The Global Capital Market Prof. Ian Giddy New York University.

The Global Capital Market

Prof. Ian Giddy

New York University

Copyright ©1996 Ian H. Giddy The Global capital Market 2

The International Capital Market

International bank financing Eurobonds, foreign bonds and global

bonds “A Day in the Life”

The secondary marketThe primary market

Structured financing


Short-Term Financing: Evolution

INTERMEDIATED

DIRECT

ENHANCED

BANK LOANS

COMMERCIAL PAPER

BANK L/Cs


Alternative Sources ofShort-Term Financing

FINANCINGFINANCING

DEBT EQUITYDOMESTIC

LOANS

DOMESTIC

LOANSEUROMARKET

LOANS

EUROMARKET

LOANSSYNDICATED

EUROCREDITS

SYNDICATED

EUROCREDITSNOTE ISSUANCE

FACILITIES

NOTE ISSUANCE

FACILITIESEUROCOMMERCIAL

PAPER

EUROCOMMERCIAL

PAPER


A RevolverThe Bigfoot Group

£115,000,000equivalent

Committed Revolving Facility

Arranged by

Credit Suisse First Boston Limited

Underwriting Banks

ABN-AMRO N.V. Banque Indosuez Crédit LyonnaisDeutsche Bank Fuji International Finance Limited Banque Paribas

Samuel Montague & Co. Limited County Bank KredietbankBanque Bruxelles Lambert S.A. Citibank Crédit Suisse

Sumitomo Finance International Westdeutsche Landesbank Girozentraleo Finance International Westdeutsche Landesbank

Tender Panel Members

ABN-AMRO N.V. Indosuez Crédit Lyonnais CIBC LimitedDeutsche Bank Fuji International Finance Limited Banque ParibasLTCB International Limited J.P. Morgan County Bank Kredietbank

Banque Bruxelles Lambert S.A. Citibank Crédit Suisse Commerzbank Merrill Lynch Capital Markets Sumitomo Finance International

Salomon Brothers International Westdeutsche Landesbank Girozentrale

Tender Panel and Facility Agent

Credit Suisse First Boston Limited

RUF Structure:ArrangerUnderwriting

banksTender

panelAgent


RUF Stuff

Need lots of money fast?

Have trouble accessing CP market?

Arrange syndicated

creditYES

Confident of always being able

to access the short-term market?

Arrange Euronote

programYES

Arrange RUF or MOF:

Underwritten Euronote program

Need funds? Don’t issue paperNO

Cannot sell paper at L+10bp? Borrow from banksYES

Issue Euronotes or other paper


Alternative Sources ofLong-Term Financing

FINANCINGFINANCING

DEBT EQUITY

Bank credits - syndicated

lending and facilities Bonds

Domestic, foreign, EuroPublic, privateStructured, such as principle-indexed notes

Medium-term notes Asset-backed financing and leasing Project financing


Long-Term Financing: Evolution

INTERMEDIATED

DIRECT

ENHANCED

BANK TERM LOANS

PUBLIC BONDS

BANK-GUARANTEED BONDS


The Global Bond Market

Domestic bonds Foreign bond

(Issued within country of currency, by non-resident issuers)

Eurobonds(Issued and sold in a jurisdiction outside the

country of the currency of denomination) Global Bonds(Issued in the domestic and the Eurobond

markets simultaneously)


International Bond Markets are Linked

Issuers and investors compare terms in the domestic and Eurobond markets, which are linked across currencies via currency swaps

BONDMARKETSWITHINCOUNTRYOFCURRENCY

BONDMARKETSOUTSIDECOUNTRYOFCURRENCY

CurrencySwaps

Long-datedForwardExchange

Domestic US

- Gov't- Corporate

ForeignBonds

"Yankee"

DomesticJapanese

- Gov't- Corporate

ForeignBonds

"Samurai"

EurodollarBond Market

EuroyenBond Market


Foreign Bonds

A foreign bond is a bond issued in a host country's financial market, in the host country's currency, by a foreign borrower

The three largest foreign bond markets are Japan, Switzerland, and the U.S., representing issuance of about $40 billion in bonds annually


Private Placements and Rule 144A

The private placement exemption from registration and disclosure is extended to Eurobonds as long as the U.S. investors meet the following requirements:They are large and sophisticatedThere are only a few investorsThey have access to information and analysis similar

to that which would ordinarily be contained in a registered offering prospectus

They are capable of sustaining the risk of losses, andThey intend to purchase the bonds for their own

investment portfolios, and not for resale.


