The eurobond is a special type of bond issued in a currency that is different from that of the country or market in which the bond is issued. Due to this external currency characteristic, these types of bonds are also known as external bonds.
This article describes the working of the eurobond, along with its benefits, risks and usage.
Eurobond: Examples and Categorization
Though the name includes the word "euro," the eurobond has nothing to do with Europe or the euro currency. Instead, the word “euro” means external currency. These eurobonds should not be confused with “Eurobonds,” as the latter are standard bonds issued by the European Union and European governments.
Eurobonds are categorized by the currency in which they are denominated. For example, a U.K.-based company can issue a U.S. dollar-denominated eurodollar bond in Japan. Similarly, an international financial syndicate can issue euroyen bonds in Singapore, which can be denominated in Japanese yen.
Who Issues Eurobonds?
Private organizations, international syndicates, and even governments who are in need of foreign denominated borrowings for a specified duration find eurobonds suitable for their needs. Eurobonds are usually offered at fixed interest rates, offering a clear fixed-payment debt structure for the issuer even in the long term.
For example, say a U.S.-based company like Coca-Cola Co. wants to enter a new market by establishing a large manufacturing facility in India. Expenses for the facility will require large capital in local currency – the Indian rupee (INR). Being a new entrant in India, the company may not have the necessary credit in Indian markets, which can lead to a high cost for borrowing locally. Coca-Cola Co. decides to source the money locally and issues a rupee-denominated eurobond in the U.S. Investors with INR available in their U.S.-based accounts will purchase the bond, effectively loaning principal money in INR to the company.
The U.S.-based company collects this capital and floats a subsidiary company locally in India. The collected capital, in INR, can be given to the local Indian subsidiary by the U.S.-based parent company. If the local plant becomes operational and profitable, the proceeds are used to pay the interest to bondholders.
Benefits of Eurobonds for the Issuer
There are many benefits to the issuer for using eurobonds rather than domestic bonds:
- Issuers have the freedom to issue bonds in the country of their choice. They also have the choice of currency with eurobonds. Both of these can be selected to provide the most benefit for their planned use.
- Interest rates vary from one country to the other, and the issuer can choose a country with favorable rates.
- Companies can study immigrant population patterns to decide which currency would be most beneficial. For example, a large population in the U.K. is from India, Pakistan and Bangladesh. Issuing a eurobond in the U.K. in a currency of these countries can see huge investments. Immigrants are emotionally attached to their native countries and are often keen to invest money in such bonds if the issuer is reputable.
- Using eurobonds, the company mitigates forex risk. In the Coca-Cola example above, the company could have issued the domestic bonds in the U.S. in U.S. dollars, converted the amount to INR at prevailing forex rates to move money to India, then moved the INR money back to U.S. dollars for interest payment to bondholders. This option leads to forex rate risk as well as transactional costs, which are eliminated using eurobonds.
- A wide range of maturity duration can be selected.
- Although eurobonds are issued in a particular country, they are traded globally, which helps in attracting a large investor base.
Benefits of Eurobond for Investors
The majority of eurobonds have lower face value. Denominating these in foreign currencies and launching them in nations with stronger currencies keeps them highly liquid for local investors. For example, an Indian rupee eurodollar bond issued in the U.K. with par value of INR 10,000 may appear cheaper to U.K. investors. It will cost only GBP 100 to U.K. investors, considering the GBPINR forex rate of 100.
The Bottom Line
Eurobonds offer a unique advantage to reputable, multinational companies when it comes to raising low-interest debt from global markets. The investors also benefit from diversification through the addition of other currency debt. However, investors should keep in mind they have to bear the forex risk while investing in eurobonds. (For related reading, see: The Ins and Outs of Corporate Eurobonds.)