The Global Capital Market: Prof. Ian Giddy New York University

The Global Capital Market
Prof. Ian Giddy

New York University
The International Capital Market
 International bank financing

 Eurobonds, foreign bonds and global
bonds
 “A Day in the Life”
The secondary market
The primary market
 Structured financing
Copyright ©1996 Ian H. Giddy The Global capital Market 2

Short-Term Financing: Evolution
DIRECT
COMMERCIAL PAPER
ENHANCED
BANK L/Cs
INTERMEDIATED BANK LOANS

Alternative Sources of FINANCING
Short-Term Financing
DOMESTIC DEBT EQUITY

LOANS
EUROMARKET
LOANS
SYNDICATED
EUROCREDITS
NOTE ISSUANCE
FACILITIES
EUROCOMMERCIAL
PAPER
A Revolver
The Bigfoot Group
RUF Structure:
£115,000,000
Arranger equivalent
Committed Revolving Facility
Underwriting Arranged by
Credit Suisse First Boston Limited
banks
Underwriting Banks
Tender ABN-AMRO N.V. Banque Indosuez Crédit Lyonnais

Deutsche Bank Fuji International Finance Limited Banque Paribas
Samuel Montague & Co. Limited County Bank Kredietbank
panel Banque Bruxelles Lambert S.A. Citibank Crédit Suisse
Sumitomo Finance International Westdeutsche Landesbank Girozentrale
o Finance International Westdeutsche Landesbank
Agent Tender Panel Members
ABN-AMRO N.V. Indosuez Crédit Lyonnais CIBC Limited
Deutsche Bank Fuji International Finance Limited Banque Paribas
LTCB International Limited J.P. Morgan County Bank Kredietbank
Banque Bruxelles Lambert S.A. Citibank Crédit Suisse Commerzbank
Merrill Lynch Capital Markets Sumitomo Finance International
Salomon Brothers International Westdeutsche Landesbank Girozentrale
Tender Panel and Facility Agent

Credit Suisse First Boston Limited

RUF Stuff
Need lots of money fast? Arrange syndicated

YES
Have trouble accessing CP market? credit
Confident of always being able Arrange Euronote

YES
to access the short-term market? program
Arrange RUF or MOF:

Underwritten Euronote program
Need funds? Don’t issue paper

NO
Cannot sell paper at L+10bp? Borrow from banks

YES
Issue Euronotes or other paper

Alternative Sources of FINANCING
Long-Term Financing
 Bank credits - syndicated
DEBT EQUITY
lending and facilities
 Bonds
Domestic, foreign, Euro
Public, private
Structured, such as principle-indexed notes
 Medium-term notes
 Asset-backed financing and leasing
 Project financing

Long-Term Financing: Evolution
DIRECT
PUBLIC BONDS
ENHANCED
BANK-GUARANTEED BONDS
INTERMEDIATED BANK TERM LOANS

The Global Bond Market
 Domestic bonds
 Foreign bond
(Issued within country of currency, by non-
resident issuers)
 Eurobonds
(Issued and sold in a jurisdiction outside the
country of the currency of denomination)
 Global Bonds
(Issued in the domestic and the Eurobond
markets simultaneously)
The Global Bond Market
 Domestic bonds
 Foreign bond
(Issued within country of currency, by non-
resident issuers)
 Eurobonds
(Issued and sold in a jurisdiction outside the
country of the currency of denomination)
 Global Bonds
(Issued in the domestic and the Eurobond
markets simultaneously)
International Bond Markets are Linked
 Issuers and investors compare terms in the

domestic and Eurobond markets, which are
linked across currencies via currency swaps
Domestic US Domestic
BOND Japanese
MARKETS - Gov't
WITHIN - Corporate - Gov't
COUNTRY - Corporate
OF Foreign
CURRENCY Bonds Foreign
"Yankee" Bonds
"Samurai"
Currency
Swaps
BOND
MARKETS
OUTSIDE Eurodollar Euroyen
COUNTRY Bond Market Bond Market
OF
CURRENCY
Long-dated
Forward
Exchange

