside the control of the US regulators
the growth of the euromarkets continued even after the abolition of most controls
on f/x flows into and out of the USA
interest rates offered on deposits are generally higher than interest rates offered on
similar term deposits in the USA, while interest rates charged on euromarket loans
are generally lower than the rates charged on similar term loans available through
sources in the country of the currency
growth in the euromarkets is fundamentally driven by interest rate factors
bank euromarket transaction costs tend to be lower per dollar of business
transacted than for domestic operations. For example, most loans are very large
and are made to borrowers with very strong credit ratings
since operating costs per dollar traded in the euromarket are lower than those in
their domestic operations, euromarket bankers can shave (narrow) the spread
between the deposit and lending rate, and still maintain a profit rate similar to that
attained by the domestic operations
by so doing, the euromarkets provide an ongoing incentive for funds to flow into
the market, while simultaneously ensuring a demand for the funds by borrowers

2.
Describe the features of short-term eurocurrency bank advances and
stand-by facilities. Explain why a company may seek funding through these two
avenues. What risks may be faced by a borrower in the eurocurrency markets?
Short-term eurocurrency bank advance:
a fully drawn advance provided by a bank to an overseas borrower in another
currency

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the term of the advance is set and the full amount is generally drawn-down on
approval
a commitment fee is charged to the borrower if the advance is not drawn shortly
after approval
the repayment of principal and interest normally takes place as a lump sum at the
end of the term of the loan, with no provisions for early repayment
the short-term advance can be extended to provide a revolving credit arrangement
the borrower can normally choose a mixture of currencies at each roll over
this allows the company to tailor the currency mix of the facility, and thus of its
repayment commitments, to match the expected currency inflows from its
business transactions. This minimises its exposure to foreign exchange
movements
the interest reference rate is usually the rate at which banks in the market offer
funds to each other, for example, LIBOR or SIBOR
borrowing in the eurocurrency markets may provide lower interest costs, enable
foreign exchange risk management, and provides funding diversification

Eurocurrency stand-by 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 liquidity funding
typically, stand-by facilities will be needed during periods of tight liquidity, and if
the facility is arranged with a local supplier of funds there is the risk that the
supplier will also be subject to liquidity constraints at the very time that the
borrower needs to draw against the facility
stand-by facilities are not intended by the lender to be used as a source of ongoing
finance. Drawings may be limited for a fixed term of, for example, a few months
through the period for which the facility has been arranged; alternatively, there
may be a requirement that the facility remain unused for a specified number of
months per year
the charges associated with the stand-by facility include both a commitment fee
and an interest charge on the funds that are drawn
since the facility will be drawn in periods of cash flow problems, the lender will
charge a higher risk premium than would be charged on a regular, fully drawn
advance
3.
Banks in the eurocurrency markets provide longer-term loans. Describe
the common features of such loans. Outline the techniques that have been
introduced by lenders in order to add to the liquidity of their longer-term loans.
What impact have these developments had, from the point of view of the
borrower?
Common features of a eurocurrency term loan include:
the minimum size of a term loan is likely to fall in the range of $3 million to $5
million
a single lender may be prepared to fund up to $50 million to $100 million
as the amount approaches $100 million, it is probable that a syndicate of banks
would be involved in the loan
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where a syndicate is arranged, the lead manager takes the primary responsibility
for arranging the transaction, structuring the facility, negotiating the price and
terms of the loan, and organising the participation of other banks
the lead bank may also underwrite the whole facility
where the facility is large, it is likely 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 merely as providers of funds to the borrower
an agent bank acts on behalf of the syndicate in the administration of the loan
the term of the facility is commonly between five and ten years
the interest rate is normally at a margin above LIBOR, with the interest period
usually nominated by the borrower
fees include establishment fee, participation fees, legal fees, annual commitment
fees, and fees payable to the agent bank for its administration of the loan
amortised, interest only and deferred repayment loans are all available

Liquidity and sell-down provisions:

