Euro bond

The name is misleading, and the workbook says so directly. A euro bond need not be issued in Europe, and need not be denominated in euros.

What makes a bond a euro bond is a mismatch. It is issued in one country, in the currency of a different country.

An Indian company selling yen bonds in Germany is the workbook's example. Germany does not use the yen, so the mismatch is there, and the issue is called a Euro Yen Bond.

One version of this matters a lot to India. A euro bond denominated in rupees, issued outside India, is called a masala bond.

The definition. Section 2.2.2: where an external bond is issued in a foreign country in a currency which is not the local currency of that foreign country, it is a euro bond.

And the warning that follows it, which the workbook puts in as many words: a euro bond "does not mean that it is issued in Europe, or, in a currency that is Euro."

The naming convention. The workbook's example is an Indian company issuing an external bond in Germany denominated in Japanese yen. Because Germany does not use the yen, that is a euro bond, and it is called a Euro Yen Bond — the issue being referred to as a Euro Issue. The currency goes into the name, not the place.

Section 2.2.2.2 restates the test with a second illustration: a US dollar denominated bond issued in Kuwait is a euro bond, because the currency of the bond is the dollar while the currency of the country of issue is the Kuwaiti dinar.

Masala bonds, with the workbook's figures. Euro bonds denominated in Indian rupees are called masala bonds — issued outside India but denominated in rupees. They were issued for the first time in November 2014 by the International Finance Corporation, and that issue was listed on the London Stock Exchange.

Who bears the currency risk — and this is the examinable reversal. Foreign currency bonds issued by Indian entities create currency risk for the issuer. Masala bonds transfer that risk to the foreign investor instead. Because the bond is denominated in rupees, a depreciating rupee means "the amount received by the investor will be less in their local currency terms."

Issuer, investors, medium, regulator. Section 2.2.2.2: companies, government and SPVs; institutional and individual investors; direct issuance by issuers through stock exchanges; regulated by the regulators in the respective country of issue.

A workbook contradiction, and both sides are in the text. The heading of section 2.2.2.2 reads "Euro bonds / External Bonds", treating the 2 as the same thing, and chapter 3 repeats the conflation — "External bonds, also referred as Euro bonds". But section 2.2.2 itself says external bonds split into 2 categories, foreign bonds and euro bonds, which makes a euro bond a subset of an external bond rather than a synonym for one. Both formulations appear in the workbook. State the 2-category split when asked to classify, and do not be thrown if a question uses "external bond" to mean euro bond.

Start with the workbook's own cases, then put figures on the masala bond.

Illustrative figures. An Indian company issues a Rs 2,000 crore masala bond in London at 7.8%, when the rupee stands at Rs 80 to the dollar. A US investor buys Rs 100 crore of it, paying USD 12.5 million.

Annual coupon to the investor = Rs 7.8 crore
At Rs 80/USD                  = USD 0.98 million

Now the rupee depreciates to Rs 92.

Annual coupon                 = Rs 7.8 crore, unchanged
At Rs 92/USD                  = USD 0.85 million, down 13%
Principal on redemption       = Rs 100 crore = USD 10.9 million, against USD 12.5 mn invested

The Indian issuer's obligation never changed: Rs 7.8 crore a year and Rs 100 crore at maturity. The investor lost USD 1.6 million of principal value to the exchange rate. That is precisely the transfer of currency risk the workbook describes, and it is the mirror image of the dollar bond case where the Indian issuer carries it.

Section 2.2.2 gives the classification, 2.2.2.2 (Euro bonds / External Bonds) gives the detail and the masala bond history, and chapter 3 repeats the material in its debt terminology section.

The near-certain questions are: what a euro bond is not (Europe, the euro); the naming convention, where a yen bond issued in Germany is a Euro Yen Bond; the masala bond facts — November 2014, International Finance Corporation, London Stock Exchange; and who bears the currency risk on a masala bond, which is the foreign investor.

• Nothing to do with Europe or the euro. The workbook states this expressly, and it remains the most common error on the section.
• A euro bond is in a third currency; a foreign bond is in the local currency of the market of issue. Both are external bonds. That one distinction is the whole classification.
• On a masala bond the investor bears the currency risk. On a foreign currency bond the issuer does. Learn the pair together.
• A masala bond is a euro bond, not a domestic bond, even though it is denominated in rupees — because it is issued outside India.
• November 2014, IFC, London Stock Exchange. 3 facts about the first masala bond, and any of the 3 can be the question.
• The workbook uses "external bond" both as the parent of foreign and euro bonds and as a synonym for euro bonds. Section 2.2.2 gives the 2-category split; the heading of 2.2.2.2 and chapter 3 use the synonym. Both readings are in the text.
• A rupee depreciation hurts the masala bond investor, not the issuer. Reverse that and you have reversed the point of the instrument.