Foreign Bonds
 A foreign bond is a bond issued in a host

country's financial market, in the host country's
currency, by a foreign borrower
 The three largest foreign bond markets are
Japan, Switzerland, and the U.S., representing
issuance of about $40 billion in bonds annually

Private Placements and Rule 144A
The private placement exemption from
registration and disclosure is extended to
Eurobonds as long as the U.S. investors meet
the following requirements:
 They are large and sophisticated
 There are only a few investors
 They have access to information and analysis similar
to that which would ordinarily be contained in a
registered offering prospectus
 They are capable of sustaining the risk of losses,
and
 They intend to purchase the bonds for their own
investment portfolios, and not for resale.
Characteristics of Eurobonds
 Issued outside country of currency

 Not subject to domestic registration or disclosure
requirements
 In most cases take form of private placements
 Placed through syndicates in many countries who sell
principally to nonresidents
 Bonds are structured so as to be free of withholding tax
 Bearer form
But...
 Eurobonds usually influenced de facto by government
and banks of country of currency

Global Bonds

Key Dates in the Issuance of a Eurobond
Issuance need or
opportunity identified
Issuer
discusses
deal with
lead Announcement of
manager Eurobond issue
Syndicate
formed,
bonds
"presold" Offering day:
prior to Eurobond issued
final terms
Final
terms,
bonds sold
by selling
group to Closing day:
investors Eurobonds delivered,
Issuer gets money

Key Players in the Issuance of a
Eurobond
SELLING UNDER-
GROUP MANAGERS
WRITERS

Who Gets What
Fees, percent Fees, amount Net price

Price paid by investor (in theory) 101.50
Price paid by member of selling group 60% 0.90 100.60
Price paid by member
of underwriting group 60%+20% 0.90+0.30 100.30
Price paid by managers
(plus "praecipium" paid to lead manager) 60%+20%+20% 0.90+0.30+0.30 100.00

Pricing Eurobonds in the Secondary
Market
 What "spread to Treasury" should it yield
relative to similar bonds--credit risk, duration
and liquidity--trading in the secondary market?
 Use the desired yield to maturity to find its
present value at the next coupon date.
 Find today's present value of that amount,
including the coupon to be paid
 Actual price is quoted as "clean price," meaning
not counting accrued interest

The Eurobond Secondary Market

Eurobond Secondary Market
Quotations
 Examine the straight bonds listed
What determines the yields?
The bid-offer spreads?
Does this differ by currency?
 Can you explain the pricing

of the floating rate notes?

A Day in the Life
of the Eurobond Market
 Examine the deals
Why were each done in that particular form?
What determines the pricing?
 Can you break the hybrids into their

component parts?

A Day in the Life...
NEW I NTER NA TIONAL BO ND ISSUES

Bo
Bo rrrrowe
owerr Am
Amou
ou nt
nt m
m .. C
Cou
ou pon
pon %
% PPrric
icee M
Maatt ur
urity
ity FFee
eess Boo
Boo kk rruu nn
nn er
er
C elwor ks Trust 1990-1¶ (b) US $250 9 1/4 99.80 1998 1 7/8- 1 5/8 C re dit Suisse
M ar ui Cor p* US $500 (4 3/ 8) 100 1995 2 1/4- 1 1/2 Nom ur a
Holder bank ( a) US $150 9 3/4 101 1994 1 3/8- 1 C SF B
Battle M ountaingold  US $100 7 1/2 100 2006 2 1/2- 1 1/2 M er rill Lynch
SN CF F F r750 9 1/4 98.55 1997 1 7/8- 1 1/4 CCF
Viennische Sta dtsba nk (a) L100bn 13 101 3/8 1994 1 3/8- 7/8 BN L
Eur ofim a (a ) P ta10bn 12 5/8 101 1/8 1996 1 5/8- 1 De utsc he Bank
Ir ish Bldg Soc .(a ) ¥15bn 7.4 101 5/8 1995 1 5/8- 1 1/8 IB J
Bank of M ontreal(c ) ¥2.8bn 7 1/4 101 1/8 1993 1 1/8- 5/8 Nippon C re dit
¶ F inal te rm s. *With equity war r ants. P rivate plac em ent. C onvertible. (a) Non-c allable. ( b) C allable at par af ter 5 year s. I f c all not
exe rcise d, bond pays 50bp over Libor in last year . (c) Rede mption linked to Nikkei stock index .