1. Novation:
the original lender transfers all rights and obligations under the original loan
agreement to a third party
once the new party signs the novation, there is effectively a new loan agreement,
and the borrower now has a new relationship, but one that contains the provisions
of the original agreement
through the novation process, the original lender removes the loan from its books
2. Subparticipation:
allows the original lender to transfer to a third party its rights to receive interest
and principal repayments, in return for a payment by the third party
the original lender retains the loan on its books
the buyer of the loan from the original lender has no direct claim against the
borrower
the buyer is dependent upon the original lender for interest and principal receipts
3. Transferable loan certificates (TLC):
allow the lender to convert the loan into transferable certificates that have the
same term as the original loan
the certificates can then be sold to third parties who are then registered by the
agent bank as the new lender
with the endorsement and sale of the TLC by the original lender, the loan is no
longer carried by the original lender on its books
TLC ownership is registered with the agent bank
4.
The euronote market is a generic term that incorporates both note
issuance facilities (NIF) and eurocommercial paper (ECP). What features of
these facilities are the same, and in what ways do they differ from one another?

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

directly into the markets
NIF and ECP are both euronote instruments; they are promissory notes issued by a
borrower into overseas markets, in a currency other than the currency of the
country in which the paper is issued

Similarities between a NIF and ECP:

promissory notes commonly referred to as commercial paper
drawn (issued) by a borrower in its own name (one-name paper)
discount securities sold for less than the face value which is payable at maturity
issued with maturities ranging from 30 to 180 days
normally issued with a roll-over arrangement in place
parties involved in an issue include the arranger, the lead manager, co-managers,
the facility agent, the tender panel, and the issuing and paying agent
typically issued in amounts in excess of USD50 million
issued in most major currencies, although USD predominates
the value and the timing of an issue, and the amount of notes outstanding at any
one time, can be fine tuned to meet the issuers cash flow requirements, and the
conditions prevailing in the market
Differences between a NIF and ECP:
a NIF incorporates an underwriting arrangement; ECP does not
a NIF is converted into a firm medium-term funding commitment by the
participation of underwriting banks who are committed, up to the underwritten
amount, to purchase any unsold notes at the issue and roll over dates
only those borrowers that have an established a good reputation in the euronote
market, and have a very strong credit rating, are able to issue ECP successfully
5.
A most important aspect of the MTN facility is that the notes under the
facility are not homogeneous. Explain this statement. What steps have been
taken to prevent the non-homogeneous nature of the notes resulting in a
fragmented, poorly-developed secondary market in MTNs?

an MTN is an unsecured bearer security that pays a specified coupon

it is typically a non-homogenous security; that is, it may be issued with different
attributes, terms and conditions
a facility may include a range of note maturities, currencies of denomination, and
fixed and floating rate interest coupons
often issued in tranches; the issue is broken up into different batches
the notes can be issued in whatever quantities and in as many separate approaches
to the market as the issuer deems appropriate
the issuer, in conjunction with the MTN dealers, determines the amount of the
facility and the preferred maturities of the notes
once the terms and conditions are agreed, the dealers act as agents for the issuer in
seeking investors
the dealers promote the secondary market in the notes by quoting two-way prices;
that is, they create a liquid market by standing ready to buy and sell the notes

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MTNs may be issued on a periodic or continuous basis

In order to allay concerns that the flexibility of the MTN issue may lead to a
fragmented stock of notes and reduce liquidity in the secondary market, two other
distribution techniques are commonly attached to issues:
the tap approach - involves the division of the full facility into a number of
tranches, each with a specified minimum and maximum dollar amount and with
notes within the tranche having identical maturity and coupons. A new tranche,
comprised of notes of a different coupon and maturity, may not be offered to the
market until the minimum amount of the first tranche has been sold
the serial offering technique - under which the maturity and coupon characteristics
of the notes are determined at the time of the establishment of the facility. The
facility may have a number of series of notes, the characteristics of the notes being
different between the series. Though there is not the minimum/maximum
constraint of the tap tranche system, the establishment of the series also limits the
diversity of the notes issued, and facilitates a reasonably deep secondary market
6.
What characteristics of a bond enable it to be labelled as a eurobond, as
opposed to a domestic bond or a foreign bond? Define and provide examples of
each of these types of bonds.

