Today's multinational corporations (MNC) can't rely on just a panel of banks to meet all of their funding needs, especially when those banks decide to cut back on lending to the MNC's business sector or they become cash constrained. One alternative, and significant source of debt finance, is the eurobond market. This subset of the global capital market is also called the international capital market or wholesale market, because it usually caters to companies, banks and governments rather than individuals.
What Is a Eurobond?
The name "eurobond" is a misnomer, as a eurobond is a bond that can be denominated in any currency, not just euros. The prefix "euro" indicates that the currency borrowed by issuing the bond is held outside the country corresponding to that currency. So, a euroyen bond is a bond to borrow yen from outside Japan in the euroyen market. A eurodollar bond is a bond to borrow U.S. dollars from outside the U.S. in the eurodollar market.
Bonds issued inside a country, and in its corresponding currency, and by foreigners, are separate from the eurobond market. So, there are many distinct markets for issuing bonds, and the eurobond is one of the oldest and largest. (Learn more about bond markets in our article, The ABCs Of The Bond Market.)
The eurobond market is generally restricted to large, single issues ($50 million or more), and is limited to large companies, banks or governments. Maturities are usually around 10 years or less. However, there are programs available for MNCs to issue smaller amounts, and for shorter periods.
Issuing eurobonds can help an MNC raise foreign-denominated debt in large amounts, for long periods of time, and usually at a fixed interest rate. This profile would be suitable for financing large, long-term, overseas developments - for example, establishing an overseas subsidiary.
Why a Company Might Issue a Eurobond
Many major MNCs, (for example, Wal-Mart) that want to expand to another market on a large scale (say, Thailand) would need plenty of that country's currency (in this example, Thai baht) and plenty of time in order to reach their goal. In order to contain interest costs, borrowing should be done at a fixed interest rate. The solution, in this example, would be for Wal-Mart is to issue a eurobond denominated in Thai baht.
However, the subsidiary, set up in Thailand to manage the operations, is unlikely to have the necessary borrowing reputation directly in the eurobond market, and would likely ask its U.S. parent, which would have a good credit rating, to issue the eurobond instead. The proceeds would then be passed through as an internal loan to the subsidiary, and denominated in Thai baht.
The Thai baht would be provided to the parent by investors who have Thai baht in accounts at banks outside of Thailand. In return, investors receive a eurobond and coupons in pre-determined increments, and at a fixed interest rate.
If the Thai subsidiary grows according to plan, it will generate earnings, which will be used to pay its loan interest to the parent. The parent then uses these receipts to meet its obligations to pay interest on the Thai eurobond. Bond principal is usually not paid until maturity, either from the sale of the Wal-Mart expansion stores to another company or by issuing another eurobond.
By issuing the eurobond in Thai baht the U.S.-based parent does not have currency risk because its Thai baht liability (the bond) is offset by a Thai baht asset (its internal loan). Similarly, the Thai subsidiary's liability to pay interest in Thai baht to its parent is matched by Thai baht income from its local superstores.
As an alternative to issuing in a foreign currency, some MNCs issue a bond in another currency, and then use currency and interest rate swaps to convert the currency and interest rate basis into the desired form. The exchange then provides the protection against currency and interest rate mismatches.
MNCs often use this alternative method, depending on their reputation in certain currency types, and are able to issue at a lower cost. (Readers unfamiliar with swaps should refer to An Introduction To Swaps.)
How MNCs Issue Eurobonds
To increase investor interest, a MNC can have its eurobond issue underwritten by a bank, which obligates those banks to provide any shortcoming in principal. In addition, banks are paid fees to distribute the eurobonds to investors, to attend road shows to generate investor interest and to prepare an information memorandum and prospectus, setting out details of the eurobond, the MNC and the purpose for the funds.
Eurobonds provide MNCs with simplified international operations. Though new obstacles arise, the advantages far outweigh the reliance on third-party entities for smooth transactions. Because the eurobond market is restricted to large well-known and reputable MNCs and other issuers, investors tend to accept less strict covenants and do not require security. (If you're interested in learning about the evolution of fixed income markets, take a look at The Bond Market: A Look Back.)
Mutual Funds & ETFsLearn about the differences between actively and passively managed mutual funds, and for which types of investors each management style is best suited.
Investing BasicsAre bonds safe or risky right now? It depends on the type of bond and how you invest in them.
Investing BasicsLearn about the ultra rich and what normally comprises their net worth; understand the top three alternative investments usually owned by the ultra rich.
Stock AnalysisLearn about the top five dividend stocks of companies operating in the health care sector that generate substantial cash flows to afford high payouts.
InvestingWealth advisers who integrate philanthropy and finance planning can stand out with baby boomer clients.
Mutual Funds & ETFsFind out what kinds of mutual funds are unsuitable for millennial investors, especially when included in millennial retirement accounts.
Bonds & Fixed IncomeTaking on high-yield bond investments requires a thorough investigation. Here are looking the fundamentals.
Investing BasicsFind out how you could potentially earn hundreds of thousands of dollars by just investing $100 a month in stocks during your working years.
Mutual Funds & ETFsLearn about the top three exchange-traded funds (ETFs) that invest in sovereign and corporate bonds issued by developed countries, including Japan.
TaxesLearn the proper procedure for deducting stock investing losses, and get some tips on how to strategically take losses to lower your income tax bill.
There are some types of mutual funds, called stock funds or equity funds, which hold only stocks. However, there are a number ... Read Full Answer >>
The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>
Some mutual funds pay interest, though it depends on the types of assets held in the funds' portfolios. Specifically, bond ... Read Full Answer >>
Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic ... Read Full Answer >>
Depending on the specific assets in its portfolio, a mutual fund may generate income for shareholders in the form of capital ... Read Full Answer >>
There are two broad categories of annuity: fixed and variable. These categories refer to the manner in which the investment ... Read Full Answer >>