Asset-Backed Eurobonds
Legal risk:
Legal structure: sale of assets to separate
subsidiary that issued ABS.
Default risk:
Overcollateralization dictated by rating
agencies
Replenishment of collateral
Third-party garantees.
Prepayment risk:
Early redemption caused by “spread trigger”.
Equity-Linked Eurobonds
 Eurobonds with warrants

Marui
 Convertible Eurobonds
Battle Mountaingold
 Index-linked Eurobonds
Bank of Montreal

Equity Financing Choices
Warrants Conver-
tibles
Equity
ADRs Common

Values and Market Premium
V Conversion
a
l Value
u
e
o Market
f Value
C
o
Market Premium
n
v
e
r
t Straight
i
b
l
Bond Value
e
B
o
n
d
($) 0
Price Per Share of Common Stock
Copyright 1994, HarperCollins Publishers
Values and Warrant Premium
V
a
l
u
e
o
f
W
a Market
r Value
r Theoretical
a Market Premium
n Value
t
($)
0
Price Per Share of Common Stock ($)

“Hybrid” Features
of A Bond Issue
 Conversion Feature - compound

option
 Warrants - two instruments
 Index-linked bonds
 Call Feature
Bond value = straight bond value - call value
These are all example of hybrid bonds and
should be priced by decomposition
International Equity Markets and
Portfolio Diversification
 No well-accepted international version of the capital
asset pricing model.
 The benefits of diversification globally are empirical
issues.
 The empirical case for international diversification has
two components.
 Establish the riskiness of foreign investment, and the extent to
which combining a foreign with a domestic portfolio reduces
risk.
 Even if it reduces risk, does foreign investment also reduce
expected return?
 Then what we have to do is make sure we understand
how international diversification is best achieved.

Portfolio Return and Risk
Portfolio return:
n
E( R p ) =  w i E( Ri )
i=1
where wi are the weights of each asset in the portfolio.
(Expected return is simply the weighted sum of the
individual asset returns.)
Portfolio variance:
n n
   w i w j  i  j  ij
2
P =
i=1 j=1
When i = j, the term wiwjFiFjDij becomes wi2Fi2.

The Minimum-Variance Frontier of
Risky Assets
E(r)
Efficient frontier
Individual
assets
Global minimum-
variance portfolio

Optimal Overall Portfolio
E(r) Indifference CAL

curve
P Opportunity
set
Optimal complete
portfolio

The Global Efficient Frontier
AVERAGE RETURN
% PA
30
STOCKS
AND STOCKS
BONDS ONLY
25
20
15
EAFE EAFE STOCKS

STOCKS
& BONDS
10
WORLD STOCKS
WORLD STOCKS & BONDS
US STOCKS
US STOCKS & BONDS
US BONDS RISK, % PA
5
5 10 15 20 25 30
Evidence Suggests Index Funds are
Not for the International Investor
 For the international investor the capitalization-
weighted portfolio may not be the optimal one.
The reason is market segmentation. The world
stock market is not efficient yet, the evidence
suggests, at least not in the "mean-variance
efficiency" sense that is required by the CAPM.
 Because of real exchange risk (deviations from
PPP), what is the optimal portfolio for an
investor in one country may not be the optimal
portfolio for an investor in another, even if there
were a single risk-free asset acceptable to both.
 Studies confirm these propositions
International Portfolio Optimization:
Passive vs Active Portfolios
(Let the proportions of all possible assets vary until the
optimal proportions are found.)
RETURN
The results of
0.23
letting the 0.22
0.21
100% Japan
computer
0.2
find the best 0.19 Minimum risk
portfolio Market capitalization
0.18
proportions for 0.17 weighted portfolio
various levels 0.16