a bond is a long-term debt security issued directly into the capital markets and
paying a defined interest coupon. The coupon may be based on a fixed or variable
interest rate. The face value is repayable at maturity
bond markets comprise three broad market groupings: domestic bonds, foreign
bonds and eurobonds
domestic bonds - these are bonds issued in a specific country, by a borrower from
that country, and denominated in the currency of that country
for example, an Australian company issues a bond into the local Australian bond
market that is denominated in AUD
foreign bonds - these are bonds issued by a borrower in a country other than the
borrowers own country, and denominated in the currency of the country in which
the bond is issued. Foreign bond issues, and their secondary market trading, are
conducted under the supervision and regulation of the authorities of the country in
which the bond is issued
for example, a USD issue by an Australian corporation, placed in the domestic
USA market, would be identified as a foreign bond issue
foreign bonds often have quite colourful names. Bonds placed in the USA are
known as Yankee bonds and those issued in Japan are known as Samurai bonds
eurobonds - these are bonds, generally underwritten by a multinational syndicate
of banks, and placed in countries other than the country of the currency in which
the issue is denominated. These bonds are not marketed on a single, specific,
national bond market. Therefore, they are not subject to the listing or trading
requirements imposed by national authorities
for example, an Australian corporation issuing USD denominated bonds in an
overseas location other than the USA
a straight eurobond pays a fixed coupon rate; a floating rate note pays a variable
coupon

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7.
As an account manager with an investment bank, you have been
approached by one of your corporate clients to advise on issuing bonds into the
eurobond market. Briefly outline to your client the processes and parties
involved in the issue of a eurobond.
Parties to a eurobond issue:
a eurobond issue is organised by an international bank called a lead manager
the lead manager arranges the issue; discusses the issue and its syndication with
the issuer; determines the appropriate institutions to include in various roles within
the facility, and invites their participation; and prepares the facility documentation
the lead manager invites between five and 30 banks to act as co-managers;
together they 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
usually 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 may vary from 30 to 300, and usually comprise
international banks from all regions of the world. Together with the management
group, the underwriters guarantee final placement of the bonds at a set price
the selling group is responsible for selling the bonds to the public. It consists of
managers, underwriters, and additional banks that have a good selling base. A
particular participant may, at the one time, be manager, underwriter and seller
a separate fee is paid to compensate the participants for the particular services that
they provide. Total fees payable may range from about 1.5% to 2.5% of the issue
price. The members of the selling group may pass some of their fee along to the
final buyer of the bond
eurobond underwriters are not obliged to maintain the bond's market price at or
above the issue price until the syndicate is disbanded. This means that the bonds
may be placed at a price below the issue price
Eurobond issue process:
the lead manager and the borrower discuss the terms of the bond. The terms to be
determined include the amount, the maturity, whether it is to be a fixed rate or
floating rate offering, the coupon if it is fixed rate, whether or not to include
options, and the currency of denomination
the terms of the bond often remain provisional until the official offering day
during the intervening period, the lead manager arranges the management group
and prepares various documents, including a preliminary prospectus, at this stage
sometimes called a red herring
on the announcement day, the managers send electronic messages describing the
proposed bond issue and inviting banks to join the underwriting and selling groups
a week or two later, the final terms of the bond are set, and the syndicate commits
itself to the borrower
a final prospectus is printed and the bonds are publicly offered on the offering day
at the end of a public placement period (normally not more than two weeks), the
subscription is closed, and the bonds are delivered in exchange for cash paid to the
borrower

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often the clearing-houses of CEDEL or Euroclear are used in the settlement

process
the completion of a successful issue is marked by the publication of an
advertisement in the international financial press. Since the advertisement marks
the end of the issue, it is referred to as a tombstone
after closing day, public secondary market trading in the bonds begins. However,
trading actually takes place well before the closing day - a grey market