Characteristics of Eurobonds

Issued outside country of currency Not subject to domestic registration or disclosure

requirements In most cases take form of private placements Placed through syndicates in many countries who sell

principally to nonresidents Bonds are structured so as to be free of withholding tax Bearer form

But... Eurobonds usually influenced de facto by government

and banks of country of currency


Global Bonds


Key Dates in the Issuance of a Eurobond

Issuance need oropportunity identified

Announcement ofEurobond issue

Offering day:Eurobond issued

Closing day:Eurobonds delivered,

Issuer gets money

Issuerdiscussesdeal withleadmanager

Syndicateformed,bonds"presold"prior tofinal terms

Finalterms,bonds soldby sellinggroup toinvestors


Key Players in the Issuance of a Eurobond

MANAGERSUNDER-

WRITERS

SELLING

GROUP


Who Gets What

Fees, percent Fees, amount Net pricePrice paid by investor (in theory) 101.50

Price paid by member of selling group 60% 0.90 100.60

Price paid by member

of underwriting group 60%+20% 0.90+0.30 100.30

Price paid by managers

(plus "praecipium" paid to lead manager) 60%+20%+20% 0.90+0.30+0.30 100.00


Pricing Eurobonds in the Secondary Market What "spread to Treasury" should it yield

relative to similar bonds--credit risk, duration and liquidity--trading in the secondary market?

Use the desired yield to maturity to find its present value at the next coupon date.

Find today's present value of that amount, including the coupon to be paid

Actual price is quoted as "clean price," meaning not counting accrued interest


The Eurobond Secondary Market


Eurobond Secondary Market Quotations

Examine the straight bonds listedWhat determines the yields?The bid-offer spreads?Does this differ by currency?

Can you explain the pricing

of the floating rate notes?


A Day in the Lifeof the Eurobond Market

Examine the dealsWhy were each done in that particular form?What determines the pricing?

Can you break the hybrids into their component parts?


A Day in the Life...

NEW INTER NA TIONAL BO ND ISSUES

Bo rrowerBo rrower Amou nt m .Amou nt m . Cou pon %Cou pon % Pr icePr ice Mat ur ityMat ur ity FeesFees Boo k ru nn erBoo k ru nn er

Celworks Trust 1990-1¶ (b) US$250 9 1/4 99.80 1998 1 7/8-1 5/8 Credit Suisse

Marui Corp* US$500 (4 3/ 8) 100 1995 2 1/4-1 1/2 Nomura

Holderbank (a) US$150 9 3/4 101 1994 1 3/8-1 CSFB

Battle Mountaingold US$100 7 1/2 100 2006 2 1/2-1 1/2 Merrill Lynch

SN CF FFr750 9 1/4 98.55 1997 1 7/8-1 1/4 CCF

Viennische Stadtsbank (a) L100bn 13 101 3/8 1994 1 3/8-7/8 BN L

Eurofima (a ) P ta10bn 12 5/8 101 1/8 1996 1 5/8-1 Deutsche Bank

Ir ish Bldg Soc . (a ) ¥15bn 7.4 101 5/8 1995 1 5/8-1 1/8 IBJ

Bank of Montreal (c ) ¥2.8bn 7 1/4 101 1/8 1993 1 1/8-5/8 Nippon Credit

¶Final te rms. *With equity warrants. Private placement. Convertible. (a) Non-callable. (b) Callable at par af ter 5 years. I f call notexercised, bond pays 50bp over Libor in last year . (c) Redemption linked to Nikkei stock index .

