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8. Junk Bonds
DESCRIPTIVE
1. Trace the development of the International Capital Markets The financial revolution has been characterized by both a tremendous quantitative expansion and an extraordinary qualitative transformation in the institutions, instruments and regulatory structures. Global financial markets are a relatively recent phenomenon. Prior to 1980, national markets were largely independent of each other and financial intermediaries in each country operated principally in that country. The foreign exchange market and the Eurocurrency and Eurobond markets based in London were the only markets that were truly global in their operations. Financial markets everywhere serve to facilitate transfer of resources from surplus units (savers) to deficit units (borrowers), the former attempting to maximize the return on their savings while the latter looking to minimize their borrowing costs. An efficient financial market thus achieves an optimal allocation of surplus funds between alternative uses. Healthy financial markets also offer the savers a range of instruments enabling them to diversify their portfolios.
A key difference between stocks and bonds is that stocks make no promises about dividends or returns. General Electric's dividend may be as regular as a heartbeat, but the company is under no obligation to pay it. And while GE stock spends most of its time moving upward, it has been known to spend months -- even years -- going the other way. When GE issues a bond, however, the company guarantees to pay back your principal (the face value) plus interest. If you buy the bond and hold it to maturity, you know exactly how much you're going to get back (in most cases, anyway). That's why bonds are also known as "fixed-income" investments -- they assure you a steady payout or yearly income. And although they can carry plenty of risk, this regular income is what makes them inherently less volatile than stocks. Global Bond: They have a minimum value of $1 billion and are effected simultaneously in Europe, America and Asia. The salient features of these bonds are that they permit to raise very high amounts. They offer very high liquidity since they are quoted on several exchanges while secondary market functions round the clock, with uniform price all over the world. They are especially used by governments, public enterprises, international organisations and private financial institutions. External Bond Market: The external bond market refers to bond trading activity wherein the bonds are underwritten by an international syndicate, are offered in several countries simultaneously, are issued outside any country's jurisdiction, and are not registered. The Eurobond market is a major external bond market. The external bond market combined with the internal bond market comprises the global bond market. Examples of an external bond are the "global bond," issued by the World Bank, and Eurodollar bonds. Internal Bond Market: The internal bond market refers to all bond trading activity in a given country and is comprised of both a domestic bond market and a foreign bond market. Also referred to as the "national bond market." The internal and external bond markets comprise the global bond market Bulldog Bonds: A sterling denominated foreign bond, priced with reference to the UK gilts. Rembrandt Bond: Denominated in the Dutch guilder. (For more information, please refer to page 504-505 in P G Apte) 3. What are the different international financial markets? The international financial markets consist of the credit market, money market, bond market and equity market. The international credit market, also called Euro credit market, is the market that deals in medium term Euro credit or Euro loans. International banks and their clients comprise the Eurocurrency market and form the core of the international money market. There are several other money market instruments such as the Euro Commercial Paper (ECP) and the Euro Certificate of Deposit (ECD). Foreign bonds and Eurobonds comprise the international bond market. There are several types of bonds such as floating rate bonds, zero coupon bonds, deep discount bonds, etc. The international equity market tells us how ownership in publicly owned corporations is traded throughout the world. This comprises both, the primary sale of new common stock by corporations to initial investors and how previously issued common stock is traded between investors in the secondary markets.
SHORT NOTES
1. Participants in International Project Financing a) Sponsors b) Lenders Sponsors These are partners in the project who bring in the equity capital or risk capital. Being so, they are keenly interested in the successful completion of the project and shoulder major responsibilities as regards its execution. The fact that they bring in the equity capital is an indication of their interest. Also the amount of equity that they bring has a marked bearing on the extent of debt that can be raised for the project. Sometimes people who bring in the equity capital are just the initiators of the project. Included in this category are multinational firms, future buyers of products or services of the project, the public or private investors, international organisations, development banks etc. Lenders They bring in the debt capital. Financing of a big project necessitates intervention of a banking pool consortium composed of banks, national or international financial institutions, export financing institutions etc. Guarantors Guarantees maybe provided by banks, public financing organisations, international financial institutions, private insurance companies etc. Project Operators An operating company intervenes in the erection of the project. It brings its organisational know-how to manage the project.
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4. Counter party Risk - The risk that a counter party will default on a financial obligation. 5. Liquidity Risk -The risk that a financial position cannot be sold quickly at prevailing prices. 6. Delivery Risk - The risk that a buyer will not deliver payment of funds after a seller has delivered securities or
foreign exchange that were purchased.
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7. Rollover Risk - The risk of being closed out from a financial market and unable to renew (or roll over) a 8. Other risks - Other risks relate to the risk of cost overruns and bad management.
3. Financing of MNCs in local or international market Project financing may be defined as financing of an economic unit, legally independent, created with a view to setting up of a big project, which is commercially profitable and financially viable. Project is considered as a distinct legal entity and is financed, to a marked extent, by debt (65 to 75 percent). Therefore the risk to be borne is substantial. There are two major methods of financing international projects: 1. Financing with total risk borne by lenders where only the future cashflows ensure the reimbursement of the loan. This method of financing was used in petroleum and gas industry in the USA and Canada. Due to increased level of risks, this method of project financing is generally not preferred. 2. In another type of financing, both the lender and the promoter share the risk. The problem sometimes encountered in this method is to decide the proportion in which the risk is to be shared between two parties. Domestic v/s Offshore markets Financial assets and liabilities denominated in a particular currency - say the Swiss Franc - are traded are primarily in the national financial markets of that country. These financial markets are known as Domestic Markets. In case of many convertible currencies they are traded in the financial markets outside the country of that currency. These financial markets are known as Offshore Markets. While it is true that neither both markets will offer both the financing options nor any entity can access all segments of a particular market, it is true generally that a given entity has an access to both the segments of the markets for placing as well as raising funds. There are theories by experts that suggest that there are no two types of financial markets (viz. Domestic and offshore markets) but everything is a part of single Global Financial Market. Similarity Experts suggest that arbitrage will ensure that both these markets will be closely linked together in terms of costs of funding and returns on assets. Differences Both of these markets significantly differ on the Regulatory dimension. Major segments of the domestic markets are subject to strict supervision by the relevant authorities such as SEC in US, Ministry of Finance in Japan and the Swiss National Bank in Switzerland. These authorities regulate foreign (non-resident) entities access to the public capital markets in their countries by laying down eligibility criteria, disclosure & accounting norms and registration & rating requirements (similarly for domestic banks, reserve requirements and deposit insurance). The offshore markets on the other hand have minimal regulation and often no registration. Finally it must be noted that though the nature of regulation continues to distinguish Domestic from the offshore markets, there are segments like Private Placements, Unlisted Bonds, Bank loans etc. in domestic markets where regulation tends to be the least.
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