8.
A highly rated financial institution has decided to issue paper into both
the euronote market and the eurobond market. The bank makes the following
issues:
ECPs maturing in ninety days with a face value of USD200 million and
yielding LIBOR plus 15 basis points
straight bonds with a face value of USD300 million, paying an annual fixed
coupon of 6.3% per annum, and maturing in exactly seven years. Current
market yields for similar bonds is 5.9% per annum.
What is the total amount of funds raised with each issue?
(Note: you should look in the financial press to ascertain LIBOR. However,
assume for this question that LIBOR is currently 5.87% per annum.)
Price of ECP issue:
Price

360

face value 360

yield

days to maturity
100

USD200000 000 360

360 0.0602 90
72000000000

365.418
$197034628.63

Price

as the ECP is a discount security, the issuer will receive less than the face value

Price of eurobond issue:

1 - 1 i n
n
k
P C
A1 i 1 i
i

Note: because the bond has exactly seven years to maturity the (1 + i)k is not
applied in the formula

1 - 1 0.059 7
7
P 18900000
3000000001 0.059
0.059

$105883047.03 $200839686.12
$306722733.15

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Note: because the bond is paying a fixed coupon that is higher than the current
market yield, the company raises more than the $300 million face value

9.
Describe the features of convertible bonds and warrants. What factors
affect the attractiveness of these instruments, from the point of view of lenders?
Convertible bonds:
contain an option for the holder to convert the bond and receive the redemption
proceeds in another form
equity-related convertible debt gives the holder the option to convert the bond into
equity of the issuer
alternatively, the conversion option may provide the option to convert the original
bond into other debt instruments of the issuer
Warrants:
a warrant may be issued with a bond - referred to as the host bond
the warrant can be detached and exercised or traded separately from the bond
alternatively, the warrant may be issued independently of a bond. Such warrants
are referred to as naked warrants
a warrant is essentially a company call option that provides the holder with the
right to purchase other specified securities at a specified price on a specified date,
or within a specified period
the other specified security may be equity other debt securities
Attractiveness to lenders:
investors may view a convertible debt issue more favourably than a straight equity
issue
the debt may be denominated in the currencies of the investor, thus alleviating it
of FX risk
by having the option to convert to equity, the investor can avoid the down-side
share price risk associated with a straight equity purchase. The investor thus
acquires an instrument that provides it with the option to benefit from favourable
movements in the exchange rate and in the price of the underlying equity, without
having to face the down-side risk from other sources
the equity conversion factor may prompt investors to provide longer-term funds,
and a larger quantity, than they may with the issue of straight bonds. Under either
issue the investor faces greater interest rate risk the longer the term, but with an
equity link, the investor stands a chance of making a profit from the equity option
if the option is exercised, the borrower is relieved of the FX risk that would be
encountered in redeeming the bond
investors in convertibles are often able to participate in rights issues as if they
were owners of the underlying share
10.
Subject to certain requirements, a foreign borrower is able to place USCP
(where there is no public offering) with qualified institutional investors without
SEC registration. Discuss the procedures and documentation that would be
required in this situation.

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US commercial paper (USCP) a promissory note, being a discount security,

issued in the US money markets
placements of USCP with qualified institutional investors, where there is no public
offering, to not require official SEC registration

Exempt private placement documentation and procedures include:

offering memorandum - contains a description of the USCP, statement of use,
information on issuer, summary financial statements, and supporting credit
enhancements. Dealers must supply an offering memorandum to each purchaser
offeree and purchaser limitations - offer and sales may only be made to qualified
institutional investors
manner of offering - private placements cannot include an offer to the general
public, or any advertising.
dealer agreement - the dealers must provide certain basic representations and
warranties, generally under a standard agreement form. The dealer will be
indemnified against misstatement, omission, or breach of representations and
covenants by the issuer
issuing and paying agent agreement - a standard agreement provided by the
issuing and paying agent, relating to the issuance, transfer, payment and
cancellation of the USCP
denominations - an aggregate sale of USCP to an investor generally must not be
less than USD150 000.
resale restrictions - USCP purchased for investment purposes can be resold only to
accredited investors, unless the paper is registered with the SEC. This restriction
also applies to the commercial paper dealers
fiduciary purchasers - third party purchasers must also be accredited investors
legal opinions - required on the legal structure and compliance issues
11.
One type of bond issued in the US debt markets is a Yankee bond. Define
a Yankee bond, and explain how an issuer might issue these bonds through a
shelf registration. Also, explain what occurs if the issue is being made by book
entry.