NEW INTER NA TIONAL BO ND ISSUES

Bo rrowerBo rrower Amou nt m .Amou nt m . Cou pon %Cou pon % Pr icePr ice Mat ur ityMat ur ity FeesFees Boo k ru nn erBoo k ru nn er

Celworks Trust 1990-1¶ (b) US$250 9 1/4 99.80 1998 1 7/8-1 5/8 Credit Suisse

Marui Corp* US$500 (4 3/ 8) 100 1995 2 1/4-1 1/2 Nomura

Holderbank (a) US$150 9 3/4 101 1994 1 3/8-1 CSFB

Battle Mountaingold US$100 7 1/2 100 2006 2 1/2-1 1/2 Merrill Lynch

SN CF FFr750 9 1/4 98.55 1997 1 7/8-1 1/4 CCF

Viennische Stadtsbank (a) L100bn 13 101 3/8 1994 1 3/8-7/8 BN L

Eurofima (a ) P ta10bn 12 5/8 101 1/8 1996 1 5/8-1 Deutsche Bank

Ir ish Bldg Soc . (a ) ¥15bn 7.4 101 5/8 1995 1 5/8-1 1/8 IBJ

Bank of Montreal (c ) ¥2.8bn 7 1/4 101 1/8 1993 1 1/8-5/8 Nippon Credit

¶Final te rms. *With equity warrants. Private placement. Convertible. (a) Non-callable. (b) Callable at par af ter 5 years. I f call notexercised, bond pays 50bp over Libor in last year . (c) Redemption linked to Nikkei stock index .


Asset-Backed Eurobonds

Legal risk:Legal structure: sale of assets to separate

subsidiary that issued ABS.

Default risk:Overcollateralization dictated by rating

agenciesReplenishment of collateralThird-party garantees.

Prepayment risk:Early redemption caused by “spread trigger”.


Equity-Linked Eurobonds

Eurobonds with warrantsMarui

Convertible EurobondsBattle Mountaingold

Index-linked EurobondsBank of Montreal


Equity Financing Choices

Equity

Warrants Conver-tibles

ADRs Common


Values and Market Premium

ConversionValue

StraightBond Value

Market ValueMarket Premium

Value

of

Convertible

Bond

($) 0

Price Per Share of Common Stock


Values and Warrant Premium

TheoreticalValue

Market ValueMarket Premium

Value

of

Warrant

($)

0Price Per Share of Common Stock ($)

1994, HarperCollins PublishersCopyright


“Hybrid” Features of A Bond Issue

Conversion Feature - compound option

Warrants - two instruments Index-linked bonds Call Feature

Bond value = straight bond value - call value

These are all example of hybrid bonds and should be priced by decomposition


International Equity Markets and Portfolio Diversification No well-accepted international version of the capital

asset pricing model. The benefits of diversification globally are empirical

issues. The empirical case for international diversification has

two components. Establish the riskiness of foreign investment, and the extent to

which combining a foreign with a domestic portfolio reduces risk.

Even if it reduces risk, does foreign investment also reduce expected return?

Then what we have to do is make sure we understand how international diversification is best achieved.


Portfolio Return and Risk

Portfolio return:

where wi are the weights of each asset in the portfolio. (Expected return is simply the weighted sum of the individual asset returns.)

Portfolio variance:

When i = j, the term wiwjFiFjDij becomes wi2Fi

2.

E(R ) = w E(R )pi=1

n

i i

P2

i=1

n

j=1

n

i j i j ij = w w


The Minimum-Variance Frontier of Risky Assets

Efficient frontier

Individual assets

Global minimum-variance portfolio

E(r)


Optimal Overall Portfolio

Indifference curve

Opportunity set

CALE(r)

P

Optimal complete portfolio


The Global Efficient Frontier

10 15 20 25 30 5

5

10

15

20

25

30

STOCKSANDBONDS

STOCKSONLY

EAFESTOCKS& BONDS

EAFE STOCKS

WORLD STOCKS & BONDS

WORLD STOCKS

US STOCKS & BONDSUS STOCKS

US BONDS

AVERAGE RETURN% PA

RISK, % PA


Evidence Suggests Index Funds are Not for the International Investor For the international investor the capitalization-

weighted portfolio may not be the optimal one. The reason is market segmentation. The world stock market is not efficient yet, the evidence suggests, at least not in the "mean-variance efficiency" sense that is required by the CAPM.

Because of real exchange risk (deviations from PPP), what is the optimal portfolio for an investor in one country may not be the optimal portfolio for an investor in another, even if there were a single risk-free asset acceptable to both.

