Foreign bond

What is a Foreign Bond?

A foreign bond is a debt security issued in a domestic market by a foreign entity in the domestic market's currency as a means of raising capital. For foreign firms doing a large amount of business in the domestic market, issuing foreign bonds, such as bulldog bonds, yankee bonds, and samurai bonds, is a common practice. This allows foreign borrowers to tap into the domestic markets to secure funds efficiently.

Foreign Bonds Explained

Since investors in foreign bonds are usually the residents of the domestic country, these bonds are attractive because they allow for portfolio diversification without the added exchange rate exposure. Nevertheless, there are still some unique risks of owning foreign bonds.

Investing in foreign bonds involves multiple risks, and thus, they typically offer 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, if an investor owns a 10-year bond paying 4% and interest rates increase to 5%, few investors would want to take on the bond without a price cut to offset the difference in income.

Foreign bonds also face inflation risk. Buying a bond at a fixed interest rate means the real value of the bond is affected by inflation. If an investor purchases a bond with a 5% interest rate during a period of 2% inflation, the investor's real payout is the net difference of 3%.

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

Types of Foreign Bonds

1. Government Bonds. Issued by a national government, these bonds are typically considered low-risk investments. Examples of government bonds include those issued by Mexico, Bonds 2.93% 26aug2044, JPY (JP548400EQ81) and China, Bonds 2.45% 15mar2034, CNY (BCMKFB24004, HK0000998069)

2. Corporate Bonds. Issued by companies or government agencies, corporate bonds offer higher yields compared to government bonds due to higher risk. Corporate bonds issued by multinational corporations fall into this category.

3. Yankee Bonds. Dollar-denominated bonds issued by foreign entities in the U.S. market. These bonds help foreign issuers raise capital in the U.S. and are subject to U.S. regulations. Example:  Commonwealth Bank (New York Branch) Bonds, 4.577% 27nov2026, USD (US20271RAU41)

4. Samurai Bonds. Yen-denominated bonds issued by foreign companies in Japan. These bonds allow issuers to tap into the Japanese market and are subject to Japanese regulations. Example: Renault Bonds, 2.8% 22dec2026, JPY (26th) (10261238, JP525019ANC9)

5. Bulldog Bonds. Issued by foreign entities in the United Kingdom, these bonds are denominated in British pounds and allow foreign firms to access the UK market. Example: Abrus Resources Bonds, 7.75% 15mar2028, GBP (GB00BM8GDW62)

6. Maple Bonds. Canadian Dollar-denominated bonds issued by foreign corporations in Canada. These bonds allow foreign issuers raise capital in Canada. Example: Walt Disney Bonds, 3.057% 30mar2027, CAD (CA254687FU53)

7. Kangaroo Bond. Issued by foreign companies in Australia, these domestic bonds denominated in Australian dollars Example: Toronto-Dominion Bank Bonds, 5.248% 23jul2029, AUD (AU3CB0311553)

Risks

1. Interest Rate Risk. Foreign bonds are subject to interest rate risk, meaning that when interest rates rise, the resale value or market price of these bonds declines. For example, if an investor owns a 10-year bond paying 4%, and the interest rate rises to 5%, few investors would buy the bond without a price reduction to offset the income difference.

2. Inflation Risk. When purchasing a bond at a fixed interest rate, the bond's value is impacted by inflation. If an investor buys a bond with a 5% interest rate during a period of 3% inflation, the real payout is reduced to 2%.

3. Currency Risk. Currency risk is inherent in foreign bonds due to fluctuations in exchange rates. For instance, a bond yielding 7% in a European currency might yield only 2% when converted into Indian rupees because of exchange rate differences.

4. Political Risk. Political risk involves the stability of the government issuing the bonds and the legal environment. If the issuing country faces political instability or economic turmoil, it might struggle to meet its debt obligations. This could result in investors losing some or all of their principal and interest payments.