Financial Management

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UNIVERSITY COLLEGE DUBLIN

Bachelor of Science (Singapore)

Financial Management (FIN3003S)

Assignment 1

UCD number: 13207874

Lecturer: Mr Chong Chin Siong

Words count: 900

Recently, there are varieties of option to raise capital for an organization. In addition, companies are not only issuing bonds in domestic markets and local currencies but also can issue bonds in foreign markets and other currencies. Due to interest rates may differ from country to country, ‘companies investing in foreign sovereign bonds to seek higher returns may face higher risks on currency and on credit’.

As the world’s lowest domestic interest rates on Japanese government bonds, Japanese firms are turning to foreign bonds and foreign bond funds to boost portfolio yield potential and provide greater diversification. In the past decade, the world bond markets have been substantial growth and maturation. That, combined with the current globalization of businesses and capital flow, can make foreign bonds a good option for many investors (Hauer, 2013).

Furthermore, issued by national governments lead to sovereign bonds are generally become the safest investments in most countries. Even if countries are not particularly creditworthy, their sovereign bonds are usually safer than their other domestic alternatives. Sovereign debt comes in two general categories: those issued by the national governments of large, developed economies and those issued by emerging market countries. Bonds issued by developed countries (such as United State, Great Britain, Germany, and Japan) usually are considered safe, have high credit ratings, and offer relatively low yields (Hauer, 2013). Bonds issued by emerging market countries usually are perceived as more risky, have lower credit ratings, and thus carry higher yields (Hauer, 2013).

In fact, in Japan due to confronted with low interest rates and sluggish lending at home, Japanese firms were eager to look beyond traditional investments in low-yielding Japanese Government Bonds (JGBs) (Saoshiro, 2014). Saoshiro also shown that Nomura Securities, which led the way by launching bond ladder funds in June 2012, has seen investment by regional financial institutions top 500 billion yen ($4.87 billion) as of end-June. It said about two-thirds are in foreign sovereign bonds from the United States, Germany, France and Britain. In April 2013, the BOJ launched its super loose monetary policy lead to demand for foreign bond ladders increased rapidly. As a result, the benchmark 10-year JGB yield has drifted down to a low 0.5 per cent. While a U.S. Treasury note of the same maturity yields more than 2.5 per cent. That was attractive to Japanese companies investing foreign bonds.

Besides the above attractive, there are some risk from investing foreign bonds include risks on currency and on credit. Firstly, currency risk and its effects are principal on interest. Purchasing foreign currency bonds involve conversion from Japanese yen into a foreign currency and are subject to exchange rates. The exchange risk can account for a significant portion of a bond’s risk and return. Therefore, it is crucial to understand the volatility of the base currency in which the bond is issued, as well as its relationship to the Japanese yen. Even though the purchase is confirmed and settled in Japanese yen, the principal and interest payments remain at risk due to currency fluctuations. This means that even if held to maturity, the proceeds may be more or less than the stated par value after the currency conversion. The same applies to coupon payments during the life of the bond. For example, a Japanese firm wishes to purchase $ 100,000 face value of a five-year U.S. Treasury Note paying 5%. The current price in the foreign currency is 100% of face value. Let assume that the currency exchange rate at the time of trade is 120 JPY for every U.S dollar [$1 = ¥120]. So the cost of the trade in Japanese yen is ¥12,000,000. The client holds the bond to maturity and receives all interest and principal due, paid in U.S dollar. Let’s assume that, on the maturity date, the prevailing exchange rate is $1 = ¥115. The client receives ¥11,500,000, thereby losing ¥500,000 of invested principal. The same risk applies to the coupon payments.