Clearing Up The Myths About Eurobonds And Understand Why They Are A Great Choice For Investors.

Most people assume that a Eurobond and a foreign bond are one and the same when in fact they really are not. A Eurobond is a bond issued and traded in a country other than the one in which it's currency is denominated. Not all originate or circulate in Europe , though most are issued by non-European companies or governments to be traded by European investors.

For example: The French government issues euro-denominated bonds (the Franc was discontinued in 2002) that buy and sell on Japanese financial markets. Issuers get creative. A Eurobond can be denominated in U.S. dollars, but issued in Japan by an Australian company. Even Wal-Mart issues bonds in U.S. dollars that trade on the German exchanges.

In fact, most new issues in the international bond market are Eurobonds and it's now larger than the U.S. bond market. This is because Eurobonds give issuers some additional tools for creative financing, since they can choose a country based on regulatory and tax environment. Investors benefit by having more to choose from.

However nothing is ever without risk and Eurobonds are no different. Most investors are moderately familiar with conditions in their own country. But even in this day of Internet-available international news and financial information, events elsewhere are usually much less well tracked.

Added to the natural ignorance of events far away is the significant risk of foreign currency trading. Compared to the size of currency markets, bond trading is small. The equivalent of over $1.5 trillion dollars per day changes hands in the foreign currency markets. By comparison, U.S. Treasury Securities trade around $360 billion per day.

With Eurobonds, currency exchange is also significantly more volatile. This is due to wider price swings over shorter time frames and greater sensitivity to momentary political changes.

As we know, a bond bought today generally matures a few years later. Suppose, a U.S. investor pays £1,000 (~$1,770 today, hence £1 GBP = $1.77USD today) for a new eurobond which is held to maturity and repaid five years later. When repaid, the issuer repays in GBP (British Pounds) on the face value, £1,000. But in the interim, the exchange rate has changed to £1 = $1.66. The investor will be paid back the equivalent of $1,660. (And this example ignores any complicating factors of local inflation.)

The $110 loss comes entirely from currency risk. Of course, the scales tip both ways. It's possible, and just as likely, for currency rates to change in favor of the investor. The exchange rate may change so that £1 = $1.88.

But then the investment becomes one not merely of bond trading but currency speculation. Not a bad investment medium, millions make enormous sums that way every day, but a much riskier market.

Eurobonds