Eurobonds

A Eurobond is an international bond that is denominated in a currency not native to the country where it is issued. Don't let the “Euro” prefix fool you; it’s a historical quirk and has nothing to do with the Euro currency or necessarily with Europe. Think of “Euro” as meaning “external.” For example, if a Japanese company issues a bond in U.S. dollars and sells it in London, that's a Eurobond (specifically, a Eurodollar bond). These bonds were born in the 1960s as a clever way for issuers and investors to navigate around certain national regulations, particularly the U.S. withholding tax on interest payments to foreign investors. They are typically issued by large corporations, international organizations, or governments looking to tap into a global pool of capital. An international underwriting syndicate of banks manages the sale and distribution, making it a truly global financial instrument. For investors, Eurobonds can offer opportunities for diversification and potentially higher yields, but they also come with a unique set of risks.

Imagine a well-known American company, let's call it “Global Tech Inc.,” wants to raise $100 million to expand its operations in Asia. Instead of issuing a regular domestic bond in the United States, it decides to issue a Eurobond.

1. The Issue: Global Tech Inc. issues bonds denominated in U.S. dollars.
2. The Location: It lists these bonds not on the New York Stock Exchange, but on the London Stock Exchange or the Luxembourg Stock Exchange.
3. The Sale: A group of international banks from London, Frankfurt, and Hong Kong work together to sell these bonds to investors all over the world—except, traditionally, to a significant extent within the U.S.

The key here is that the bond is issued outside the regulatory framework of the country whose currency it's in. By issuing a dollar-denominated bond in London, Global Tech Inc. avoids the registration requirements of the U.S. Securities and Exchange Commission (SEC) and, historically, allowed investors to receive interest payments gross, without any tax being withheld at the source.

Eurobonds have a few distinct features that every investor should know.

Historically, Eurobonds were issued as bearer bonds. This meant whoever physically held the bond certificate was considered the owner, offering complete anonymity. You could literally clip a coupon and present it for payment. While this made them popular for privacy and tax avoidance, it also made them attractive for money laundering. Today, due to global regulations, most new Eurobonds are issued in a registered form, just like standard bonds.

The original and most powerful draw of Eurobonds was the absence of withholding tax. For an investor in, say, Switzerland, buying a U.S. corporate bond meant the U.S. government would withhold a chunk of the interest for taxes. But by buying a Eurodollar bond issued by the same company in Luxembourg, the investor received the full interest payment. While many countries have since abolished this tax, this feature cemented the Eurobond market's place in global finance.

The “Euro” prefix is followed by the currency of denomination.

• Eurodollar bond: Denominated in U.S. Dollars.
• Euroyen bond: Denominated in Japanese Yen.
• Euro-renminbi bond: Denominated in Chinese Renminbi.

This means you can invest in a U.S. company but in a yen-denominated bond, or a German company in a dollar-denominated bond, offering complex ways to manage currency risk.

Beneath the international flair, a bond is a loan. A value investor must cut through the noise and assess a Eurobond with the same cold, hard logic as any other investment.

Never be distracted by a fancy structure or a slightly higher yield. Your primary job is to protect your principal.

1. Credit Risk: The most important question is: can the issuer pay you back? It doesn't matter if the bond is sold in London or Timbuktu; if the underlying company or government is financially weak, it's a bad investment. Dig into the issuer's financial health, its debt levels, its cash flow, and its credit rating. For a sovereign debt Eurobond, you must analyze the country's economic stability and political landscape.
2. Currency Risk: This is the big one. If you are an American investor and you buy a Euroyen bond, your return depends on two things: the bond's performance and the JPY/USD exchange rate. If the yen weakens against the dollar, it can erase your interest gains or even lead to a loss in dollar terms. Never invest in a foreign currency bond without understanding this risk and having a strong opinion on the currency's future direction.
3. Geopolitical and Legal Risk: Eurobonds operate in a less-regulated space. This can be a double-edged sword. While it offers flexibility, it can mean fewer protections if things go wrong. Furthermore, the investment is exposed to geopolitical risk—a sudden political crisis in the issuer's home country could make an otherwise solid bond nearly worthless.

While the risks are real, opportunities can exist for the diligent investor.

• True Diversification: Eurobonds can provide exposure to economies and companies you can't easily access through your domestic market. This can be a powerful way to build a robust, diversified portfolio.
• Yield Pickup: Sometimes, an issuer has to offer a higher interest rate on its Eurobond compared to its domestic bonds to compensate investors for the added currency and political risks. A value investor's job is to determine if that extra yield provides a sufficient margin of safety for taking on those risks.
• The Bottom Line: The principles of value investing apply perfectly to Eurobonds. Know what you are lending to. Whether it's corporate debt or a government bond, understand the underlying financial reality. Be skeptical of yields that seem too good to be true, and always demand to be paid fairly for the risks you are taking.