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FNCE 3020 Financial Markets and Institutions
 

FNCE 3020 Financial Markets and Institutions

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    FNCE 3020 Financial Markets and Institutions FNCE 3020 Financial Markets and Institutions Presentation Transcript

    • FNCE 3020 Financial Markets and Institutions Lecture 9 The Capital Markets: An Overview of The Bond Markets
    • Capital Markets: Overview
      • Capital Markets Defined: Financial markets involving financial assets with maturities of greater than one year.
      • Best known capital market securities include:
        • Stocks and bonds
        • Mortgages
      • Primary issuers of these securities:
        • Federal government and local governments
        • Corporations (U.S. and foreign)
        • Individuals
      • Largest purchasers of capital market securities.
        • Individuals and Financial Instructions .
          • Pension funds, mutual funds.
    • Size and Composition of Capital Markets, 2006
      • Stock Bond Total Capital
      • Markets Markets Markets
      • World $50.8 (43%) $68.7 (57%) $119.5 (100%)
      • U.S. $19.6 (39%) $26.7 (39%) $46.3 (39%)
      • EU $13.1 (26%) $23.2 (34%) $36.6 (31%)
        • Euro $8.4 (17%) $18.8 (27%) $27.2 (23%)
        • U.K. $3.8 ( 8%) $ 3.3 ( 5%) $ 7.1 ( 6%)
      • Japan $ 4.8 ( 9%) $ 8.7 (13%) $13.5 (11%)
      • Note: Trillions of U.S. dollars, and (%) of total.
      • Source: IMF, Global Financial Stability Report, 2007 http://www.imf.org/External/Pubs/FT/GFSR/2007/02/index.htm
    • Size and Composition of Capital Markets, 2005
      • Stock Bond Total Capital
      • Markets Markets Markets
      • World $37.2 (39%) $59.0 (61%) $96.2 (100%)
      • U.S. $17.0 (46%) $23.8 (40%) $40.8 (42%)
      • EU $ 9.6 (26%) $18.7 (32%) $28.3 (29%)
        • Euro $6.0 (16%) $15.2 (26%) $21.2 (22%)
        • U.K. $3.1 ( 8%) $ 3 3 ( 6%) $ 6.4 ( 7%)
      • Japan $ 7.5 (20%) $ 8.7 (15%) $16.2 (17%)
      • Note: Trillions of U.S. dollars, and (%) of total.
      • Source: IMF, Global Financial Stability Report, 2006 http://www.imf.org/External/Pubs/FT/GFSR/2006/02/index.htm
    • Global Capital Markets: Summary
      • By year end 2006, the estimated value of all the world’s capital markets was $115.5 trillion (this was an increase of 24% over 2005).
        • In 2006, stock markets grew by 37% and the bond markets by 16%
        • Bond markets are the larger of the two capital markets (57% versus 43% in 2006 but down from 61% and 39% in 2005).
      • The United States capital market is the largest at 39% of the total (but down from 42% in 2005), while the EU is second at 31% (up from 29% in 2005).
      • Japan’s share of the world’s capital markets fell from 17% in 2005 to 11% in 2006.
    • Global Bond Markets: Summary
      • By year end 2006, the estimated value of all the world’s bond markets was about $69 trillion (compared to $59 trillion in 2005).
      • The United States bond market was the largest at 39% of the total (40% in 2005), while the EU was second at 34% (32% in 2005).
      • Japan’s share of the global bond market slipped from 15% to 13%.
    • Size and Composition of Developed and Emerging Capital Markets, 2006
      • Stock Bond Total Capital
      • Markets Markets Markets
      • World $50.8 (43%) $68.7 (57%) $119.5 (100%)
      • Developed $39.2 (77%) $62.1 (90%) $101.3 (85%)
      • Emerging $11.6 (23%) $ 6.1 (10%) $ 17.7 (15%)
        • Asia $6.9 (13%) $3.5 ( 5%) $10.4 ( 9%)
        • Latin Amer $1.5 $1.6 $ 3.1
        • Europe $1.9 $ .7 $ 2.6
        • Africa $ .9 $ .1 $ 1.0
      • Note: Trillions of U.S. dollars, and (%) of total.
