An Overview of Foreign Bonds

The global market has shrank as technology has developed, making everything more interdependent.  In today’s economy, people should be aware of the events and opportunities with a view broader than that of national borders. One investment one should consider is buying foreign bonds of sovereign nations.

Foreign bonds are issued in a domestic market by a foreign entity, and are evaluated in the domestic market’s currency. Because these bonds are in a different nation with different rules, the risk is far greater than that of domestic investments.  Foreign bonds are known to offer potentially higher yields than US bonds, For example, the Chinese Bonds recently offered, “…three-year bills with a yield of 2.75 percent.”

Benefits of Foreign Bonds

Investing in a foreign market can offer much more return, as they have different regulation guidelines, a different point of the business cycle, and varying standards.  One would need to go through an insurance company, a broker or a bank to invest in such bonds, as well as convert currency to the one the bonds are sold in.  Many markets have promise for growth and development that allows for a greater return, but also greater risk.

Foreign Bond Risk

Foreign bonds carry a higher risk than domestic bonds.  Risks of international bonds are higher because of, “…varying stages of economic and political development, differing regulatory environments, trading days, and accounting standards.”  The reasons the bonds have more risk are also the reason for the greater return offered, so it is an inherent tradeoff of these bonds.

There are problems associated with the purchasing of non-dollar bonds.  One problem is that “the fund will not usually attempt to cushion the impact of foreign currency fluctuations on the dollar,” and thus is sensitive to the dollar.  So any fluctuation in the foreign currency before it is transferred back to American dollars, or any fluctuation in the dollar before it is transferred back, adds additional risk.

Buying Foreign Bonds

For someone to purchase these foreign bonds, one would have to go through an investing firm.  From online searches, T. Rowe Price offers the sale of and information for foreign bonds, as well as many other investment options ().  Anyone interested in more information on foreign bonds and purchasing them can easily find a site online.

Purchasing High Yielding Foreign Bonds

The wavering U.S. dollar has some investors thinking about putting their dollars elsewhere. Foreign bonds are very attractive since they high yielding bond in comparison to U.S. bonds and bond funds. If you do choose this route beware of the risks that come with the benefits.

Acquiring Foreign Bonds and Bond Funds:

Investment firms & traders that specialize in global exchanges: Look for firms registered with FINRA, an independent self-regulatory organization charged with regulating the securities industry endorsed by the U.S. Securities & Exchange Commission. They have a BrokerCheck search to find FINRA-registered firms. Or you can go with more established investment banks like J.P. Morgan which offers global FX market services and its MorganMarket global research. They may hit you with lots of fees and commissions, but it will save you the trouble of doing the hard work yourself.

The country’s treasury or national bank website: Buying directly from a nation’s treasury means higher interest rates and less fees. For example, Australia’s government sells its bonds through the Reserve Bank of America (RBA). You must fill out a Purchase Form, Identification Reference Form, and send your payment by mail to the Registry for Commonwealth Government Inscribed Stock at the Reserve Bank in Sydney or Canberra. Further information on bank fees, prices, and required amounts can be found at the RBA’s website. However, most countries dont sell bonds directly to the public, but they may list local brokerages that do.

Certain banks: Some banks offer foreign currency accounts. They have some minimum investment requirements. Everbank, for instance, has WorldCurrency account that allow you to open an account with a variety of currency options. It is FDIC insured and has no monthly account fee. They offer foreign investment services as well.

Typically, acquiring foreign debts require a minimum investment amount. This may be anywhere from 10,000 to 100,000 units in the foreign country’s currency. Some popular countries to invest in are Japan, Australia, China, and any in Western Europe because of their growth and/or stability. Before choosing a country it is important to assess risks of putting your money into the foreign market.

Risks with Foreign Debt Dealings:

  • Currency risk:  How stable is the country’s currency? A change in the exchange rate between the U.S. dollar and the currency of your issued bond may lower your return.
  • No protection: An advantage to buying U.S. bonds is that there is legal backing to protect your investments. There is a chance for default or non-exchange to U.S. currency– this is  not for the faint at heart.
  • Political Impact: You must research the political atmosphere of countries you are considering thoroughly. Political instability means a higher chance of a country defaulting. There has been an increase in protectionism across the globe, and this is not good for foreign debts and investments. These countries want to keep their money at home.

The Risks of Investing in Foreign Government Bonds

Muncipal bonds or “munis”, U.S. treasury bonds and most other forms of government bonds are, by comparison to other investments, usually considered safe and secure investments. However, not all governments are created equally and, therefore like all other forms of investments some government bonds carry greater risk. For example, foreign government bonds may be subject to greater investment risk as a consequence of the reckless or misguided fiscal policy of that sovereign nation.

Apart from Moody’s rating system what are the ways to determine if a foreign government bond carries unusual or unaccpetable risk?

Some ways to assess the risk-reward of foreign government bonds include consideration of the stability of the bond’s native currency, the long term or future prospects of government stability, and current events, both global and domestic, that can affect a nation’s economy.

The stability of the underlying currency of a bond can be a significant factor affecting bond risk. Some countries may attempt to offset the inflation/currency risk of their bonds by offering higher interest rates. One must be mindful of indications that inflation may strip away the benefits of a higher interest rate. This is not a risk solely associated with foreign bonds. All bonds have this “…risk of a loss of principal when interest rates rise”.

An investor can also look at the current events to simulate the risk of a government bond. Instability of the government can make the bond less appealing, and make it a riskier investment. Take, for example, how on May 24, 2010 Spain seized a “troubled regional bank”. This larger scale or “regional financial instability” created uncertainty and a lack of trust in the Spanish government’s ability to repay debts. Being part of the European Union (EU), Spain’s difficulties could/would affect all of its members, making uncertainty arise across all of its members.  Unlike the American government, which can print more money if there is trouble paying the owed bond, the Spanish government cannot print more money, since it is not just their currency.

A recent event that may illustrate how a bond could be riskier than one would expect would be the large scale labor strikes in Greece, along with its international rescue loans worth $140 billion.  Bailouts of this magnitude can cause trust to dissolve in the government and the taint may last for years or decades. Even if Greek government bonds were propped up by assurances from the central bankers of the E.U. it is likely that their bonds will be steeply discounted for the foreseeable future.

By – Domenic Gabriella