What it means
The defining features of a foreign bond are the location of the investors and the currency. The issuer is foreign to the market it is selling into, but the bond itself is a local instrument governed by local rules and paid in local currency, which is what makes it attractive to domestic buyers.
Issuers use foreign bonds for three main reasons. The target market may be deeper and cheaper than the issuer's home market, the issuer may want to diversify its investor base so it is not dependent on one set of buyers, and it may already earn revenue in that currency, in which case the debt provides a natural hedge.
The cost of entry is regulatory. A foreign bond must satisfy the host market's registration, disclosure and accounting requirements, which can mean restating financial statements, obtaining local ratings and paying higher legal and underwriting fees than a domestic issue would carry.
For investors the appeal is simple. They buy a bond in their own currency, so there is no direct exchange rate exposure, while gaining access to credits and geographies that their domestic market does not otherwise offer.
What they take on instead is the credit risk and the country risk of a foreign issuer. The main risk sits with the issuer rather than the investor.
If a company issues in dollars but earns in another currency, a fall in its home currency makes every coupon and the final principal repayment more expensive, which is why most issuers pair a foreign bond with a cross-currency swap.
In practice
Real-world examples.
Example
A Brazilian electricity utility issues a Yankee bond because the domestic corporate bond market cannot absorb a ten-year deal of the size it needs. It swaps the dollar proceeds back into local currency so that its debt service matches its regulated tariff income.
Example
A United States insurance group buys Samurai bonds issued by European banks into the Japanese market. The insurer is chasing yield and issuer diversification, and it hedges the yen exposure separately rather than avoiding the bonds altogether.
Example
A Canadian mining company issues a Bulldog bond in sterling ahead of acquiring a British processing business. Because the acquisition target's cash flows are in sterling, the sterling debt gives the group a natural hedge with no swap required.
Formula
Calculation
Effective annual cost of a foreign bond = (annual coupon + annual amortised issue costs) / net proceeds.
Worked example. A United Kingdom infrastructure group issues a $200,000,000 Yankee bond with a 5.5% coupon and a 10-year maturity. The annual coupon is $200,000,000 x 0.055 = $11,000,000. Issue costs, covering underwriting, legal work and registration, come to 1.25% of the face amount, which is $200,000,000 x 0.0125 = $2,500,000, so net proceeds are $200,000,000 - $2,500,000 = $197,500,000. Spread evenly over the 10-year life, the issue costs add $2,500,000 / 10 = $250,000 a year. The effective annual cost is therefore ($11,000,000 + $250,000) / $197,500,000 = $11,250,000 / $197,500,000 = 5.70%. The headline coupon of 5.50% understates the true cost by about 0.20 percentage points.Case study
Seen in the real world.
Talvern Rail Group is a fictional rolling stock operator invented to illustrate how foreign bonds are used. It was based in a small European market where the domestic bond market could comfortably absorb an issue of about $80,000,000, but its fleet renewal programme required roughly $250,000,000 of long-dated funding.
Talvern chose to issue into the United States market instead. The registration process took five months and added around $2,000,000 of costs against a domestic issue, but the order book was three times covered and the group secured a 12-year maturity that no domestic buyer would have offered. Because its revenue was in euros, it entered a cross-currency swap on day one to convert the dollar obligation back into euros at a fixed rate.
The illustrative point is that the foreign bond solved a capacity and maturity problem rather than a pricing problem. The coupon itself was broadly similar to what a domestic issue would have cost, but the size and tenor were only available abroad.
Watch out
Common mistakes.
- Using the terms foreign bond and eurobond interchangeably, when a foreign bond is sold inside a domestic market under local rules and a eurobond is sold outside the currency's home jurisdiction.
- Comparing the coupon on a foreign issue directly with a domestic coupon while ignoring registration, legal and underwriting costs that raise the effective rate.
- Issuing in a currency the business does not earn and leaving the exposure unhedged, which converts a funding decision into a currency bet.
Questions
People also ask.
Why would a company borrow abroad at all?
Usually because the foreign market offers greater capacity, longer maturities or a wider investor base than its home market can provide, and sometimes because it earns revenue in that currency.
Does a domestic investor face exchange rate risk on a foreign bond?
Not directly, because the bond pays in the investor's own currency, although a severe currency move can still affect the issuer's ability to pay.
How do issuers manage the currency mismatch?
Most pair the bond with a cross-currency swap that converts the coupon and principal obligations back into the currency of their revenue at a rate fixed at issue.
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