Theeurobondis a type of bond that is issued in a currency that is different from that of the country or market in which it is issued. Despite its name, it has no particular connection to Europe or the euro currency.
Due to this external currency characteristic, these types of bondsare also known as external bonds.
Understanding the Eurobond
The "euro" in eurobond is meant to imply external. These eurobondsshould not be confused with Eurobonds with a capital "E." When capitalized, the word defines bonds issued by the European Union andEuropean governments.
Key Takeaways
- A eurobond issue may be used to finance a company's expansion into a foreign market.
- The bond raises the money needed in the currency that is needed, without the forex risk.
- An investor may gain exposure to a foreign market while investing in an established domestic company.
The names of eurobonds (small "e") reflect the currency in which they are denominated.For example, a U.K.-based company might issue a U.S. dollar-denominated eurodollar bond in Japan. Or, an international financial syndicate could issue euroyen bonds in Singapore, which are denominated in Japanese yen.
Who Issues Eurobonds?
Private organizations, international syndicates, and even governmentsin need of foreign-denominated money for a specified length of time find eurobonds suitable to their needs.Eurobonds are usually offered at fixed interest rates, even if they are issued for long periods of time.
An Example
For example, say a company like Molson Coors wants to enter a newmarketby establishing a manufacturing facility in India.Expenses for the facility will require a large amount of capital in the local currency, the Indian rupee (INR).
As it is new to India, the company may not have the necessary credit in the Indian markets, which canlead to a high costfor borrowing locally.Molson Coors decides to source the money locallyandissues a rupee-denominated eurobond in the U.S. Investors withIndian rupees in their U.S.-based accounts may purchase thebond, effectively loaning money in Indian rupees to the company.
The eurobond is denominated in a foreign currency but launched in a nation with a strong currency. That keeps them highly liquid for their investors.
The North American company collects this capital and floats a subsidiary company locally in India. The collected capital, in rupees, is transferred to the local Indian subsidiary by the parent company. The plant becomes operational, and the proceeds are used to pay the interest to bondholders.
Benefits of Eurobonds for the Issuer
There are a number of benefits to issuing eurobondsrather than domestic bonds for a project of this type:
- Companies can issue bonds in the countryof their choice and the currency of their choice, depending on what is most beneficial for the planned use.
- The issuer can choose a country with an interest rate that is favorable to its own at the time of the issue, thus reducing the costs of borrowing.
- Eurobonds have particular appeal to certain investor populations. For example, many U.K. residents with roots in India, Pakistan,and Bangladesh view investments in their homelands favorably.
- The company reducesforex risk. In the example above, the company could have issued the domestic bonds in the U.S. in U.S. dollars, converted the amount to Indian rupees at the prevailing rates in order to move it to India, then exchanged rupees for U.S. dollars in order to pay interest to bondholders. This process adds transactional costs and forex rate risk.
- Although eurobonds are issued in a particular country, they are traded globally, which helps in attracting a large investor base.
Benefits of Eurobonds for Investors
For the investor, eurobonds can offer diversification with a smaller degree of risk. They are investing in a solid and familiar local company that is expanding its business into an emerging market.
Also, eurobonds are denominated in foreign currencies but launched in nations with strong currencies. That keeps them highly liquid for their local investors.
For example, an Indian rupee eurodollar bond issued in the U.K. with par value of 10,000 Indian rupees will cost a U.K. investor the equivalent of about 104 British pounds at the prevailing exchange rate.
