any shortfall needed to pay the investors. If funds are drawn down
during a particular period they will usually be repaid later if the
Further reserve funds can be built up into separate ways. Either a
portion of the proﬁts upon issuance is placed on deposit, or the excess
servicing spread is pooled (if any). These represent proceeds generated
from the difference between the incoming payments and the debt ser-
1.8 International bonds
The International (often called the Eurobond) market is now one of the
largest and most important sources of capital. It continues to grow and
develop new structures in response to the varying demands placed
upon it by the investor community (Figure 1.22).
The International marketplace can only be used by a good credit
including some governments, large corporates and supranationals.
Investors are predominantly institutional but the private client is also
important, looking to invest in the Eurobond market due to a lack of
development within their domestic market. Indeed many instruments
are designed to be tax efﬁcient speciﬁcally to appeal to the private
The distinguishing characteristic of the Eurobond is the nature of
issuance. They are placed across borders by an international syndicate
of banks. This method of issuance is distinct from the auction system
characteristic of government bonds. The bond is subsequently traded
OTC by the market participants in a number of international ﬁnancial
centres. A further characteristic of the market is the lack of any one cen-
tral authority to provide regulation. They are, however, usually registered
on a national exchange enabling some types of institutional investor
access to the market who might otherwise be frozen out. Possibly because
of local legislation banning the holding of non-exchange traded assets.
30 Credit risk: from transaction to portfolio management
Figure 1.22 International bond volumes by country (May 2003). Source:
The major currencies of issuance are the dollar, euro, sterling and
yen. The term ‘euro’, originally used as a preﬁx, was coined to repre-
sent dollar deposits within Europe in the 1960s. These received a pref-
erential rate due to the perception of higher risk. Now we have a
situation where ‘euro’ refers to any currency on deposit outside of the
country of issue. For example sterling on deposit in Japan would be
called eurosterling. The currency of issuance does not necessarily
match the currency in which the borrower is domiciled, indeed the
currency will be chosen on the basis of how attractive that debt will be
perceived by the investor community within that currency.
Interest on Eurobonds is paid gross of any tax. They are bearer
bonds and have no central register. However, they are usually held in
a central repository for settlement purposes. These features were key
to the development of the market.
The majority of Eurobonds are conventional bullet structures with a
ﬁxed coupon and maturity date. The latter typically from 5 to 10 years,
many bonds are considerably longer dated. This is particularly true of
the eurosterling market, thus meeting the considerable demand of
institutional clients which have long dated pension obligations.
The bond is typically unsecured and consequently depends upon the
borrower’s credit worthiness in order to appeal to the investor base.
The Eurobond market gave birth to the FRN. Here the coupon pay-
ment varies and is dependent upon a reference rate typically either
libor or euribor. There will be an additional spread, dependent upon
the credit quality of the issuer. For example borrowers with a poorer
credit than AA (which is representative of the swap market) will be
referred to as libor plus borrowers, conversely issuers with a better
credit than AA will be able to borrow at libor minus. Typically spreads
range from 10 to 200 basis points.
Common non-vanilla structures, especially within the sterling mar-
ket are perpetuals, which pay a regular coupon but do not mature,
and conventional bonds with an embedded call or step up feature. We
have discussed these arrangements and will not go into detail here.
Also important within the Eurobond market is the zero coupon bond
which pays no coupon but is issued at a discount to par. The effective
interest is implied by the return on the difference between par and
the issue price. This return is locked in so effectively represents an
income. However for tax purposes it is categorized as a capital gain
and taxed at a preferential rate. These bonds have correspondingly
become less important within the US and UK who have adjusted their
tax legislation. Correspondingly the return counts as income and not
capital gain. Table 1.4 illustrates a typical deal.
Fixed income credit 31