International and Emerging Markets Bonds
Just as you can buy bonds from the U.S. government and U.S. companies, you can purchase bonds issued by foreign governments and companies. Since interest rate movements may differ from country to country, international bonds are another way to diversify your portfolio. Since information is often less reliable and more difficult to obtain, you risk making decisions on incomplete or inaccurate information.
Like Treasuries, international and emerging market bonds are structured similarly to U.S. debt, with interest paid semiannually, although European bonds traditionally pay interest annually. Unlike U.S. Treasuries, however, there are increased risks in buying international and emerging market bonds (described below), and the cost associated with buying and selling these bonds is generally higher and requires the help of broker.
International bonds expose you to a mixture of risks that are different for each country. A country's unique set of risks is known collectively as sovereign risk. A nation's political, cultural, environmental and economic characteristics are all facets of sovereign risk. Unlike Treasuries, which carry essentially zero default risk, default risk is real in emerging markets, where the sovereign risk (such as political instability) could result in the country defaulting on its debt.
Furthermore, investing internationally also exposes you to currency risk. Simply stated, this is the risk that a change in the exchange rate between the currency in which your bond is issued—euros, say—and the U.S. dollar can increase or decrease your investment return. Because an international bond trades and pays interest in the local currency, when you sell your bond or receive interest payments, you will need to convert the cash you receive into U.S. dollars. When a foreign currency is strong compared to the U.S. dollar, your returns increase because your foreign earnings convert into more U.S. dollars. Conversely, if the foreign currency weakens compared to the U.S. dollar, your earnings are reduced because they translate into fewer dollars. The impact of currency risk can be dramatic. It can turn a gain in local currency into a loss in U.S. dollars, or it can change a loss in local currency into a gain in U.S. dollars.
Some international bonds pay interest and are bought and sold in U.S. dollars. Called yankee bonds, these bonds are generally issued by large international banks and most receive investment-grade ratings. Indeed, credit rating services such as Moody's and Standard & Poor's, which evaluate and rate domestic bonds, also provide Country Credit Risk Ratings that are helpful in determining risk levels associated with international and emerging market government and corporate bonds.
International Bond Snapshot
|Issuer||International government, corporate entity or other non-domestic issuer|
|Interest Payment||Fixed, floating/variable and zero-coupon. Interest may be paid semi-annually or (for Eurobonds) annually.|
|How to Buy/Sell||Through a broker with international expertise|
|Bond Interest Rate||Determined at origination, varies by bond|
|Price Information||Through a broker with international expertise|
|Risk Profile||Credit and default risk: Varies significantly from bond to bond and is sometimes hard to determine.
Liquidity risk: It can be difficult to find a buyer for an international government or corporate bond.
Currency risk: The risk that a change in the price of the U.S. dollar or currency of the country in which the bond is issued will have a negative impact on return.
Interest rate risk: If interest rates rise, the value of an international bond on the secondary market will likely fall.
Event risk: Mergers, acquisitions and other tumultuous events can have a negative impact on a bond issuer's ability to pay its creditors.
|Website for More Info||European Government Bonds|