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Comparative funding advantage application
Introduction
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What are Derivatives?
“a financial contract whose value is linked to, or derived from, that of an underlying asset such as a bond, stock, or commodity”
- Wall Street Journal
Available for...Available for... In a variety of forms...In a variety of forms...
Interest Rate
Currency
Commodity
Equity
Credit
Exchange-traded Listed futures and options
Over the counter, bilateral contracts Swaps, forwards, options, etc.
Securitized Callable bond, convertibles,
structured notes
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Derivatives allow the efficient interaction between issuers and investors in the capital markets
IssuersIssuers InvestorsInvestors
Capture comparative advantages across markets
Transparency in evaluating cost alternatives
Removes interest rate, currency and market preference from decision-making
Invest in instruments or credits not available in desired markets
Overcome liquidity restraints to specific markets allocation
Isolate or introduce interest rate and credit risk as desired
A financial wold without boundaries, where managers can define the risk of their asset/liability portfolio strictly according to economic conditions
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Introduction
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Issuer objectives
Raise long term money (10yrs)
Create liabilities in USD only (issuer is USD functional)
Achieve a spread with a low premium compared to both the Sovereign and same name in the international market
Create demand for its bonds by local investors
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IADB_seminarCorporate bonds tend to price tighter to the sovereign onshore vs. offshore
Synthetic USD bondSynthetic USD bond
Risk free rate (Treasury)
Sovereign Spread
Corp. Spread
4.00%
0.50%
0.70%
5.00%
0.50%
5.20% (T + 1.20%) 5.50% (Local T + 0.50%)
Yankee Bond
(USD)
Local Bond
(Pesos)
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IADB_seminarAlthough the local bond has a higher coupon, it’s priced at a lower spread to local Libor
Synthetic USD bondSynthetic USD bond
Sovereign Spread
Corp. Spread 0.55%
USD Libor + 0.55% Local Libor + 0.10%
4.00% 5.00%
0.10%
0.65% 0.40%
Yankee Bond
(USD)
Local Bond
(Pesos)
Relative savings of 45bp, but it local currency terms...
Savings must be compared in USD equivalent terms...
Libor (Treasury + Swap Spread)
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Converting the spread over local Libor to a USD fixed equivalent yields a synthetic USD bond with a lower coupon
Synthetic USD bondSynthetic USD bond
Libor (Treasury + Swap Spread)
Corp. Spread
USD Libor + 0.30%
4.00%
0.65%
Synthetic Yankee Bond
(USD)
Local Libor + 0.10%
5.00%
0.10%
0.40%
Local Bond
(Pesos)
Swap from pesos to
USD
0.10%
0.20%Basis/ Credit Charge
Savings of USD 25bp to Yankee bond
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Swap cashflows
Synthetic USD bondSynthetic USD bond
Issuer JPMorgan
Local Investor
USD
Local Currency
Local Currency
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IADB_seminarThis comparative advantage presents itself opportunistically
Credit priced more aggressive to the sovereign in the local market
Local market swap market must be available and liquid Basis risk between bonds and swaps
Wide USD swap spreads and narrow local swap spreads
Limited credit availability to deal in swaps Credit pricing can erode this advantage
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IADB_seminarA synthetic USD bond can improve funding costs
Client swaps Local debt from
local currency to USD
Client swaps Local debt from
local currency to USD
All-in USD rate in Swap yields a synthetic USD
bond that is cheaper than
Yankee issuance
All-in USD rate in Swap yields a synthetic USD
bond that is cheaper than
Yankee issuance
Issue local Debt at spread of
100bp to benchmark
Issue local Debt at spread of
100bp to benchmark
Synthetic USD bondSynthetic USD bond
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IADB_seminarWhen structuring a derivative transaction, it is important to consider the following issues
Credit How much credit exposure arises in a derivative transaction? How is the credit exposure handled? Depends on type of transaction (single vs. cross-currency)
Documentation Is the appropriate documentation on file? (ISDA, CSA, Trade
Confirmation, etc.) What are the specific terms that must be agreed to? Local legal implications
Acces to local markets Observable yield curve Liquidity considerations
* Credit and documentation affect the pricing of a derivative transaction
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IADB_seminarThe credit cost of a transaction can be reduced using a variety of techniques
Collateral agreementMark-to-market structure
Guarantee
Letter of credit
Special purpose vehicles
Elective termination right
Credit downgrade protection
Reduce exposure profile
Reduce default risk, spreads
Combination- reduce total cost
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This presentation was prepared exclusively for the benefit and internal use of IDB in order to indicate, on a preliminary basis, the feasibility of a possible transaction or transactions and does not carry any right of publication or disclosure to any other party. This presentation is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by JPMorgan. Neither this presentation nor any of its contents may be used for any other purpose without the prior written consent of JPMorgan.
The information in this presentation is based upon management forecasts and reflects prevailing conditions and our views as of this date, all of which are subject to change. In preparing this presentation, we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was provided to us by or on behalf of IDB or which was otherwise reviewed by us. In addition, our analyses are not and do not purport to be appraisals of the assets, stock, or business of IDB. The information in this presentation does not take into account the effects of a possible transaction or transactions involving an actual or potential change of control, which may have significant valuation and other effects
JPMorgan is a marketing name for investment banking businesses of J.P. Morgan Chase & Co. and its subsidiaries worldwide. Securities, syndicated loan arranging, financial advisory and other investment banking activities are performed by J.P. Morgan Securities Inc. and its securities affiliates, and lending, derivatives and other commercial banking activities are performed by JPMorgan Chase Bank and its banking affiliates. JPMorgan deal team members may be employees of any of the foregoing entities.
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