Page 252 - DMGT545_INTERNATIONAL_BUSINESS

Unit 13: Basics of International Accounting and Financial Management

types of Debt instruments notes

The international bond markets have been more innovative than the domestic bond market in the
types of instruments offered to investors.

Straight Fixed Rate Issues

Straight fixed rate bond issues have a fixed maturity date at which the principal value of the
bond is promised to be repaid. During the tenure of the bonds, fixed coupon payments which are
a percentage of face value are paid as interest to the bond holders. In contrast, domestic bonds
make semi-annual coupon payments. The reason is that Euro bonds are usually bearer bonds and
annual coupon redemption is more conversant for the bond holders and less costly for the bond
issuer since the bond holders are scattered geographically.

Floating Rate Notes

Floating Rate Notes (FRNs) are typically medium term bonds with coupon payments indexed to
some reference rate. Coupon reference rates are either 3 months or 6 months.
Nations LIBOR. Coupon payment on FRNs is quarterly or semi annually and in accordance with
the reference rate. For example, consider a five year FRN with coupon referenced to 6 months
dollar LIBOR paying coupon interest semi annually. At the beginning of every 6 month period,
the next semi annual coupon payment is reset to be 0.5 x (LIBOR + x percent) of face value, where
x represents the risk premium over LIBOR. The issuer must pay based on its creditworthiness.
As for example, if x equals 1/8 percent and the current 6 month LIBOR is 6.6 %, the next period
coupon rates on a $1000 face value FRN will be 0.5 x (0.066 + .00125) x $1000 = $ 33.625. If on
the next reset date six month LIBOR is 5.7%, the semi annual coupon will be set at 0.5 x (0.057 +
0.00125) x $1000 = $ 29.125.

Equity Related Bonds

There are two types of equity related bonds; convertible bonds and bonds with equity warrants.
A convertible bond allows the investor to exchange the bond for a predetermined number of
equity shares of the owner. The floor value of a convertible bond is straight fixed rate bond value.
Convertible usually sell at a premium above the straight debt value and their conversion value.
Additionally, investors are usually willing to accept a lower coupon rate of interest than the
comparable straight fixed coupon bond rate because of attractive terms of the conversion.
Bonds with equity warranty: can be viewed as straight fixed rate bonds with the addition of a call
option (or warrant) feature. The warrant entitles the bond holder to purchase a certain number of
equity shares of a pre stated price over a predetermined period of time.

Did u know? The convertible bond markets in the United States and Japan are of primary
global importance. These two domestic markets are the largest in terms of market
capitalization.

Zero Coupon Bonds

Zero coupon bonds are sold at a discount from face value and do not pay any coupon interest
over the tenure. At maturity the investor receives the full face value. Alternatively, some zero
coupon bonds originally sell for face value and at maturity the investor gets something for the
use of the money.

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