Russia Sells $1
Billion Bonds
News
Russia went to the Eurobond market to raise $1.0
billion in five-year notes. The first day of trading in
these issues was November 21, 1996. This is the country's
first bond offering since the 1917 revolution.
Analysis
I would like to use the news to raise issues related
to the yield on bonds.
What is a Eurobond?
There are two, not necessarily mutually exclusive,
definitions of a "eurobond." It is a bond that
is issued in a currency that is not the legal tender in
the country it is being issued in. An example would be a
Japanese company issuing US dollar denominated bonds in
Canada. Thus, don’t confuse "euro" with
Europe.
The second definition would be that of a bond that is
simultaneously marketed in more than one country. In the
example at hand, both definitions apply.
Why Would A Company Issue Bonds Internationally?
Marketing a bond internationally increases the potential
buyers, thus the issuing party can raise more money.
Russia actually ended up issuing double the amount that
investors originally expected as investors reacted
favorably to the issue.
Why Would A Company Issue A Bond In A Currency
Different From The "Home’s"?
"Home" is intentionally put in quotation marks
as a number of companies operate not just at home but in
many countries. These are called multinationals. Thus, a
German company, say, BMW, might need to build a plant in
the U.S. In such a situation, BMW would have the option
to either raise the necessary money through an issue of
new bonds in, for example, German Marks in Germany then
transfer the money to US dollars, or raise the money
through a bond issue in U.S. dollars in the USA.
Obviously the company would choose the cheaper source of
financing.
Pricing
The Eurobonds were priced "to yield 3.45 percentage
points more than five-year U.S. treasury notes, which
currently have a rate of 5.91 percent."
What Are These Yields Also Referred To?
These are the yield-to-maturity (YTM), or the required
return on the bonds.
If The Bonds Were Priced At Par, What Would Be
Their Coupon Rate?
A bond that his a price of $1,000, or is said to be
selling at par, would have its coupon rate equal to its
yield-to-maturity. Thus, in this case the coupon rate is
9.36 (=3.45 + 5.91) percent. Unless otherwise stated,
bonds in general tend to have their coupons fixed over
the life of the bond. The YTM, on the other hand, changes
as the price of the bond fluctuates.
Rating
Standard & Poor's gave the Russian issue a BB-
rating, one notch below the BB for Mexico and one notch
above the B+ for Brazil. Moody's Investors Service gave
Russia a B2A rating, the same as Mexico and two notches
above Brazil and Argentina.
What Does The Higher 3.45 Percent Yield Represent?
Your answer should be based on the determinants of yield
on debt, namely
required return on debt = compensation for (time value
of money, liquidity, maturity, expected inflation,
default), where the time value of money is typically
measured by the yield on a risk-free asset such as
T-bill.
Since both of these numbers represent a premium over a 5-year U.S. treasury
note, there is no additional risk associated with differences in maturities.
Also, since the issue is in the U.S., expected inflation in the U.S. would
already be reflected in the 5.91 percent yield on the treasuries. Thus,
the difference has to come from the default risk and liquidity. The treasuries
are assumed to be default free and thus have no ratings. Moreover, one
would safely assume that U.S. treasury debt is more liquid than its Russian
counterpart.
By Alex Tajirian
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