Why go abroad for holidays? Is it the sun and the sea that draws you, or is it the exhilaration of experiencing new languages and cultures? Perhaps you have family and friends that live abroad and can combine a holiday with a social call. Companies tend to be homebodies, issuing shares and bonds in their country of domicile. But as many companies are now multinational it makes sense to raise capital in the country where capital is needed. If McDonald’s needs to buy properties in China for its expanding franchise then it makes sense to raise capital in the local currency. If the capital is raised as debt then the bonds are called eurobonds. This is a confusing name, as it has nothing to do with the euro currency, “euro” simply means “global”.
Another reason for issuing eurobonds is that it might be cheaper than issuing bonds in domestic currency. If this is the case then the cash raised is converted back into the domestic currency. The danger to the issuer is then foreign exchange rate risk, so the way to hedge this risk is to use cross-currency basis swaps. These swap cash flows in one currency with those in another, allowing the issuer to convert the foreign principal and coupon payments back into their domestic currency. A bank’s debt capital markets team will always look at eurobonds as an option, and can advise customers whether issuing in foreign currencies might be cheaper. This depends on borrowing rates in the foreign currency and also on the cross-currency basis swap rate. If there is a huge demand for European companies borrowing dollars this will push up the cross-currency swap rate. On the face of it you might think that eurobonds where the cash is kept abroad create foreign exchange risk for the issuer. However this is not the case because the fluctuation in the value of the foreign cash raised by the issue are exactly cancelled by the value of the foreign debt. Say McDonald’s issues a bond in Australia and the AUDUSD rate falls as the US dollar strengthens against the aussie dollar. The cash raised in AUD will be worth less in USD, but the bonds will be worth more.
As usual in financial markets there is jargon that it helps to know. In the eurobond market the jargon is quite amusing. Bonds tend to take on a name that goes with the national symbol of the country where they are issued. Here are some examples: Matador bonds (Spain), Kangaroo bonds or Matilda bonds (Australia), Samurai bonds (Japan), Yankee bonds (USA), Bulldog bonds (UK), Maple bonds (Canada), Sushi bonds (issued outside Japan by a Japanese domiciled company), Shogun bonds (issued in Japan but in the currency of company domicile), Dragon bonds (issued in Asia but denominated in USD) and Dim Sum bonds (issued in Hong Kong and denominated in Chinese renminbi). Like foreign holidays eurobonds provide some variety for issuers, and help them meet their liabilities in an increasingly globalized World economy.
You can find out more about the way eurobond issues are currency hedged in Chapter 5 of the Financial Bestiary which is all about bonds.