Lesson 2.5: Foreign Debt Securities

The term Eurodollars refers to A)a worldwide currency system that is expected to someday replace existing currency systems. B)obsolete currency that was formerly backed by the gold standard. C)American dollars held by banks in other countries, especially in Europe. D)European currency held in U.S. banks.

C)American dollars held by banks in other countries, especially in Europe. Explanation American dollars held in international banks, especially—but not exclusively—in Europe, are known as Eurodollars.

When a U.S. resident investor purchases foreign bonds, A)depreciation of the bonds and appreciation of the foreign currency benefit the domestic investor. B)appreciation of both the bonds and the foreign currency benefits the domestic investor. C)depreciation of both the bonds and the foreign currency benefits the domestic investor. D)appreciation of the bonds and depreciation of the foreign currency benefit the domestic investor.

B)appreciation of both the bonds and the foreign currency benefits the domestic investor. Explanation In the same manner that purchasing foreign equities adds diversification to a portfolio, purchasing foreign bonds does as well. As with any security, if the value goes up (it appreciates), that is a benefit to the investor. When foreign securities are involved, there is another concern—currency risk. Because the foreign bond is denominated in the local currency, an increase in that currency's value versus the U.S. dollar means the semiannual interest payments will translate into more dollars. At maturity, the return of principal will be higher as well. Of course, it can go the other way if the market value or the foreign currency depreciates against the dollar.

The net asset value of an international bond fund can be expected to increase if which of these occur? Interest rates rise abroad. Interest rates fall abroad. The U.S. dollar strengthens. The U.S. dollar weakens. A)II and III B)I and III C)II and IV D)I and IV

C)II and IV Explanation If interest rates fall, bond prices will rise, thus increasing the NAV of a bond portfolio. If the U.S. dollar weakens, the value of other currencies will rise. This would also increase the NAV for a portfolio of international bonds.

An investor interested in investing in sovereign debt would most likely purchase A)European Central Bank debt issues. B)bonds issued by the Bank of the United States. C)Sweden 2.5s of 2032. D)bonds backed by gold sovereigns.

C)Sweden 2.5s of 2032. Explanation Sovereign debt refers to bonds and other debt instruments issued by a specific country. The European Central Bank manages the currency of the 19 countries that have adopted the euro. There is no such thing as the Bank of the United States, and gold sovereigns are coins—they are not used to back debt.

Which of the following best describes a Yankee bond? A)A U.S. dollar-denominated bond issued by a U.S. entity inside the United States B)A U.S. dollar-denominated bond issued by a non-U.S. entity inside the United States C)A U.S. dollar-denominated bond issued by a non-U.S. entity outside the United States D)A U.S. dollar-denominated bond issued by a U.S. entity outside the United States

B)A U.S. dollar-denominated bond issued by a non-U.S. entity inside the United States Explanation Yankee bonds are issued by non-U.S. entities in marketplaces inside the United States. The bonds are issued in U.S. dollars, meaning these foreign issuers will have currency risk if the dollar drops in value against their local currency.

Partners with the United States in the creation of Brady bonds were which of these? International Monetary Fund (IMF) Import/Export Bank United Nations World Bank A)III and IV B)I and II C)I and IV D)II and III

C)I and IV Explanation Joining the United States in creating Brady bonds were the IMF and the World Bank.

When a corporation domiciled in the United Kingdom issues U.S. dollar-denominated bonds in the United States, it is issuing A)ADRs. B)eurobonds. C)Yankee bonds. D)Ameribonds.

C)Yankee bonds. Explanation Yankee bonds are foreign bonds, denominated in U.S. dollars and issued in the United States by foreign banks and corporations. ADRs are issued in the United States by domestic banks and represent receipts for securities traded on foreign exchanges. Eurobonds are issued by a borrower in a foreign country, denominated in a currency other than one native to the issuer's country. Yankee bonds are a form of eurobond, but that is not the best answer to this specific question.

When investing in a foreign bond fund, a customer will profit if which of these occur? The U.S. dollar strengthens. The U.S. dollar weakens. Foreign currencies strengthen. Foreign currencies weaken. A)I and III B)II and IV C)I and IV D)II and III

D)II and III Explanation Because the fund is purchasing bonds denominated in foreign currencies, a weakening of the U.S. dollar or strengthening of foreign currencies will be beneficial.

The most common collateral securing a Brady bond is A)an asset, or group of assets, pledged by the borrowing entity. B)U.S. Treasury zero-coupon bonds with a maturity corresponding to the maturity of the individual Brady bond. C)the credit standing of the banking institution acquiring the Brady bond. D)the credit standing of the sovereign nation issuing the Brady bond.

B)U.S. Treasury zero-coupon bonds with a maturity corresponding to the maturity of the individual Brady bond. Explanation Although other securities may be pledged, the most common is zero-coupon U.S. Treasuries, selected to mature at roughly the same time as the specific Brady bond. An investor purchasing a Brady with collateralized principal knows that, at maturity, a third-party paying agent will receive a payment from the U.S. Treasury that will be used to repay the principal on the Brady issue. In the event of default, the bondholder will receive the principal collateral on the maturity date.

A U.S. dollar-denominated bond that is sold outside the United States and the issuer's country but for which the principal and interest are stated and paid in U.S. dollars is best described as A)a Brady bond. B)a eurobond. C)a Eurodollar bond. D)a Yankee bond.

C)a Eurodollar bond. Explanation This is the definition of a Eurodollar bond. Yes, it is also a eurobond, but because the question specifies U.S. dollars, the more accurate choice is Eurodollar bond. A Yankee bond is U.S. dollar-denominated but is issued in the United States; Eurodollar bonds are not. Brady bonds are issued only by foreign governments, usually—but not always—are U.S. dollar-denominated, and are available for purchase in the United States.