0.15
of return: 0.14
0.13 Same risk as 100% USA,
but higher return
0.12
0.11 100% USA portfolio
0.1
0.05 0.1 0.15 0.2 0.25 0.3 0.35
RISK
Copyright ©1996 Ian H. Giddy (STANDARD DEVIATION)
The Global capital Market 40
Obstacles to International Investment
Might Include:
 Information barriers.
 Political and capital control risks.
 Foreign exchange risks.
 Restrictions on foreign investment and
control.
 Taxation.
 Higher costs.

Conclusion:
 The international equity market is

imperfect
 Hence there may be advantages to
international equity issuance
 How should companies achieve this?

Financing with
Structured Securities
Prof. Ian Giddy

New York University
Principles of Innovation Through
Financial Engineering
 Bundling and unbundling basic instruments
 Exploiting market imperfections (sometimes
temporary)
 Creating value added for investor and issuer
by tailoring securities to their particular
needs
Key: For the innovation to work, it must

provide value added to both issuer and
investor.
Anatomy of a Deal
Issuer:
Looking for large amounts of floating-rate
USD and DEM funding for its loan porfolio.
Wants low-cost funds: target CP-.10
Is not too concerned about specific timing
of issue, amount or maturity
Is willing to consider hybrid structures.

Anatomy of a Deal
Investor:
Has distinctive preference for high grade
investments
Looking for investments that will improve
portfolio returns relative to relevant indexes
Invests in both floating rate and fixed rate
sterling and dollar securities
Can buy options to hedge portfolio but
cannot sell options

Anatomy of a Deal
Intermediary:
Has experience and technical and legal
background in structure finance
Has active swap and option trading and
positioning capabilities
Has clients looking for caps and other forms
of interest rate protection.

The Deal
1 Initiate medium term note programme for the

borrower, allowing for a variety of currencies,
maturities and special structures
2 Structuring a MTN in such a way as to meet the
investor’s needs and constraints
3 Line up all potential counterparties and
negociate numbers acceptable to all sides
4 Upon issuer’s and investor’s approval, place
the securities

The Deal / 2
5 For the issuer, swap and strip the issue into the
form of funding that he requires
6 Offer a degree of liquidity to the issuer by
standing willing to buy back the securities at a
later date.

The Issue
 Issuer: Deutsche Bank AG

 Amount: US$ 40 Million
 Coupon:
First three years: semi-annual
LIBOR + 3/8% p.a., paid semi-annually
Last 5 years: 8.35%
 Price: 100
 Maturity: February 10, 2000
 Call: Issuer may redeem the notes in full at par on
February 10, 1995
 Fees: 30 bp
 Arranger: Credit Swiss First Boston
The Deal in Detail
Deutsche sells 3-year
floating rate note paying SCOTTISH
DEUTSCHE LIBOR - 3/8%
LIFE
For an additional 3/4% p.a.,
For 1% p.a., Deutsche buys three-
Deutsche sells year put option on 5-year
CSFB a swaption fixed-rate 8.35% note to
(the right to pay SL in 3 years
fixed 8.35% for 5
years in 3 years)
CSFB sells the swaption to a
corporate client seeking to
CSFB hedge its funding cost CLIENT
against a rate rise

What’s Really Going On?
Note:
 Issuer has agreed to pay an above-market rate
on both the floating rate note and the fixed rate
bond segment of the issue
FRN portion: .75 % above normal cost
Fixed portion: .50% above normal cost
 Issuer has in effect purchased the right to pay a
fixed rate of 8.35% on a five-year bond to be
issued in three years time.

