What is a Eurobond?
A Eurobond is a fixed-income debt instrument (security) denominated in a different currency than the local one of the country where the bond’s been issued. Hence, it is a unique type of bond.
Eurobonds allow corporations to raise funds by issuing bonds in a foreign currency. The bonds are also called external bonds because they can be originated in a foreign currency (external currency).
If a Eurobond is denominated in US dollars, then it can be called a euro-dollar bond. If it is denominated in Chinese yuan, then this would be named euro-yuan bond.
How Do Eurobonds Work?
The essence of Eurobonds is that a company can choose any country to issue bonds depending on its economic and regulatory environment (e.g., interest rates in the country, economic cycle, market sizes, etc.). What makes the bonds attractive among investors is a small notional amount of a bond (face value or par value), which means that the bond is relatively cheap to obtain.
Importantly, Eurobonds are highly liquid and can be converted into cash within one fiscal year.
The categorization of Eurobonds is dependent on the currency in which the bonds were issued. If a US-based company decides to release Eurobonds in China in British pounds, then the bonds will be categorized as euro-pound bonds.
How is a Eurobond Issued?
Typically, financial institutions, such as investment banks, issue bonds on behalf of the borrower. If a bank will be responsible for the underwriting process, it implies a guarantee to the borrower that the whole bond issue will be sold in the primary market during the initial debt offering process.
Please note that the term “Eurobond” refers only to the fact that the bond was issued in a different country and currency. It does not need to be a country in Europe. It can be whatever country in the world.
For example, Eurobonds can be issued in China and denominated in US dollars.
Eurobonds are issued by many institutions, such as:
The primary reason for issuing Eurobonds is a need for foreign currency capital. Since the bonds are fixed-income securities; they usually offer a fixed interest rate to investors.
Imagine, as an example, a US company aims to permeate into a new market and plans to erect a large factory, say, in China. The company will need to invest large sums of money in local currency – the Chinese yuan. As the company is a new entrant to the Chinese market, it may lack access to credit in China.
The company decides to go with yuan-denominated Eurobonds in the United States. Investors who hold yuan in their accounts will invest in the bonds, which will provide funds to a new facility in China. If a new factory is profitable, the cash flow will go to settling the interest to US-based bondholders.
Benefits to Issuers
A list of benefits to Eurobond issuers consists of the following:
- Flexibility to choose a favorable country to originate bonds and currency
- A country choice with lower interest rates
- Avoidance of currency risk or forex risk by using Eurobonds
- Access to a huge range of bond maturity periods that can be chosen by the issuer
- International bond trade despite being issued in a certain country that broadens potential investor base
Benefits to Investors
The main benefit to local investors in purchasing a Eurobond is that it provides exposure to foreign investments staying in the home country. It also gives a sense of diversification, spreading out the risks.
As mentioned previously, Eurobonds are pretty cheap, with a small face value and are highly liquid.
If a Eurobond is denominated in a foreign currency and issued in a country with a strong economy (and currency), then the bond liquidity rises.
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