What Are Yankee Bonds?
A Yankee bond is issued by foreign entities like banks or financial institutions and traded in the United States in US dollar currency. These bonds are governed by the Securities Act 1933, and many documents are required to get them registered. And are rated by credit rating agencies like Moody’s and S&P.
Reverse Yankee bonds are also available, traded, and issued outside the US and the respective country’s currency. Yankee bond issuer also gets the advantage of the most stable capital marketCapital MarketA capital market is a place where buyers and sellers interact and trade financial securities such as debentures, stocks, debt instruments, bonds, and derivative instruments such as futures, options, swaps, and exchange-traded funds (ETFs). There are two kinds of markets: primary markets and secondary markets. in the US to raise funds for long-term requirements. Also, the issue of such bonds may act as a natural hedge for future collections against receivables to the company.
Table of contents
- Yankee bonds are issued by foreign businesses such as banks or financial institutions and exchanged in U.S. dollars in the United States. The Securities Act of 1933 governs these bonds, and various documents are necessary to register them. Credit rating firms such as Moody’s and S&P grade them as well.
- The Yankee bond’s price is determined mainly by duration, coupon, and yield. Bond yields and prices are inversely linked.
- It gained popularity in the United States amid the 2008 global financial crisis. American investors can diversify their investment portfolios by entering developing markets. However, these bonds are not risk-free investments.
Yankee Bonds Explained
Yankee bonds have become popular in the US post-global crisis in 2008.
They are named so because of the fact that they are foreign bonds that are issued in the US. They are very attractive to the investors in the US who do not want to face currency losses but want to invest in foreign companies.
It is, however, issued by non-US entity, which may be a foreign corporation or government. The yankee bonds list must obey the rules and regulations of the US securities. Due to this, they are subject to the same type of reporting and disclosure requirements as any other domestic issuer. This is important to maintain transparency and protect the investors from any problems. They are good investment options for American investors since they are traded in the US bond market.
American investors get opportunities to tap emerging economies and diversify their investment portfoliosInvestment PortfoliosPortfolio investments are investments made in a group of assets (equity, debt, mutual funds, derivatives or even bitcoins) instead of a single asset with the objective of earning returns that are proportional to the investor's risk profile.. However, these bonds are not risk-free investments. Investing in Yankee bonds is not everybody’s cup of tea. Through understanding, due diligence of the company, its local laws, and financial statements is required before taking a big investment step.
However, apart from diversification benefits, the investment is a good option because there is no requirement for currency conversion. Interests on bonds are paid in US dollars, making the income calculation less complex. It has various uses in the financial market, like raising capital for corporates for the purpose of debt repayment, project financing, or expansion and growth.
Correlation To Bond Price
Duration, coupon, and yield are major factors responsible for the price of the Yankee bond. Yield and bond pricesBond PricesThe bond pricing formula calculates the present value of the probable future cash flows, which include coupon payments and the par value, which is the redemption amount at maturity. The yield to maturity (YTM) refers to the rate of interest used to discount future cash flows. are inversely related. As the price of the bond increases, the yield falls, and the bond becomes expensive for an investor due to the price rise. Similarly, bond price falls when yield increases as more and more investors are willing to invest in bonds.
- C = periodic payment of the coupon
- Y = yield to maturityYield To MaturityThe yield to maturity refers to the expected returns an investor anticipates after keeping the bond intact till the maturity date. In other words, a bond's returns are scheduled after making all the payments on time throughout the life of a bond. Unlike current yield, which measures the present value of the bond, the yield to maturity measures the value of the bond at the end of the term of a bond. (YTM)
- F = face value of the bond
- T = time
In short, the price of the Yankee bond is the present value of all future cash flows of the bond.
If coupon payments are made semi-annually, then the coupon rateCoupon RateThe coupon rate is the ROI (rate of interest) paid on the bond's face value by the bond's issuers. It determines the repayment amount made by GIS (guaranteed income security). Coupon Rate = Annualized Interest Payment / Par Value of Bond * 100% and YTM are divided in half. Depending on the frequency of coupon payments, coupon rate and yield are to be adjusted.
YTM is used as a discounting rate to arrive at the present value of the bond.
Let us take the following examples to understand the concept.
Yankee bond with a face value of 1000$, a coupon rate of 4%, YTM of 4%, and maturity of 5 years.
The price of the bond using the above formula will be 1000 $. This is because coupons and YTM are the same. When coupons and YTM differ, bonds are sold at a premiumBonds Are Sold At PremiumA premium bond refers to a financial instrument that trades in the secondary market at a price exceeding its face value. This occurs when a bond’s coupon rate surpasses its prevailing market rate of interest. For instance, a bond with a face value (par value) of $750, trading at $780, will reflect that the bond is trading at a premium of $30 ($780-750). or discount.
If YTM is 3% and 5%, the rest of the other variables remaining the same, bond price will be 1037.17$ and 964.54$, respectively. When YTM falls, the bond price will rise and vice-versa on the increase in YTM. When YTM falls, bonds having fixed coupon rates become popular in the market; hence bonds will be available at a premium.
On the flip side, when YTM rises, bonds having a fixed coupon rate become less attractive than other market investments, then bonds will be available at a discount.
