What Are Eurobond and How Do They Work?

Eurobonds are a fixed-income debt instrument (security) denominated in a currency other than the local currency of the country where the bond is issued.

Eurobonds enable corporations to raise funds by issuing bonds in a foreign currency. The bonds are also known as external bonds because they can be issued in a foreign currency (external currency).

When a Eurobond is denominated in US dollars, it is referred to as a euro-dollar bond. If it is denominated in Chinese yuan, it is referred to as a euro-yuan bond, and so on

How do Eurobonds Work?

The essence of Eurobonds is that a corporation can issue bonds in any country based on its economic and regulatory environment. (e.g., interest rates in the country, economic cycle, market sizes, etc. The bond’s small nominal amount (face value or par value) makes it appealing to investors because it is relatively inexpensive to obtain.

Importantly, Eurobonds are extremely liquid and can be converted into cash within a fiscal year.

Eurobond classification is determined by the currency in which the bonds were issued. If a company based in the United States decides to issue Eurobonds in British pounds in China, the bonds will be classified as euro-pound bonds.

How are Eurobonds Issued?

Bonds are typically issued on behalf of the borrower by financial institutions such as investment banks. If a bank is in charge of the underwriting process, the borrower is guaranteed that the entire bond issue will be sold in the primary market during the initial debt offering process.

It is important to note that the term “Eurobond” only refers to the fact that the bond was issued in another country and currency. It does not have to be a European country. It could be any country in the world. Eurobonds, for example, can be issued in China and denominated in US dollars.

Eurobonds are issued by many institutions, such as:
• Corporations
• Governments
• Syndicates

The primary reason for issuing Eurobonds is a need for foreign currency capital. Since the bonds are fixed-income securities; they usually offer a fixed interest rate to investors.

Imagine, as an example, a Nigerian company that aims to enter a new market and plans to set up a large factory, say, in China. The company will need to invest large sums of money in local currency – the Chinese yuan. As the company is a new entrant to the Chinese market, it may lack access to credit in China.

The company decides to go with yuan-denominated Eurobonds in Nigeria. Investors who hold yuan in their accounts will invest in the bonds, which will provide funds for a new facility in China. If a new factory is profitable, the cash flow will go to settling the interest of the Nigerian-based bondholders.

Benefits to Issuers

1. The ability to select a favorable country to issue bonds and currency.
2. A country with lower interest rates as an option
3. Avoidance of currency risk or forex risk through the use of Eurobonds
4. Access to a wide range of bond maturity periods that the issuer can select
5. Despite being issued in a specific country, international bond trade broadens potential investor base

Benefits to Investors

The primary advantage of purchasing a Eurobond for local investors is that it provides exposure to foreign investments that remain in the home country. It also provides a sense of diversification by spreading the risks out.

Eurobonds, as previously stated, have a low face value and are highly liquid. If a Eurobond is denominated in a foreign currency and issued in a country with a strong economy (and currency), bond liquidity increases.