Investing in International and Foreign Bonds — What Do You Need to Know?
Bonds are generally considered safe investments, but there are many different types that you can invest in, and they each carry different risk profiles. Two types of bonds that often get confused are international and foreign bonds. While these two terms are often used interchangeably, they represent two different types of bonds.
You should understand the difference between these terms, as the risk profiles for each type of bond is different. Each of these types of bonds can serve an important role in your portfolio — provided that you understand the unique circumstance of each.
Both represent a debt obligation between the investor and an organization, just as with any other bond, but they vary in terms of currency and risk.
Key Points to Know about International Bonds
International bonds are issued in a country other than their own, typically in the currency that the issuer uses. Just as with other bonds, international bonds will pay interest at set intervals and then return the principal at maturity. Usually, these are corporate bonds.
Corporations will issue these bonds to get funding from outside their country of operation. Tapping into global markets of investors can open up new opportunities for funding and potentially enable companies to find cheaper capital. Because these bonds are issued in the company’s native currency, they are an easy way to raise capital.
Mutual funds often invest in international bonds because they are typically under different pressures than domestic ones, which means they can add valuable diversification to a portfolio. Individual investors can also benefit from this diversification since foreign markets tend to move differently than domestic ones.
At the same time, it is important to remember that international bonds will pay interest in a foreign currency, so the value of these bonds can fluctuate a great deal as exchange rates shift. Currency risk is a significant consideration when investing in international bonds, since a dramatic shift can take a major toll on earnings.
On the other hand, shifts can also increase your earnings. Another point to consider is that different regulatory and taxation requirements may apply since these bonds come from an external market.
How Foreign Bonds Differ from International Bonds
As mentioned, the term “foreign bond” is often used interchangeably with international bond, but these investments are different. Foreign bonds are issued in a domestic market by a foreign organization. For that reason, the currency is always in that of the domestic country.
A bond issued in Canada by a British company in Canadian dollars would be an example of a foreign bond. In this same scenario, an international bond would be in British pounds even though the investor holding it is in Canada. This distinction is quite important in terms of how the bond fits into a larger portfolio and the risks involved. Foreign bonds often have unique names that indicate the target currency. For example, samurai bonds are in Japanese yen and bulldog bonds are in British pounds.
Generally speaking, companies only issue foreign bonds if they do a lot of business in the target market, so they are used differently than international bonds. Investors tend to like foreign bonds because they add diversification without the same exchange rate exposure of international bonds.
However, there are still some important risks to understand. As with other bonds, there is both interest rate risk and inflation risk. The former is the fact that the price of a bond will decrease as interest rates increase. The latter is the risk that interest paid by the bond does not outpace inflation during the time to maturity.
Investors also need to think about political risk. The stability of the issuing country can impact the issuer’s ability to pay back the principal and interest.
Examples of International and Foreign Bonds
For many investors, international and foreign bonds have become key parts of an overall portfolio strategy. One term to be familiar with is a Eurobond, which is a debt issued and traded in countries other than that of the issuer. Often, Eurobonds are issued in currencies other than that of the issuer or the target market.
For example, a French company might issue bonds in Japan that are denominated in American dollars. This particular example would be called a Eurodollar bond. Euroyen and Euroswiss bonds are also quite common. If the same French company issued bonds in both Japan and the United States, the product would be known as a global bond since it is also offered in the market of the bond currency.
Foreign bonds make sense to issue when the interest rate in the target country is lower than in the domestic country. For example, a company with operations in the United Kingdom would be inclined to issue bulldog bonds when British interest rates are particularly low.
Outside of bulldog and samurai bonds, Matilda bonds are also common. These are bonds issued in Australia by non-Australian companies. Yankee bonds are those issued in the United States and maple bonds are those issued in Canada.
