Lecture 12 International stocks and bonds Flashcards
American Depository Receipts (ADRs)
ADRs are negotiable securities that represent ownership claims on foreign shares trading in the United States.
They allow U.S. residents to own foreign stocks without engaging in cross-border transactions.
ADRs are issued by U.S. depository banks against foreign shares they have purchased.
ADRs are priced in U.S. dollars and pay dividends in U.S. dollars.
Closed end country funds
Closed-end funds are investment companies whose shares trade on stock exchanges or over-the-counter.
Closed-end funds raise a fixed amount of capital by issuing shares through an IPO. They are then traded like individual stocks on exchanges, usually through brokers.
Many closed end funds are country funds that invest in stocks or bonds of a specific country (such as the India Fund or the Swiss Helvetia Fund).
Closed-end country funds are usually actively managed.
They can trade at a premium or a discount to net asset value — the market value of the securities in the fund’s holdings.
What are Open end mutual funds?
Open-end funds are mutual funds that have no restrictions on the amount of shares the fund will issue. The fund will continue to issue shares to meet demand.
Open-end funds also buy back fund shares if investors wish to sell or redeem them.
If, however, the fund’s managers determine that the fund has become too large and unwieldy to meet its investment objectives they may close the fund to new investors.
Open-end funds can be purchased through brokers, but typically are bought directly from the sponsoring investment companies. Vanguard, Fidelity, and T.Rowe Price all offer emerging market open-end funds.
Because open-end funds stand ready to buy and sell shares to meet demand they typically do not sell at a premium or discount to net asset value.
What are ETFs?
Exchange-traded funds
ETFs are securities that track an index, commodity, bonds, or basket of stocks.
Many ETFs buy a basket of stocks representative of a index of a country’s stocks (such as the iShares MSCI Japan Fund).
ETF country funds are usually not actively managed.
ETFs can be created or redeemed by their issuers, and arbitraged against their underlying assets. As a result, they do not trade at a large premium or discount to their net asset value.
How do you expand an ETF?
When an ETF issuer (such as iShares, which is owned by BlackRock) wants to create new units of an ETF it contacts an authorized participant (AP), a major financial institution that makes a market in the ETF.
The AP buys the underlying assets and gives them to the ETF issuer and receives shares in the ETF. The reverse is done redemptions.
What is ETF arbitrage?
Arbitrage also ensures that ETF prices will equal the prices of the underlying assets.
If demand for the ETF is high and it trades at a premium to the underlying assets APs or individuals can profit by buying the underlying assets and selling short the ETF.
If the ETF is trading at a discount the reverse can occur: the market participant can sell short the underlying assets and buy the ETF until the price discrepancy disappears (usually very quickly).
What are sovereign bonds
Sovereign bonds are government bonds issued in a foreign currency.
— Strictly speaking, “sovereign” means the chief of state of a monarchy, though today most issuers of sovereign bonds are not monarchies.
Developing countries often issue sovereign bonds in US dollars, yen, or euros. Developed countries sometimes do, too.
What are Yankee bonds?
Yankee bonds are U.S. dollar-denominated sovereign or corporate bonds that generally trade on corporate bond desks in New York. They are usually issued by borrowers with investment-grade credit ratings.
What are Eurobonds?
Eurobonds are foreign currency denominated straight sovereign and corporate bonds that trade mostly in Europe.
What are Global bonds?
Global bonds are foreign-currency sovereign bonds issued simultaneously in local markets, Europe, and the United States. They have become the most common form of sovereign emerging market debt.
What are Brady bonds?
The first Brady bonds were issued in March 1989.
Brady bonds are a form of government bonds that were issued by emerging countries, particularly those in Latin America, as a means to restructure their commercial bank debt. They are named after former U.S. Treasury Secretary Nicholas Brady, who proposed the Brady Plan in 1989.
Under the Brady plan banks could exchange their nonperforming developing-country loans for tradable USD-denominated bonds partially collateralized by U.S Treasuries.
The bonds, which were sovereign obligations of the issuing countries, were a success, but carried a stigma.
In 2003 Mexico retired its Brady bonds, followed by the Philippines, Colombia, Brazil, and Venezuela. Some Brady bonds issued by smaller countries remain outstanding.
What are sovereign spreads?
Sovereign bonds typically trade at a spread over the yields on government bonds in the currency in which the sovereign bond was issued.
— In February 2018 the United States of Mexico issued a global bond in USD maturing in 2028 with a 4.15% coupon.
On February 28, 2018 it was trading at a yield of 3.94%, which is a 107 basis point spread over the 2.87% yield on 10-year U.S. Treasuries.
Credit default swaps (which can be used to insure against or take on exposure to sovereign risk) also trade at a spread to the benchmark bonds of the government of the currency of denomination.
The main difference between the yields on a country’s sovereign bond and its government bonds issued in local currency is:
(1) Expected exchange rate changes; and
(2) A currency risk premium that compensates the investor for the risk that the exchange rate could depreciate by even more than expected.
What goes into sovereign yield?
The yield on a foreign-currency sovereign bond, YSov, can be decomposed into three components:
YSov = Rf + Iliquidity premium + Country risk premium
Where: Rf is the risk-free rate; if the sovereign bond is a 10-year USD-denominated obligation the risk-free rate would be the yield on a 10-year U.S. Treasury bond.
Liquidity premium is compensation investors require for holding an asset that may be costly or difficult to trade promptly.
Country risk premium is the compensation investors require for bearing the risk of an interruption of debt service, including default, a shortage of foreign exchange, or debt repudiation. This is sometimes split into a default risk premium and a currency crisis premium.