      • Source: IMF, Global Financial Stability Report, 2007 http://www.imf.org/External/Pubs/FT/GFSR/2007/02/index.htm
    • Size and Composition of Developed and Emerging Capital Markets, 2005
      • Stock Bond Total Capital
      • Markets Markets Markets
      • World $37.2 (39%) $59.0 (61%) $ 96.2 (100%)
      • Developed $30.6 (82%) $54.5 (92%) $ 85.1 (89%)
      • Emerging $ 6.6 (18%) $ 4.5 ( 8%) $ 11.1 (11%)
        • Asia $4.4 (12%) $2.4 ( 4%) $ 6.8 ( 7%)
        • Latin Amer $1.2 $1.3 $ 2.5
        • Europe $ .3 $ .7 $ 1.0
        • Africa $ .6 $ .1 $ 0.7
      • Note: Trillions of U.S. dollars, and (%) of total.
      • Source: IMF, Global Financial Stability Report, 2007 http://www.imf.org/External/Pubs/FT/GFSR/2007/02/index.htm
    • Developed and Emerging Capital Markets: Summary
      • Developed country capital markets dominate the world’s total capital markets.
        • But their share is declining (89% in 2005 to 85% in 2007)
      • The increase in emerging capital markets is occurring in Asia, and especially in their equity markets.
        • Emerging market equity markets increased from 18% of total world equity markets in 2005 to 23% in 2006.
        • By 2006, emerging Asia equity markets represented 13% of the world’s total equity markets.
    • The Bond Markets: Governments and Corporates, 2006
      • Bonds Total
      • Government Corporate Bonds
      • World $25.6 (37%) $43.1 (63%) $68.7(100%)
      • U.S. $ 6.2 (24%) $20.5 (48%) $26.7 (39%)
      • EU $ 7.7 (30%) $15.5 (36%) $23.2 (34%)
        • Euro $6.6 (26%) $12.2 (28%) $18.8 (27%)
        • UK $ .8 ( 3%) $ 2.5 ( 6%) $ 3.3 ( 5%)
      • Japan $ 6.7 (26%) $ 2.0 ( 5%) $ 8.7 (13%)
      • Emerging $ 3.8 (15%) $ 2.2 ( 5%) $ 6.0 ( 9%)
      • Note: Trillions of U.S. dollars, and (%) of total.
      • Source: IMF, Global Financial Stability Report, 2007
    • Composition of Global Debt Markets
      • Government debt’s share of the global bond market has declined in recent years especially since the mid-90s.
      • In the early 1990s, Government debt was over 60% of the total global bond market.
      • By 2006, Government debt was less than 40% of the total global bond market.
    • Government and Corporate Bond Markets: Summary
      • From 2001 to 2006, the world’s bond markets grew from $37 trillion to $69 trillion.
        • This represents an increase of about 85%
      • The greatest increase in this total was represented by the corporate (i.e., private) bond market.
        • The corporate (private) bond market’s share of the total bond market increased from 50% in 2001 to 63% by 2006.
        • With the exception of Japan, in the United States and in the EU, the corporate bond markets are now larger than the government bond markets.
        • In the emerging countries as a group, the government bond markets dominate the corporate bond markets.
    • Rise of Corporate Debt
      • As noted from the previous exhibit, corporate debt has risen substantially in recent years.
      • In effect, both domestic and multinational corporations have been increasing their participation in global debt markets since the mid-1990s.
      • Why?
        • (1) Deregulations of capital markets (associated with the globalization process) has expanded the number of debt markets which non-resident corporations can enter.
    • Rise of Corporate Debt – Continued
      • (2) Since January 1999, the advent of the euro and the single market process in the eurozone has encouraged the growth of global corporate issuance within this area.
      • (3) The general decline in global interest rates in the last 10 years has made borrowing relatively more attractive (coupled with a tax incentive in many countries).
      • (4) Some governments, especially in Europe, have reduced their funding needs (e.g., the Growth and Stability Pact in the Euro-zone has limited European Government debt issues).
        • Japan is the exception (see next slide).
    • Government Debt as a % of GDP
    • Rise of the Eurozone Bond Market
      • Historically, the U.S. bond market has dominated the global bond market.
        • For both U.S. companies and non-residents.
      • But, since the introduction of the euro in 1999 and the resulting development of a true pan-European debt market, the Eurozone bond market has increased in importance.
        • In 2001, the U.S represented 47% of the world’s bond market and the Eurozone countries represented 21%.
        • But by 2006, the U.S. share had fallen to 39% and the Eurozone share had grown to 27%.
    • Bond Market Growth in Europe
    • Growth in Corporate Bonds in the Eurozone, 1998-2005 (Billions of Euros)
    • U.S. Interest Rates: 1990 - 2008
    • Eurozone: 10-year Government Bond Rates, 1990-2008
    • Japan: 10-Year Government Bond Rates, 1990 - 2008
    • Australia: 10-Year Government Bond Rates, 1990-2008
    • The World’s Bond Markets
      • The world’s bond market can be divided into two broad groups: (1) the domestic bond market and (2) the international bond market.
