What is Eurobond? Definition, Benefits and How it Works

Eurobonds allow businesses to issue bonds in foreign currency, to raise funds. At present, Eurobonds play a key role in global finance, offering investors opportunities to raise capital beyond their home markets.

In this blog post, we will learn the Eurobond definition and an analysis of the Eurobond market.

Eurobonds Meaning?

A Eurobond, which is also called an external bond is a fixed-income debt instrument that allows entities to raise funds in a currency other than the country where the bond is issued. These bonds usually have a long-term maturity of 5 to 30 years.

The term “Euro” in Eurobonds does not mean they are issued in Europe or denominated in euros. Instead, it refers to bonds issued in a foreign currency. The term “Euro” is used because the market for Eurobond initially emerged in Europe in 1960s.

For example, a Eurobond denominated in US dollars is called a Eurodollar bond, while one in Japanese yen is called a Euroyen bond. These bonds provide governments, corporations, and other entities access to international financial markets, enabling them to raise funds from outside their home countries.

How do Eurobonds Work?

Eurobonds are issued by governments, corporations, and financial institutions to raise funds in a foreign currency. They are typically issued through lead ‘managers’ investment banks, which issue and distribute bonds on behalf of the issuer. Once issued, Eurobonds provide investors with fixed interest payments.

The lead manager collects these payments from the borrower and distributes them to bondholders. The issuing country’s authorities do not regulate these bonds, making them more flexible for global investors.

Eurobonds are highly liquid and can be easily traded on stock exchanges. Their small face value makes them affordable for many investors. Since they are issued in foreign currencies, they help borrowers raise capital at competitive interest rates.

Who Issues Eurobonds? How are They Issued?

Eurobonds are issued by various entities that require foreign-denominated funds. They are a viable means of catering to these needs.

Who Issues Eurobonds?

1. Governments: The government issues Eurobonds to finance their infrastructure projects or manage debt.
2. Corporation: Corporations issue Eurobonds to raise capital for business expansion. They prefer the low cost of funding and, therefore, look to many geographies.
3. Financial institutions: Financial institutions also raise capital from Eurobonds to provide loans or diversify investments.
4. International organisations: Similar to the government, specific international organisations are also engaged in issuing Eurobonds to fund global initiatives.

Eurobonds Issuance Process

1. Planning: The issuer determines the bond’s currency, maturity period, and interest rate.
2. Appointment of Underwriters: Investment banks are selected to structure and market the bond.
3. Due Diligence: Underwriters assess the issuer’s financial strength, market conditions, and reputation.
4. Offering Memorandum: A document outlining the bond’s terms, risks, and financial details is prepared.
5. Marketing & Pricing: The bond is promoted to global investors, and pricing is set based on demand.
6. Subscription & Allocation: Investors place orders, and underwriters allocate interest-based bonds.
7. Settlement: Investors transfer funds, and in return, they receive the Eurobonds.
8. Listing & Trading: If chosen, the Eurobonds are listed on a stock exchange for easy trading.

Advantages and Disadvantages of Eurobonds

Advantages of Eurobonds

For Issuers:

• Eurobonds provides its issuer access to international capital markets.
• It allowed the issuer to raise funds in a strong foreign currency.
• Eurobonds help lower borrowing costs compared to domestic loans as the issuer country might have a higher interest rate than foreign countries through which funds will be raised.
• There are no local market restrictions on the issuance of Eurobonds.

For Investors:

• Eurobonds offer diversification opportunities for investment portfolios.
• Eurobonds offer higher yields compared to domestic bonds.
• As the Eurobonds are actively traded, they provide liquidity.
• Additionally, Eurobonds can be issued in foreign currencies, which allows investors to choose from various currencies.

Disadvantages of Eurobonds

Here are some of the disadvantages of Eurobonds for both issuer and investor:

• Exchange rate risks: Eurobonds are issued across countries, leading to vulnerability to specific countries’ political or economic risks and directly affecting exchange rate fluctuations.
• Regulatory risks: In the issuer’s home country, Eurobonds are not regulated in the home country, making the Eurobonds riskier compared to other debt instruments.
• High issuance costs: Trading in Eurobonds is more expensive and requires the involvement of a broker.

Delivery and Market Size of Eurobonds

Eurobonds are generally delivered electronically to investors through book-entry systems. This makes the process more efficient and secure by eliminating the need for physical certificates. Investors receive confirmation of their ownership electronically, and the bonds are held in their accounts with custodian banks or financial institutions.

In terms of market size, the Eurobond market has shown significant growth and popularity among issuers and investors. Eurobond market size is expanding due to factors such as international capital flows, diversification of investment portfolios, and flexibility in terms of currency choice.

Eurobonds vs Foreign Bond

Following are some differences between the Eurobonds and Foreign Bond

Conclusion

Eurobonds are a vital tool for global financing, allowing issuers to raise funds internationally and investors to diversify their portfolios. While they offer benefits like liquidity, higher returns, and access to foreign currency, they also carry risks such as exchange rate fluctuations and regulatory challenges. Investors should thoroughly research before investing in Eurobonds to balance potential rewards with associated risks.