4 & 5 - International Debt & Trade Flashcards
3 types of debt include - Domestic bonds - Which two types of international bonds
Foreign bonds: issued in a domestic market by a foreign borrower, denominated in the domestic currency, marketed to domestic residents and regulated by domestic authorities Eurobonds: denominated in one or more currencies and traded in markets outside the borders of the countries issuing the currencies. Largely untaxed, unregulated or subjected to different regulations than domestic issuances
What are some types of debt instruments:
• Straight fixed-rate bond • Euro-medium-termnotes(Euro-MTNs) • Floating-rate notes (FRNs) • Equity-relatedbonds – convertible bond – bonds with equity warrants • Dual-currencybonds
How does the ‘expectation hypothesis’ affect the choice between floating rates and fixed rates?
The hypothesis states that long-term rate is determined purely by current and future expected short-term rates, in such a way that the expected final value of wealth from investing in a sequence of short-term bonds equals the final value of wealth from investing in long-term bonds. This hypothesis assumes that the various maturities are perfect substitutes and suggests that the shape of the yield curve depends on market participants’ expectations of future interest rates
where: 𝑖𝑡 is the long-term rate, 𝑖𝑛 is the current 𝑛-year short- term rate and 𝐸(𝑖𝑡−𝑛,𝑛) is the expected future (𝑡 − 𝑛) year short-term rate, 𝑛 years from now
Moody’s, Standard & Poor’s and Fitch provide credit ratings on domestic and international bonds
They classify bond issues into categories (investment, speculative and junk) based on what?
the creditworthiness of theborrower which reflects the firm’s:
– financial structure
– Profitability
– stability of cash flows, and
– long-term growth prospects
The highest rating that a bond can have is affected by what factor?
due to rating agencies’ ‘sovereign ceiling’ policies that require firms’ ratings to remain at or below the sovereign rating of their country of domicile.
Moody’s, S&P, and Fitch rating vereign bond issues based ona variety of factors including the country’s institutions,economy, external environment, monetary and fiscal status.
The following effects are experienced when a sovereign credit rating is downgraded.
Government bond yields rise – higher costs of borrowing for the government;
Higher taxes or reduced spending to deal with increased budget deficits;
Higher risk of government bonds induces capital flight, causing currency depreciation;
Corporate and SOEs financing costs increase worsening their balance sheets, lowering aggregate investments;
Economic growth declines.
What are the costs and benefits of international bond issues?
BENEFIT: Markets “reward” countries with positive macroeconomic balances with lower yields E.g. Gabon and Senegal (fiscal and current account surpluses; strong economic growth)
COSTS:
– Compared to borrowing domestically: international debt cheaper partly dues to lower interest rates abroad; partly due to underdeveloped bond markets in Africa)
– Compared to concessional loans? Commercial debt is more expensive and has lower maturities
– Interest and principal repayments are made in the foreign currency: challenge for volatile African currencies
What are bond issues normally used for by sovereigns?
o Financing of infrastructure development
o Refinancing of public debt (e.g. Rwanda, Gabon, Ghana, Kenya)
o Debt restructuring and rescheduling (Cote d’Ivoire, Gabon, Seychelles have used Eurobonds to collate commercial debt, reducing interest obligation and making repayment more straightforward)
o No conditionality by lenders: government have put loans to uses other than those spelled out in prospectuses
o To provide a benchmark for pricing of loans for domestic firms and banks borrowing abroad
A common policy prescription is for African countries to reduce reliance on external debt by developing domestic bond markets.
Why aren’t there more African domestic/local bond markets?
Many lack the size, length of yield curve, liquidity or currency stability to satisfy investors;
Access to others remains restricted or closed for foreign investors, especially in the CFA franc zone
A Credit Default Swap (CDS) is a form of insurance. It is a credit derivative that protects the holder of a loan (the lender) against the loss of the principle on a bond in the event of the default of the issuer (the borrower).
How is this relevant to sovereign default risk?
A sovereign CDS (SCDS) allows the investor to buy protection against the event that a sovereign defaults on or restructures its debt.
- The SCDS spread is a measure of the default risk of the sovereign and thus provides an alternative measure to the sovereign credit spread or credit rating from an agency.
- Main uses:
– Hedging: protection against a sovereign defaulting on their loan.
– Speculating: speculating that the sovereign may default on debt repayments, achieved by taking an uncovered position in an SCDS.
It has been found that SCDS spreads reflect the same economic fundamentals and market conditions as the underlying bonds (IMF, 2013), and may react more more rapidly to new information compared to bond spreads.
What’s the African Eurobond crisis?
Africa’s eurobond debt passed the $100-billion milestone in 2019
Brookings Institute and others find Brookings does find “unsettling”: the rapid rate of increase in debt, rising debt servicing costs and the nature of the debt structure relative to the “highly indebted nations” years.
Debt-service costs and repayment risks are the bigger looming issues.
Future: If the global economy is bad shape in mid-2020s, it won’t be easy to roll over debt.
Eurobonds: Do African countries pay more to borrow?
Olabisi & Stein (2015) find that African economies pay higher-than- normal coupon rates on these markets (c. 2.9%); observed risk measures like agency ratings and debt to GDP ratios do not explain the deviation from the norm.
Countries in better financial standing tend to self-select into the private markets, such that their risk profiles cannot explain the high coupon rates.
Export Credit Agencies (ECAs) act as an intermediary between national governments and exporters to issue export financing. What kind of financial products do they supply?
–Trade finance; provided directly as a loan; indirectly as insurance or guarantee on a commercial loan.
–SME finance
–Exportinsurance: mostly in developed countries; cover both commercial and political risks.
–Medium and long-term financing: typically involve capital goods exports or projects.