Motivations for Issuing Hybrids Bonds
 Company has a view

 There are constraints on what the
company can issue
 The company can arbitrage to save
money
 Always ask: given my goal, is there an
alternative way of achieving the same
effect (e.g., using derivatives?)

The International Capital Market
 International bank financing

 Eurobonds, foreign bonds and global
bonds
 “A Day in the Life”
The secondary market
The primary market
 Structured financing

The Global Capital Market: Prof. Ian Giddy New York University

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The Global Capital Market

Prof. Ian Giddy

 International bank financing

Copyright ©1996 Ian H. Giddy The Global capital Market 2

INTERMEDIATED BANK LOANS

Copyright ©1996 Ian H. Giddy The Global capital Market 3

DOMESTIC DEBT EQUITY

Tender ABN-AMRO N.V. Banque Indosuez Crédit Lyonnais

Tender Panel and Facility Agent

Copyright ©1996 Ian H. Giddy The Global capital Market 9

Need lots of money fast? Arrange syndicated

Confident of always being able Arrange Euronote

Arrange RUF or MOF:

Need funds? Don’t issue paper

Cannot sell paper at L+10bp? Borrow from banks

Issue Euronotes or other paper

Copyright ©1996 Ian H. Giddy The Global capital Market 11

INTERMEDIATED BANK TERM LOANS

Copyright ©1996 Ian H. Giddy The Global capital Market 12

 Issuers and investors compare terms in the

Copyright ©1996 Ian H. Giddy The Global capital Market 15

 A foreign bond is a bond issued in a host

Copyright ©1996 Ian H. Giddy The Global capital Market 16

 Issued outside country of currency

Copyright ©1996 Ian H. Giddy The Global capital Market 18

Copyright ©1996 Ian H. Giddy The Global capital Market 19

Copyright ©1996 Ian H. Giddy The Global capital Market 20

Copyright ©1996 Ian H. Giddy The Global capital Market 21

Fees, percent Fees, amount Net price

Copyright ©1996 Ian H. Giddy The Global capital Market 22

Copyright ©1996 Ian H. Giddy The Global capital Market 23

Copyright ©1996 Ian H. Giddy The Global capital Market 24

 Can you explain the pricing

Copyright ©1996 Ian H. Giddy The Global capital Market 25

 Can you break the hybrids into their

Copyright ©1996 Ian H. Giddy The Global capital Market 26

NEW I NTER NA TIONAL BO ND ISSUES

Copyright ©1996 Ian H. Giddy The Global capital Market 27

 Eurobonds with warrants

Copyright ©1996 Ian H. Giddy The Global capital Market 29

Copyright ©1996 Ian H. Giddy The Global capital Market 30

Values and Warrant Premium

Copyright ©1996 Ian H. Giddy The Global capital Market 32

 Conversion Feature - compound

Copyright ©1996 Ian H. Giddy The Global capital Market 34

When i = j, the term wiwjFiFjDij becomes wi2Fi2.

Copyright ©1996 Ian H. Giddy The Global capital Market 35

E(r) Indifference CAL

EAFE EAFE STOCKS

various levels 0.16

Copyright ©1996 Ian H. Giddy The Global capital Market 41

 The international equity market is

Copyright ©1996 Ian H. Giddy The Global capital Market 42

Prof. Ian Giddy

Key: For the innovation to work, it must

Copyright ©1996 Ian H. Giddy The Global capital Market 46

Copyright ©1996 Ian H. Giddy The Global capital Market 47

Copyright ©1996 Ian H. Giddy The Global capital Market 48

1 Initiate medium term note programme for the

Copyright ©1996 Ian H. Giddy The Global capital Market 49

Copyright ©1996 Ian H. Giddy The Global capital Market 50

 Issuer: Deutsche Bank AG

Copyright ©1996 Ian H. Giddy The Global capital Market 56