Eurobonds are international bonds that are issued in currency other than the currency of the country where it is issued. The currency in which Eurobonds are issued determines its name like Euroyen, which are issued in Yen, the currency of Japan and Eurodollar, which are issued in US dollars, the currency of United States.
Euroyen bonds are issued in any other country except Japan and are aimed at borrowing Yen from outside. Similarly, Eurodollar bonds are not issued in United States. It may be issued in say, London, for example, by a company to borrow dollars. Eurobonds are payable to bearer and are exempted from withholding tax.
Autostrade, an Italian motorway network, was the first company to issue European Eurobonds in 1963.
Like book entry bonds which are maintained electronically, holders of Eurobonds, too, are not given any certificates. Clearing systems like Clearstream and Euroclear hold and trade the Eurobonds. Interests are paid regularly at yearly basis and electronically transferred to the account of Eurobond holders. The principal amount is paid at the time of maturity. Through Eurobonds, issuers can raise foreign currency for longer duration generally at a fixed rate of interest.
For issuers of the bond, Eurobonds are an attractive option since they can choose the country and the currency in which they want to issue the bonds. Investors, too, find Eurobonds attractive since these bonds have a high liquidity and small par values. The buyers or investors of these Eurobonds are generally large companies, banks or financial institutions and governments and not individuals.
How do Eurobonds function?
Many multinational companies generally issue Eurobonds to collect funds for opening a new subsidiary abroad. Suppose, a US-based multinational wants to start its operations in India, the company would need Indian rupees for the operation of its new subsidiary. The company or the parent company will issue a Eurobonds in Indian currency which will be sold to the investors having Indian currency outside India. The investors will provide Indian currency to the parent company in return of Eurobonds. The parent company will transfer the funds as a loan to its subsidiary. When the subsidiary starts earning, it will transfer its earnings to repay the interest on the loan taken from the parent company, which on its part will pay the interest to its investors.
One of the advantages for a company to issue Eurobonds is that it reduces the risk. The parent company is free from the currency risk because its liability ( the bond issued in Indian rupees) is balanced by its asset ( the loan given to the subsidiary in Indian rupees) so even if there is any change in the value of Indian rupees, the parent company will not be affected.
Eurobonds come with a fixed rate of interest or floating rate of interest.
Fixed rate of interest: In such Eurobonds, rate of interest remains the same throughout the duration of the bond. Such types of bonds have higher interest rate risk because even if the interest prevailing in the market is high, the holder of such a bond would continue to get the rate between the issuer and the investor.
Floating rate of interest: In such Eurobonds, the interest or coupons paid annually to the investors varies from year to year. If the interest rate prevailing in the market is high, the investor will get more interest and if the interest rate is less, he will get less interest. Bonds that have floating rate of interest have lesser degree of risk as far as interest rate is concerned.
As compared to Eurobonds, foreign exchange bonds have to face currency risk since the bond is issued in a foreign currency. In case of fluctuations in the value of currency the investor may not get affected. On the other hand, Eurobonds help parent company to maintain the balance between its liabilities (the issuance of the bond) and asset (loan granted to its subsidiary), preventing it from facing currency risk. Investors of Eurobonds are not much affected by the fluctuations in currency.
Also, an international syndicate underwrites the Eurobonds, which is not required to follow rules and regulations of any country. On the other hand, foreign exchange bonds have to follow rules and regulations of the country in whose currency the bond has been issued.
Thus Eurobonds are the best options for the bog and multinational companies to raise funds for starting up its subsidiary in another country.