What are Foreign Bonds? Types, Examples and Risks Involved

Foreign bonds are debt market securities issued by a country or corporation in a currency different from their domestic market. These bonds allow issuers to tap into international capital markets, diversify funding sources, and attract global investors.

Foreign bond examples include Yankee bonds (issued in the U.S. by foreign entities) and Samurai bonds (issued in Japan by non-Japanese entities). Foreign bonds provide exposure to investors to foreign markets and currencies but also carry risks like exchange rate fluctuations and geopolitical uncertainties. They play a vital role in global finance.

What Are Foreign Bonds?

Foreign bonds are issued in a domestic market by foreign governments, businesses, or organisations but denominated in the local currency of that market. They are like borrowing funds in the currency of another country or nation.

The primary objective of foreign bonds is to generate money to finance projects. Some risks associated with buying foreign bonds such as political instability, credit defaults, and currency volatility, might affect returns.

Foreign bond investments can be profitable, but they must be considered carefully. Spreading your investments across several nations can lower risks and improve chances. If you are curious about expanding your investments beyond domestic assets, consult your financial advisor to explore the potential of foreign bonds.

Remember, international investing can yield sufficient returns, but it is unpredictable.

Types of Foreign Bonds

Foreign bonds come in various forms, each catering to different markets and investor needs. Here are three types of foreign bonds:

Yankee Bonds

Yankee Bonds are U.S. dollar-denominated bonds issued by foreign governments, corporations, or supranational organisations in the American bond market. The SEC regulates these bonds, requiring issuers to follow U.S. accounting practices and obtain credit ratings from American agencies.

Yankee bonds are regulated by the U.S. Securities and Exchange Commission (SEC). The Securities and Exchange Board of India (SEBI) has no role in their issuance or regulation unless the bond is issued in India.

A notable example of Yankee bonds is when Reliance Industries Ltd. successfully issued a 50-year Yankee bond worth USD 100 million.

Samurai Bonds

Samurai Bonds are yen-denominated bonds issued in Japan by non-Japanese entities. Issuers must have a minimum investment-grade rating (A or higher) and can include supranational organisations, sovereigns, or high-quality private corporations.

Entities with strong trade links to Japan are often prioritised. Samurai bonds typically have maturities of 3 to 20 years. However, the settlement and administrative processes for These bonds can be costly.

A good example of Samurai bonds is when the World Bank issued the first Samurai Bond in 1985.

Bulldog Bonds

Bulldog Bonds are sterling-denominated bonds issued by foreign entities in the UK domestic market. They usually have longer maturities, ranging from 5 to 25 years or more. Bulldog bonds allow investors to diversify their portfolios with sterling-denominated assets and give overseas issuers access to the UK’s financial markets.

Foreign Bonds Risks

Investment in foreign bonds brings about geographical diversification and greater returns but also carries substantial risks that need proper consideration. Here are some of the primary dangers stemming from international bond investments:

• Interest Rate Risk

Foreign bonds are sensitive to changes in interest rates. When interest rates rise, the market value of existing bonds typically falls, as newer bonds offer higher yields.

For example, if an investor holds a 10-year bond with a 4% yield and foreign bond rates rise to 5%, the bond’s resale value will decline. This risk is particularly pronounced in volatile markets, where interest rate fluctuations can significantly impact bond prices.

• Inflation Risk

Inflation erodes the actual returns of fixed-income investments. If an investor purchases a bond with a 5% interest rate but inflation rises to 3%, the real return drops to just 2%. In countries with high or unpredictable inflation, this risk can severely diminish the purchasing power of bond returns, making foreign bonds less attractive.

• Currency Risk

Currency fluctuations can significantly affect the returns of foreign bonds. For instance, a bond yielding 7% in a foreign currency might only yield 2% when converted back to the investor’s home currency due to unfavourable exchange rate movements. This currency risk in foreign bond investment is inherent in all foreign bond investments and can lead to unexpected losses.

• Political Risk

Bond repayments may be threatened due to political unrest in the issuing nation. Economic penalties, civil instability, or changes in governmental policies could also result in defaults or delays in interest payments. For instance, investors risk losing principal and interest if a nation experiencing political unrest finds it challenging to fulfil its debt commitments.

• Credit Risk

Foreign bonds carry the risk of default by the issuer, especially in emerging markets with weaker financial systems. Even if a bond has a high credit rating, systemic risks or economic downturns in the issuing country can increase the likelihood of default. Investors must assess the issuer’s creditworthiness and monitor economic conditions to mitigate this risk.

Conclusion

Foreign bonds allow issuers to raise money internationally while providing investors with exposure to global markets and diversification. These bonds offer opportunities to invest in numerous currencies and geographical areas and come in various types, including Yankee bonds, Samurai bonds, and Bulldog bonds.

However, they also have inherent risks that might affect returns, including inflation, credit defaults, political unpredictability, currency fluctuations, and interest rate changes. Therefore, careful investigation and risk evaluation are crucial before purchasing foreign bonds. Consulting a financial adviser can help navigate these complications and ensure that investments in foreign bonds align with one’s personal risk tolerance and financial objectives.