Table of contents
Eurobonds are debt instruments that are issued and traded in a currency that’s not native to the country it is issued in.
Eurobonds are instruments issued and traded outside the jurisdiction of the currency in which they are denominated. These bonds are typically issued by international corporations, sovereign governments, and supranational organisations and are denominated in major currencies such as the US dollar, Euro, or Japanese yen.
In this article, we’ll get to know this financial instrument better, understand why they’re important in a diversified portfolio, and what kinds of returns they offer.
Understanding eurobonds
Bonds are debt instruments. This means that if you’re buying a bond, you’re investing the debt of someone else. For instance, when the government issues bonds, they’re borrowing your money and issuing you a ‘bond’ promising a certain return structure.
This is also why bonds are called ‘fixed income’ securities, because they entail a fixed set of cash flows that investors receive over a predetermined time period.
Eurobonds are also bonds like these, except they’re typically issued by multinational corporations, sovereign governments, and supranational organisations seeking to raise capital in international markets.
Since these bonds are denominated (or sold) in different internationally accepted currencies like the US dollar, Euro, Japanese yen, or Swiss franc, they provide issuers with access to capital globally. They can raise capital within India, for instance, from investors based in the U.S. simply by issuing bonds denominated in the U.S. dollar.
How do eurobonds work?
Here are some general steps associated with issuing eurobonds:
- A company, government, or supranational organisation decides to raise capital by issuing Eurobonds in a particular currency (e.g., US dollars) in a foreign market (e.g., London).
- The issuer appoints one or more investment banks to facilitate the whole process, both from a fundraising and regulatory point of view. These ‘underwriters’, as they’re called, conduct due diligence, determine the bond’s terms (interest rate, maturity, etc.), and market the bond to potential investors.
- Investors, both retail and institutional, from various countries can buy these bonds.
- The issuer collects the proceeds from this bond sale and traditionally stores this capital outside the currency’s jurisdiction.
Eurobonds are typically listed and traded on international stock exchanges or OTC markets. Major financial centres like London, Luxembourg, or Singapore usually host these bonds instead of the currency’s native country.
Key features of Eurobonds
Here are some things you need to know in specific about eurobonds:
- Market size: The global Eurobond market is massive, estimated to be around $25 trillion as of 2022. Sovereign governments and organisations like the World Bank and European Investment Bank are major issuers of Eurobonds.
- Maturity: Eurobonds usually have medium to long-term maturities ranging from 3 to 30 years, with 5-10 years being most common.
- Interest rates: Since these bonds are usually issued by credible governments and large corporations, they’re usually considered safe investments. Hence, they don’t command returns as high as equity markets do.
The pros and cons of eurobonds
For the issuers
Companies that issue eurobonds have several advantages to issuing this debt. First, they get to raise capital in a country of their choice (often where they are based) even if the host country itself doesn’t have the appetite for this investment.
Companies can also raise capital in their desired currency after considering other benefits like tax rules, current exchange rates, and even currency swap rates. For instance, sometimes it might be more beneficial for a Japanese company to raise money in USD to invest in the US rather than in JPY.
Foreign exchange costs and risks that most international conglomerates have to account for in their financial statements is also sometimes reduced by raising capital in the desired currency. Losses on spreads are also saved, leading to higher profit margins and lower costs of debt.
For investors
Investors who are heavily invested in their own country might face undue volatility in their portfolios if stocks or interest rates are particularly unstable. Exposure to eurobonds might offer diversification as well as potential for higher returns.
Frequently Asked Questions
The best bet for you, as an Indian retail investor, to invest in eurobonds is to open an international trading account with a foreign brokerage firm. Now, you can look for funds that invest in these eurobonds.
Generally, interest income from Eurobonds is taxable in India, and capital gains may be subject to taxation based on the applicable tax treaties between India and the country of issuance. We encourage you to consult with a tax professional for specific guidance.
You can manage currency risk most simply by investing in eurobonds that are denominated in the Indian rupee. A more complicated way is to do it the way institutions do – hedge your currency risk by using currency forwards or swaps. However, we would not recommend you do this if you don’t have previous international trading experience.
The Reserve Bank of India (RBI) imposes limits on the amount of foreign investment that Indian residents can make in a financial year. Indian investors like you might also need to comply with specific reporting requirements. This gets more complicated if you’re investing in bonds issued by countries that India has sanctioned, etc.
One way to do this is to review the credit ratings given to the securities by international agencies like Moody’s, S&P, and Fitch. If you have more corporate finance experience, you could also try to analyse key liquidity ratios in the company, including their debt levels, to measure the likelihood of a default.