As every financial concept has its own advantages and disadvantages. Let us study the advantages of these type of bonds first.
- The yankee bonds list helps in portfolio diversificationPortfolio DiversificationPortfolio diversification refers to the practice of investing in a different assets in order to maximize returns while minimizing risk. This way, the risk is kept to a minimal while the investor accumulates many assets. Investment diversification leads to a healthy portfolio. for investors to invest in different emerging economies as bond issuersBond IssuersBond Issuers are the entities that raise and borrow money from the people who purchase bonds (Bondholders), with the promise of paying periodic interest and repaying the principal amount when the bond matures. are different entities outside the US investing in US bond markets by issuing Yankee bonds.
- Bondholders are protected from currency risk as bonds are issued in home currency USD, and repayments are also in USD; hence there will be negligible currency risk.
- These bonds are actively traded in US debt markets; hence Yankee bonds offer the highest liquidity to bond investors.
- It has a lesser impact due to political and economic factorsEconomic FactorsEconomic factors are external, environmental factors that influence business performance, such as interest rates, inflation, unemployment, and economic growth, among others. prevailing in the US. Bond prices will not change drastically.
- The issuer gets access to the US market after fulfilling the complicated requirements of the SEC.
- The issuer has a fund available for a longer duration due to the longer tenure of bonds.
- The market can frequently provide funds with lower costs than any other market.
- It also acts as a natural hedge if the bond issuer has longer tenure receivable in US markets.
- It offers a higher yield than the lower yield on other American investment portfolios.
Some crucial disadvantages of the concept are given below.
- The basic principle of financial marketsFinancial MarketsThe term "financial market" refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces. – the higher the risk, the higher the reward. Lowering the risk lowers the reward; hence, investors should have a huge risk appetiteHuge Risk AppetiteRisk appetite refers to the amount, rate, or percentage of risk that an individual or organization (as determined by the Board of Directors or management) is willing to accept in exchange for its plan, objectives, and innovation. to bear losses.
- Some Yankee bonds may turn into junk bonds if the Company’s financial performance is not satisfactory. Also, foreign companies are governed by the laws of their nation; any unfavorable changes in the country’s economy would have an impact on the performance of the Company.
- Currency mismatches may happen in foreign companies. Companies have borrowed in US Dollars, but the majority of earnings may not be in US Dollars, it will be in the company’s home currency, and if the home currency depreciates against Dollars, then the company has to manage its open risk position effectively to pay bondholders and minimize currency losses.
- A bond issuer must go through the complicated procedure of registration with SEC and other legal formalities, so issuing Yankee bonds becomes time-consuming.
- After the subprime crisis, Yankee bonds have become popular in American markets due to better yield offerings than domestic bonds. So these bonds are sold well when interest rates in the US are lower.
It is to be noted that before investing in these type of bonds, it is important to take into account or evaluate the credit worthiness of the issuer, the current interest rates prevailing in the market, so as to get the maximum returns. Thus, even though the Yankee bons are a good choice for investors who want to explore the returns from the us market, they also carry some amount of risk as any other bond in the financial market.
Yankee Bonds Vs Eurobonds
Both the above types of international bond and foreign entities issue them. But they differ from each other in several aspects, as given below:
- The former is denominated in US dollars. They are issued within the US, but foreign entities issue them and mainly invested by US investors. The latter is issued in one country but not in the currency of that country. Even though it is called Euro, it can be of any currency.
- Unlike the former which is issued in the United States and cater to the investors over there, the latter is issued in the international market, in the financial centres like London, Zurich.
- The main intention of the former is to get US investors and access the capital market of the US, whereas the main intention of the latter is to get funds at a global level and increase the global base of investors. They do not follow the rules and regulations of any particular country or jurisdiction.
- The former provides investor protection and transparent investment option through the US Securties Regulation and various reporting and disclosure requirements. But in case of the latter, the investor protection depends on the rules and regulations of the country where they have been issued. However, the issuers have some flexibility because they are very often exempted from the local security laws.
- The Eurobonds may have a significant amount of currency risk because they are not in the base currency of the investors. But for Yankee bonds, the investors are mainly from the US and since the bonds are denominated in the US dollars, there is no requirement of currency conversion and so there is very less currency risk.
- The interest payments of the bonds in the case of the former are done typically in the US dollars, but for the latter, the interest payments are given in the currency in which they are denominated.
Thus, from the above points the basic differences between the two types of bonds are made clear.
Frequently Asked Questions (FAQs)
Yankee bonds allow foreign entities to access U.S. capital markets and raise funds. They contribute to the overall diversity and liquidity of the global bond market.
On the negative side, Yankee bonds can take a long time to trade, exposing them to interest rate risk, currency risk, and other issues in their native country’s economy.
Underwriters play a significant role in the issuance of Yankee bonds. They help the foreign issuer navigate U.S. regulatory requirements, determine the bond’s terms, and market the bonds to potential investors.
U.S. investors must consider tax implications, including withholding taxes on interest payments. Tax treaties between the U.S. and the issuer’s country may affect the tax rate.
This has been a guide to what are Yankee Bonds. We explain with examples, differences with eurobonds, advantages, disadvantages & correlation to bond prices. You can learn more about finance from the following articles –