a Yankee bond is a foreign bond; that is, it is a debt security issued into the USA
capital markets by a foreign issuer, with the paper denominated in USD
a straight bond is a fixed interest security, paying equal periodic interest coupons
for the term of the bond, and repaying the face value at maturity. However, a
Yankee bond may also be issued with a floating rate of interest, based on an
indicator rate. It may have debt or equity warrants attached. Interest payments
may be half-yearly or annual
interest calculations are based on a 360-day year
a Yankee bond issue would be expected to obtain a credit rating from a credit
rating agency such as Standard & Poor's, or Moody's Investors Service
the depth of the USA market has encouraged two tiers of bond issues: bonds with
an investment-grade credit rating of BBB and above, and a junk bond market with
issues rated at less than BBB

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Shelf registration:
Yankee bonds require registration with the SEC
Rule 415 permits an eligible foreign issuer to register Yankee bonds under the
Securities Act 1933 for sale in tranches, from time to time, on a delayed basis
the issue is restricted to the amount of bonds expected to be sold within a two-year
period
this form of issue is known as a shelf registration
shelf registration documentation requires the prospectus, indenture or charter
provisions, distribution and underwriting agreements, and the form of the bond
issue
as the bonds are issued in tranches, each time a tranche is issued, a pricing
information supplement is inserted into the basic documentation and delivered to
the purchaser, and a copy is registered with the SEC
an issuer must submit to the SEC copies of its audited financial statements for the
fiscal year, and its semi-annual unaudited statements, within four months of the
end of the period
Book entry:
a further efficiency refinement to the US capital markets was the introduction of
book-entry USCP
book entry involves the electronic recording of new issues and payments
this reduces the cost of printing physical paper securities and of ensuring adequate
security for the paper
12.
Two basic types of bonds may be issued into both the euromarkets and the
US capital markets. They are straight bonds and floating rate notes. Explain the
basic features of a bond, and differentiate between a straight bond and a floating
rate note.

a bond is a long-term debt security issued directly into the capital markets, and
paying a specified interest coupon. The face value of the bond is repaid to the
holder at maturity
a straight bond is a fixed interest coupon security; that is, it pays a fixed coupon
for the life of the bond
a floating rate note is a bond that pays a variable coupon rate. The coupon rate will
vary at each coupon date, based on movements in a specified reference rate, such
as LIBOR
the price of a bond has an inverse relationship with interest rates; that is, as current
market interest rates rise then price of a bond will fall, and vice versa
with a floating rate note, it is necessary to take account of the price reset dates

13.
Explain the existence and operation of the American depository receipt
market. Demonstrate in your answer how a foreign company might raise funds
in the US capital markets through an ADR issue.

American depository receipts are primarily a form of equity issuance, although

debt issue ADR programs are possible

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a depository receipt is a security issued by a US depository bank and is evidenced

by a depository share
a depository share will represent one or more shares of a foreign issuer which are
listed on the foreign companys local stock exchange
typically, a depository 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 US
investors are accustomed
an ADR program provides the opportunity for a foreign company, which
otherwise may not have been able to meet SEC listing requirements, to access the
US capital market to raise funds
given the size of the US capital markets, the ADR has become an important source
of funding for foreign companies
a depository bank acts as administrator, depository, transfer agent, and registrar for
the program. The bank will assist with program structure and compliance issues,
issue depository receipts, maintain records of registered holders, process transfers,
process dividend payments and facilitate an orderly market
the ADR market is deep and liquid. An ADR is attractive to US investors because
the issue is quoted in USD, and associated cash flows (dividends or interest
payments) are denominated in USD and therefore are protected for foreign
exchange risk. The issue is supported by the underlying shares of the issuer, and is
subject to US legal jurisdiction

An ADR program may take one of a number of forms:

Level 1. Shares of the issuer company, listed on its home exchange, are deposited
with a custodian bank in that country. ADR securities are issued and traded in the
US over-the-counter market. These ADRs are not listed on US exchanges and are
not registered for public offering. The same disclosure requirements apply as for
the home country.
Level 2. Shares of the issuer company, listed on its home exchange, are deposited
with a custodian bank in that country. These ADRs are listed on one or more US
exchanges, such as the New York Stock Exchange, AMEX, or NASDAQ, but are
not sold as a public offering. There are extensive SEC disclosure requirements.
Level 3. Offer of new shares of the issuer company, issued on its home exchange,
are deposited with a custodian bank in that country. These ADRs are listed on one
or more US exchanges and are sold as a registered public offering; that is, the
ADR issue is registered with the SEC for public offer to US investors, and must
meet extensive disclosure requirements.
144A/Reg S---Private Placement Offering. An ADR facility may be established for
the private placement of new shares of the issuer in accordance with Rule 144A of
the Securities Act 1933. The issue is restricted to qualified institutional buyers
(QIB). Disclosure is subject only to QIB requirements, and the issue is not
registered with the SEC. This form of ADR program is often used by first-time
ADR issuers as a stepping stone to a later public offer.
14.
Explain the purpose of a credit rating on a corporate debt issue. In your
answer, discuss the importance of a credit rating on an international capital
markets debt issue, from the perspective of both a borrower and an investor.

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a credit rating is the opinion of a credit rating agency 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 quality between debt issuers
there are a number of major international credit rating agencies, including
Standard and Poor's, and Moody's Investors Service
the objective is to provide a standard measure of credit risk
a rating agency issues both long-term and short-term credit ratings
S & Ps long-term ratings range from AAA, reflecting the strongest credit quality,
to D, the lowest. Ratings from AA to CCC may be modified by the addition of a
plus or minus sign to show relative standing within the major rating categories
debt issues with a rating of BBB and above are regarded as investment grade
short-term credit ratings range from A-1 to D, and also may include a plus or
minus sign
S & P adds the symbol 'r' 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. A credit rating of BBB has the same meaning no matter which
capital market it is issued. This assists with the pricing of investment
opportunities, particularly in the international markets, where the investor may not
have full knowledge of the operations of a corporation
the importance to the issuer/borrower is that the credit rating is internationally
accepted, therefore investors are more likely to buy securities that have a credit
rating attached. There is a direct relationship between risk and return: the higher
the credit rating, the lower the yield the borrower needs to offer on the issue

15.
Mega Corporation proposes to raise additional debt finance to fund its
growing business operations. The company requests S & P to provide a credit
rating on the issue. Describe the structured credit rating process used by the
credit rating agency, including in your answer important issues that would be
incorporated in the credit risk analysis.
The structured rating process involves:
preparation of financial statements, analysts' reports, and other relevant
information
issuer meetings, where management must address:
- the industry environment and prospects
- an overview of major business segments, including operating statistics and
comparisons with competitors and industry norms
- management's financial policies and performance goals
- distinctive accounting practices
- capital spending plans
- financing alternatives and contingency plans
the S & P rating committee conducts an analysis and synthesis of information and
company financial statements and
determines the credit rating
communicates credit rating to issuer
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appeal process (if necessary) - only if there is significant new information

disseminates the credit rating
conducts ongoing surveillance during the term of the issue

The rating methodology develops a profile that incorporates a balance between

business risk and financial risk. Business risk analysis includes:
issuer position in the industry
marketing
cost efficiency
technological expertise
management evaluation
cyclical characteristics
barriers to entry or exit
competition
Financial risk analysis includes:
financial policy
profitability
capital structure of assets, debt, and equity
cash flow projections and ratios
financial flexibility
off-balance-sheet financing
asset and liability diversification, mix and liquidity
Additional matters considered in an international rating analysis include:
market environment - economy, regulation, competition
information - extent of data, quality, timeliness, accounting standards,
comparability, and transparency
country risk - economic, business and social environment
sovereign risk - direct or indirect political interventions which affect the ability of
an issuer to meet offshore obligations. Also includes politically related events such
as strikes, riots, war and corruption

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