Foreign bond

An Indian company can borrow abroad. When it does, the bond is an external bond, and there are 2 kinds.

A foreign bond is the first kind. The company goes to another country and borrows in that country's own currency. An Indian issuer selling dollar bonds in the United States is the standard case.

Why do it? Because the interest rate is often much lower than at home.

And the catch is in the same sentence. The company earns rupees but owes dollars. If the dollar rises against the rupee, the debt gets bigger in the only currency the company actually has.

The definition. Section 2.2.2: "If an external bond is issued in a foreign country, and in the local currency of that foreign country, then it is a Foreign Bond. For example, an Indian company issuing bond in US, denominated in US Dollars."

Section 2.2.2.1 restates it from the currency side: these are "bonds issued by a company in a currency that is different from the currency of its home country but in the currency of that country, where it is issued."

So the test has 2 halves and both must hold. Issued offshore, and in the local money of the place it is issued.

Issuer, investors, medium, regulator. The workbook's block for 2.2.2.1: issued by companies, government and special purpose vehicles; institutional and individual investors; direct issuance by the issuers through stock exchanges; and regulated by "regulators in the respective country of issue" — not by SEBI.

Why companies use them. "Companies in emerging markets may prefer to issue bonds in USD or currencies of other economically matured countries as they carry significantly lower interest rates."

And the risk that comes with them. "However, these bonds create significant foreign currency risk to the issuer. In case of the foreign currency appreciates against the domestic currency, the issuer will need higher amount of domestic currency to repay the loan."

Compare this with a masala bond, covered under euro bonds: because a masala bond is denominated in rupees, the currency risk sits with the foreign investor instead. Foreign currency bonds and masala bonds are mirror images on exactly this point.

A conversion feature is possible but not definitional. Section 2.2.2.1 notes these "could also have a feature of conversion into shares if needed, based on preferences of issuers/investors." The instrument that makes conversion its defining feature is the Foreign Currency Convertible Bond of section 2.2.7.4 — foreign currency denominated, generally optionally convertible, issued offshore under RBI guidelines, and governed by the Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993, under FEMA. A foreign bond is classified by where and in what currency it is issued; an FCCB is classified by its convertibility. A given bond can be both, or either alone.

A workbook inconsistency to be aware of. The framing paragraph in 2.2.2 says "Foreign Currency Bonds which are explained below can be either Foreign Bonds or Euro Bonds" — making foreign currency bond the wider term covering both. But the body of 2.2.2.1, headed "Foreign bonds", then defines foreign currency bonds as bonds issued in the currency of the country where they are issued, which is the narrower foreign-bond case only. The 2 passages do not agree, and the safest reading in an exam is to answer from whichever of the 2 the question is quoting.

The workbook's own example, with the arithmetic worked out. "In February 2020, Delhi International Airport Limited (an SPV of GMR Infrastructure Ltd) issued USD bonds in US." That is a foreign bond: an Indian issuer, the US market, and the US dollar, which is the local currency of that market.

Illustrative figures from here on. Suppose the issue was USD 300 million at 6.1%, at a time when the rupee stood at Rs 72.

Amount raised  = USD 300 mn × 72 = Rs 2,160 crore
Annual interest = USD 18.3 mn × 72 = Rs 132 crore

An equivalent rupee borrowing at, say, 9.5% would have cost Rs 205 crore a year. The dollar bond saves Rs 73 crore annually — the "significantly lower interest rates" the workbook describes.

Now the rupee weakens to Rs 86.

The interest saving shrinks, and the principal obligation has grown by Rs 420 crore, or 19%, without the company borrowing another rupee. Its airport revenues are in rupees. That gap is the foreign currency risk the workbook warns about, and it is why a lower coupon is not by itself a cheaper loan.

Section 2.2.2 sets the classification and 2.2.2.1 (Foreign bonds) carries the detail and the Delhi International Airport example. Chapter 3 revisits external bonds in its debt market terminology.

Expect a classification question: given an issuer, a market and a currency, is the bond domestic, foreign or euro. Expect the Delhi International Airport example itself. And expect the risk question — who bears the currency risk on a foreign currency bond — where the answer is the issuer, in contrast to a masala bond where it is the investor.

• A foreign bond is in the local currency of the country of issue. Issued abroad in some third currency, it is a euro bond instead. That single condition is the whole classification.
• The issuer bears the currency risk, not the investor. A masala bond reverses this, and the 2 are examined against each other.
• A lower coupon is not a lower cost. The workbook gives the lower interest rate as the motive and the currency risk as the consequence, in consecutive sentences.
• Regulation follows the country of issue. The workbook names "regulators in the respective country of issue," so an Indian issuer's foreign bond is not a SEBI-regulated instrument.
• Do not equate a foreign bond with a Foreign Currency Convertible Bond. An FCCB is defined by being convertible — generally optionally — and sits in section 2.2.7.4 under RBI and FEMA guidelines, with the 1993 scheme governing it. A foreign bond is defined by its market and currency, and conversion is optional rather than definitional.
• The workbook uses "foreign currency bond" in 2 different widths. In 2.2.2 it spans foreign bonds and euro bonds; in 2.2.2.1 it means foreign bonds. Read which passage the question is drawing on.