What it means
A bond is a loan that an investor makes to a company or government in return for regular interest payments and the repayment of the face value at maturity. Most bonds are sold in the currency of the country where they are issued.
A dragon bond breaks that pattern by being sold in an Asian market but priced in a foreign currency, typically the US dollar. Issuers choose dragon bonds for several reasons.
They can reach a new pool of investors, diversify their funding sources and sometimes borrow at a lower cost than at home. A multinational company with dollar revenues may prefer a dollar bond so that its debt and income are in the same currency.
For investors in Asia, the bonds offer exposure to international borrowers and, in many cases, access to dollar-denominated assets without going through Western markets. Banks, insurers and fund managers in the region are among the main buyers.
The bonds usually trade in the over-the-counter market, which means directly between dealers and investors rather than on an exchange. The structure is part of a family of regional bond names.
A bond sold in the United States by a foreign borrower in dollars is called a Yankee bond, one sold in Japan in yen by a foreign issuer is a Samurai bond, and one sold in the United Kingdom in pounds is a bulldog bond. Dragon bonds fit the same pattern for the wider Asian region.
Pricing depends on the issuer's credit rating, the currency and the demand from local investors. A well-known issuer with a strong rating can borrow at a spread, meaning a margin above a benchmark rate, that is only slightly higher than government borrowing costs.
A weaker issuer must pay a wider spread to compensate investors for the extra risk. Risks include currency risk for issuers who earn money in another currency, interest rate risk for investors, and credit risk if the issuer defaults.
Liquidity can be limited for smaller issues, so investors may find it difficult to sell before maturity. Rules on issuing and listing differ by market, and both issuers and investors need legal advice on local requirements.
In practice
Real-world examples.
Example
A manufacturer from Southeast Asia wants to fund a new plant. It issues a $200,000,000 bond to investors in Hong Kong and Singapore, priced in US dollars. The company earns dollars from exports, so the debt matches its income.
Example
An insurance company in Taiwan buys a dragon bond issued by a European bank. The bond pays dollars and gives the insurer exposure to a borrower outside its home market. The investment team checks the credit rating, the maturity date and the yield before buying, and it limits the holding to 5% of the portfolio.
Example
A development agency raises $50,000,000 in an Asian financial centre to fund infrastructure loans. It chooses a dragon bond because local investors are keen on high-quality names. The issue is oversubscribed, which lets it reduce the coupon.
Formula
Calculation
Annual interest = Face value x Coupon rate
Worked example: a company issues a dragon bond with a face value of $100,000,000 and a coupon rate of 5%, paid once a year.
Step 1: Annual interest = $100,000,000 x 0.05 = $5,000,000
Step 2: Over a five-year life, total interest = $5,000,000 x 5 = $25,000,000
Step 3: At maturity, the company repays the $100,000,000 face value
The total cash paid to investors is $125,000,000, made up of $25,000,000 in interest and $100,000,000 in principal.Case study
Seen in the real world.
Jade Harbour Shipping is an illustrative, fictional company based outside Asia that earns most of its revenue in US dollars from Asian ports. The finance director wanted to raise $80,000,000 to buy two vessels.
She compared a domestic bond issue with a dragon bond sold in Hong Kong and Singapore. The dragon bond attracted insurers and fund managers in Asia who knew the shipping sector well, and it priced at a coupon of 6.0% versus 6.5% in the home market.
The saving of 0.5% on $80,000,000 came to $400,000 a year, or $2,000,000 over a five-year life. The illustrative lesson is that broadening the investor base can reduce funding costs, though the company also had to meet extra disclosure and legal costs.
Watch out
Common mistakes.
- Assuming a dragon bond is denominated in Asian currencies, when it is usually issued in US dollars or another foreign currency.
- Confusing it with Samurai bonds, when Samurai bonds are specifically issued in Japan in yen.
- Ignoring currency and liquidity risks, when these can affect both issuers and investors.
Questions
People also ask.
Where are dragon bonds sold?
They are sold in Asian financial centres outside Japan, such as Hong Kong, Singapore and Taipei.
What currency do they use?
They are usually denominated in US dollars, although other major currencies are possible.
Why do companies issue them?
Issuers want to diversify their investors, match currencies with revenue and sometimes lower borrowing costs.
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