      • (1) The domestic bond market is comprised of all securities issued in each country by “domestic” government entities and corporates.
        • In this case, issuers are domiciled (i.e., headquartered) in the country where those bonds are traded.
      • (2) The international bond market is comprised of non-residents borrowing in another country’s bond markets
        • The international bond market consists of two groups: Foreign Bonds of and Eurobonds.
      • The domestic market dominates the global bond market, accounting for about 80% of the total.
        • See next slide
    • Amounts of Domestic and International Bonds Outstanding, Year-End 2004 in U.S. $Billions Currency Domestic Percent International Percent Total Percent U.S. dollar $17,930.7 45.5% $4,492.5 40.5% $22,423.2 43.7% Euro $8,436.4 20.9% $4,834.5 43.5% $13,270.9 25.8% Pound $1,274.6 3.2% $778.7 7.0% $2,053.3 4.0% Yen $8,145.0 20.2% $488.6 4.4% $8,633.6 16.8% Other $4,506.6 11.2% $508.2 4.6% $5,014.8 9.8% Total (and % of Total Global) $40,293.3 78.4% $11,102.5 21.6% $51,395.8 100.0%
    • Foreign Bonds
      • Foreign Bonds: Bonds issued by a non-resident and denominated in the currency of the country in which it is being placed.
        • Example: Ford Motor Corporation issuing a yen denominated bond in Japan
      • Foreign bonds are subject to the regulations of the country in which the bond is being offered.
        • The SEC regulates foreign bond offerings in the U.S.
      • Historically, the most important foreign bond markets have been in Zurich, New York, and Tokyo.
      • Foreign bonds are often issued because of interest rate considerations (see next slide) and then swapped out for another currency.
    • Bond Spreads, April 8, 2008
    • Names for Foreign Bonds
      • The financial markets have come up with unusual nicknames for foreign bonds. These include:
        • Yankee bonds
          • Issued in the United States,
        • Matador bonds
          • Issued in Spain,
        • Rembrandt bonds
          • Issued in the Netherlands,
        • Samurai bonds
          • Issued in Japan,
        • Bulldog bonds
          • Issued in the United Kingdom,
        • Kiwi bonds
          • Issued in New Zealand.
        • Kangaroo bonds
          • Issued in Australia.
        • Maple bonds
          • Issued in Canada.
    • Eurobonds
      • Eurobonds: Bonds issued and sold simultaneously in more than one market, and all in a jurisdiction outside the country of the currency of denomination.
        • Coca Cola issuing a U.S. dollar denominated bond in Europe and Asia.
      • The advantage of the Eurobond market is that issuers can borrow from individual and institutional investors all around the world.
        • Thus the advantage of a large global capital market.
      • Issuers include national governments, “AAA” corporations and global banks.
        • Issue size can range from $50 million to $1 billion and over.
      • U.S. dollar is the dominant currency of denomination for Eurobonds.
    • The Main Features of a Eurobond
      • Denominated in an offshore currency.
        • Therefore, investors in eurobonds take both credit and foreign exchange risks.
      • Sold to a wide range of individual and institutional investors through a multinational syndicate of underwriting firms and banks.
      • Generally bearer instruments to ensure the anonymity of the ultimate investors.
      • Some publically offered eurobonds trade on stock exchanges, normally in London or Luxembourg. Others are placed directly with institutional investors without a listing (private placement).
    • History of the Euro-Bond Market
      • Until the early 1960s, foreign borrowers generally raised money by issuing securities denominated in U.S. dollars in the U.S. bond market (referred to as foreign bonds).
      • However, in the early-1960s, the U.S. Government, in an attempt to reduce an outflow of funds from U.S. (i.e., a balance of payments deficit), imposed several controls upon both domestic and foreign borrowers.
        • Interest Equalization Tax in 1963.
        • Voluntary Credit Restraint Program in 1965.
      • As a result, many US and foreign borrowers turned to the euro-bond markets (offshore).
        • First euro-bond was issued in July of 1963 by the Italian highway authority, Autostrad, a $15 million U.S. dollar denominated bond issued to investors in the UK, Belgium, Germany and the Netherlands and was listed on the London Stock Exchange.
    • Eurobond Market Surpasses U.S. Bond Market in 2005
    • Risk to Holders of Foreign Bonds
      • A holder of a foreign currency denominated bond assumes the following types of risk:
        • Default Risk (Credit Risk)
        • Price Risk
        • Foreign Exchange Risk
          • The latter is unique to holders of foreign currency denominated bonds.
