Foreignbonds

Key Takeaways

• A foreign bond is a bond issued by a foreign entity in a domestic market using the domestic market's currency to raise capital.
• Investors benefit from owning foreign bonds by diversifying portfolios internationally without direct currency exchange exposure.
• Foreign bonds carry risks, including interest rate fluctuations, inflation, currency exchange rates, and political stability in the issuing country.
• The yields on foreign bonds are typically higher than domestic ones due to these associated risks.
• Geopolitical factors and repayment risk are significant considerations for investing in foreign bonds.

What Is a Foreign Bond?

A foreign bond is a financial instrument issued by a non-domestic entity in the local market's currency to raise capital. These bonds allow companies to tap into foreign investment markets and offer investors a chance to diversify their portfolios by including international assets, all while maintaining investment in their home currency.

While foreign bonds provide diversification benefits and can protect against currency exchange risk, they also come with unique challenges. Investors must consider interest rate fluctuations, inflation risks, and potential political and economic uncertainties in the issuing country.

Foreign Bonds: Risks and Considerations

Since investors in foreign bonds are usually the residents of the domestic country, investors find these bonds attractive because they can diversify and add foreign content to their portfolios without the added exchange rate exposure. Nevertheless, there are still some unique risks of owning foreign bonds.

Because investing in foreign bonds involves multiple risks, foreign bonds typically have higher yields than domestic bonds. Foreign bonds carry interest rate risk. When interest rates rise, the market price or resale value of a bond falls. For example, say an investor owns a 10-year bond paying 4% and interest rates increase to 5%. Few investors want to take on the bond without a price cut for offsetting the difference in income.

Foreign bonds also face inflation risk. Buying a bond at a set interest rate means the real value of the bond is determined by the amount of inflation taken away from the yield. If an investor purchases a bond with a 5% interest rate during a time when inflation is 2%, the investor’s real payout is the net difference of 3%.

Currency risk is still an implicit issue for foreign bonds. When income from a bond yielding 7% in a European currency is turned into dollars, the exchange rate may, for example, decrease the yield to 2% because of exchange rate differences. Note, however, that this risk is not explicit in the sense that these bonds would always be priced in dollars.

For political risk, investors should consider whether the government issuing the bond is stable, what laws surround the bond’s issuance, how the court system works, and additional factors before investing. Foreign bonds face repayment risk. The country issuing the bond may not have enough money to cover the debt. Investors may lose some or all of their principal and interest.

Examples of Popular Foreign Bonds

There are many examples of foreign bonds, and here we only go over a small few. A bulldog bond, for instance, is issued in the United Kingdom, in British pound sterling, by a foreign bank or corporation. Foreign corporations raising funds in the United Kingdom typically issue these bonds when interest rates in the United Kingdom are lower than those in the corporation’s country.

A Matilda bond is a bond issued in the Australian market by a non-Australian company. For example, in June 2016, Apple Inc. sold $1.4 billion in notes maturing in June 2020, January 2024, and June 2026. Apple joined other companies such as Qantas Airways Ltd., Coca-Cola Co., and Asciano Ltd. in selling securities past the seven-year mark that had been the limit for many nonfinancial corporate borrowers in recent years.

A samurai bond is a corporate bond issued in Japan by a non-Japanese company. In May 2016, French bank Societe Generale SA sold $1.1 billion in samurai bonds, including senior and subordinated bonds maturing in seven years. The sale followed Bank of America Corporation’s $1.08 billion offering in a euro-yen format earlier that month.

Investing

Bonds

Fixed Income