Studies confirm these propositions


International Portfolio Optimization: Passive vs Active Portfolios

(Let the proportions of all possible assets vary until the optimal proportions are found.)

The results of

letting the

computer

find the best

proportions for

various levels

of return:

0.1

0.11

0.12

0.13

0.14

0.15

0.16

0.17

0.18

0.19

0.2

0.21

0.22

0.23

0.05 0.1 0.15 0.2 0.25 0.3 0.35

RETURN

RISK(STANDARD DEVIATION)

Same risk as 100% USA,but higher return

100% USA portfolio

100% Japan

Minimum riskportfolio Market capitalization

weighted portfolio


Obstacles to International Investment Might Include:

Information barriers. Political and capital control risks. Foreign exchange risks. Restrictions on foreign investment and

control. Taxation. Higher costs.


Conclusion:

The international equity market is imperfect

Hence there may be advantages to international equity issuance

How should companies achieve this?

Financing withStructured Securities

Prof. Ian Giddy

New York University


Principles of Innovation Through Financial Engineering

Bundling and unbundling basic instruments Exploiting market imperfections (sometimes

temporary) Creating value added for investor and issuer

by tailoring securities to their particular needs

Key: For the innovation to work, it must provide value added to both issuer and investor.


Anatomy of a Deal

Issuer:Looking for large amounts of floating-rate

USD and DEM funding for its loan porfolio.Wants low-cost funds: target CP-.10Is not too concerned about specific timing

of issue, amount or maturityIs willing to consider hybrid structures.


Anatomy of a Deal

Investor:Has distinctive preference for high grade

investmentsLooking for investments that will improve

portfolio returns relative to relevant indexesInvests in both floating rate and fixed rate

sterling and dollar securitiesCan buy options to hedge portfolio but

cannot sell options


Anatomy of a Deal

Intermediary:Has experience and technical and legal

background in structure financeHas active swap and option trading and

positioning capabilitiesHas clients looking for caps and other forms

of interest rate protection.


The Deal

1 Initiate medium term note programme for the borrower, allowing for a variety of currencies, maturities and special structures

2 Structuring a MTN in such a way as to meet the investor’s needs and constraints

3 Line up all potential counterparties and negociate numbers acceptable to all sides

4 Upon issuer’s and investor’s approval, place the securities


The Deal / 2

5 For the issuer, swap and strip the issue into the form of funding that he requires

6 Offer a degree of liquidity to the issuer by standing willing to buy back the securities at a later date.


The Issue

Issuer: Deutsche Bank AG Amount: US$ 40 Million Coupon:

First three years: semi-annual

LIBOR + 3/8% p.a., paid semi-annually

Last 5 years: 8.35% Price: 100 Maturity: February 10, 2000 Call: Issuer may redeem the notes in full at par on

February 10, 1995 Fees: 30 bp Arranger: Credit Swiss First Boston


The Deal in Detail

SCOTTISH

LIFE

CSFB

DEUTSCHE

Deutsche sells 3-year floating rate note paying LIBOR - 3/8%

For an additional 3/4% p.a., Deutsche buys three-year put option on 5-

year fixed-rate 8.35% note to SL in 3 years

For 1% p.a., Deutsche sells CSFB a swaption (the right to pay fixed 8.35% for 5 years in 3 years)

CLIENT

CSFB sells the swaption to a corporate client seeking to hedge its funding cost against a rate rise


What’s Really Going On?

Note: Issuer has agreed to pay an above-market rate

on both the floating rate note and the fixed rate bond segment of the issue

FRN portion: .75 % above normal cost

Fixed portion: .50% above normal cost Issuer has in effect purchased the right to pay a

fixed rate of 8.35% on a five-year bond to be issued in three years time.


Motivations for Issuing Hybrids Bonds

Company has a view There are constraints on what the

company can issue The company can arbitrage to save

money Always ask: given my goal, is there an

alternative way of achieving the same effect (e.g., using derivatives?)


The International Capital Market

International bank financing Eurobonds, foreign bonds and global

bonds “A Day in the Life”

The secondary marketThe primary market

Structured financing

The Global Capital Market Prof. Ian Giddy New York University.

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Transcript of The Global Capital Market Prof. Ian Giddy New York University.