          • Essentially, the risk that the foreign currency you will be receiving in the future (interest and principal repayment) will weaken relative to your home currency.
    • Impact of FX Changes on Bond Returns, 2005
      • In 2005, The U.S. dollar strengthened against most currencies.
        • Or, put another way, most foreign currencies weakened against the dollar.
      • Thus resulted in a reduction of the returns U.S. investors achieved on their foreign bond holdings.
        • As the chart shows, most foreign bonds produced negative exchange rate adjusted returns for U.S. investors.
        • The one major exception was Canadian bonds.
    • Appendix 1: Regulation of International Bonds
    • Regulations of International Bonds
      • Foreign bonds must meet the registration and listing regulations of the country in which they are issued.
        • Thus, Yankee bonds being offered to potential public buyers (i.e., public placements) must comply with 1933 Securities Act requiring full financial disclosure and the offering of a prospectus.
        • Private placements do NOT have to be registered with the SEC.
          • See next slide for U.S. requirements
      • Eurobonds , however, are not required to meet registration requirements
        • For example, euro-dollar bond offerings outside of the United States (“Reg S Bonds”) do not require SEC registration.
      • Note: Issue of time and expense in bring a foreign bond to market has resulted in a general preference for eurobond offerings by global borrowers.
    • Registering Bonds in the U.S.
      • All bonds being offered to the investing public in the United States (with the exception of U.S. government, federal agency and municipal bonds) must be registered with the Securities & Exchange Commission.
        • This requirement applies to Yankee bonds as well.
      • Registration requires that specific information be disclosed to the public, such as :
        • financial data about the borrower,
        • how the money will be spent,
        • how the borrower intends to repay.
        • the terms of the bond itself.
          • This information is included in the bond’s indenture.
    • Regulation S Bonds
      • Yankee bonds issued in the United States to the general public must be registered with the Securities and Exchange Commission.
      • However, Regulation S exempts a US dollar bond offered outside the United States by a non-resident from having to register.
      • These bonds cannot be sold to Americans.
        • Telekom (Malaysian telecommunications; Moody’s A3), $500M, 5.3% yield, offered September 15, 2004. Book runners: Deutsche Bank and UBS.
          • Sold to 183 investors representing a mix of pension funds, asset managers, banking/financial institutions, and private banks; all sales outside of the United States: 61% in Asia and 39% in Europe.
    • Appendix 2: Types of International Bonds
    • Types of International Bonds: Straight
      • Straight Fixed Rate International Bond
      • Most international bonds are of this type and are characterized by:
        • Designated maturity date,
        • Fixed coupon payments (% of par value),
        • Eurobond interest is typically paid annually:
          • Why? Less costly for borrowers to do so.
        • No options (e.g., convertibility into stock) attached
        • Entire issue brought to market at one time.
        • Sometimes referred to as “plain vanilla” bonds!
    • International Bonds: Equity Related
      • Equity Related Bonds
      • (1) either fixed income convertible issues, which:
        • Allow the holder to exchange the bond for a predetermined number of share of common stock.
        • Carry lower interest rates than a straight only bond because of the conversion option.
      • (2) or fixed income bonds with equity warrants, which:
        • Have a call option (or warrant) feature which allows the holder to purchase a certain number of equity shares at a pre-stated price over a predetermined period of time.
    • International Bond: Zeros
      • Zero Coupon Bonds have the following characteristics:
        • Sold at a discount from face (par) value,
        • Do not pay any coupon interest payments.
        • At maturity, holder receives full face (par) value.
        • Return is represented by the difference between price and face value.
        • These zero coupon bonds are especially attractive to Japanese investors
          • Why? Their tax laws treat the return on zero coupon bonds as a tax free capital gain (where in Japan coupon payments are taxable)!
    • International Bonds: Dual Currency
      • Dual-Currency Bonds
        • Fixed rate bond that pays interest in one currency, and
        • Upon maturity, repays the principal in another currency.
      • Good option for a MNE financing a foreign subsidiary .
          • Very popular among Japanese firms:
          • Coupon payments in yen; principal repayment in dollars.
      • Example of a strategy in using a dual currency bond:
          • Used by Japanese companies wanting to establish or expand U.S. based subsidiaries.
          • Japanese company has a more recognized name in Japan so they raise money initially in Japan.
          • Eventually the subsidiary will realize profits in the U.S. and at that time they will pay the principal on the debt in US$.