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Dual Currency Bond

Dual Currency Bond

What Is a Dual Currency Bond?

A dual currency bond is a sort of debt instrument where the coupon payment is designated in one currency and the principal amount in another. This sort of bond can open the holder to exchange rate risk.

A dual currency bond can measure up to a dual currency swap and dual currency deposit.

Understanding Dual Currency Bonds

A dual currency bond is a synthetic security that is recovered in one currency while interest payments over the life of the bond are made in another currency. For instance, a bond issued in U.S. Dollars (USD) that pays interest in Japanese Yen (JPY) is viewed as a dual currency bond.

The currency in which the dual currency bond is issued, which is called the base currency, will for the most part be the currency in which interest payments are made. The principal currency and amount are fixed when the bond is issued and the exchange rate may likewise be stated. The coupon interest on a dual currency bond is normally set at a higher rate than comparable straight fixed-rate bonds and is paid in the more vulnerable or lower-rate currency.

The two most common types of dual currency bonds are:

  1. Traditional dual currency bonds: The interest is paid in the domestic currency of the investor and the principal amount is designated in the issuer's domestic currency.
  2. Reverse dual currency bonds: The interest is paid in the domestic currency of the issuer and the principal amount is designated in the investor's domestic currency.

Dual currency bond issues are most commonly initiated by multinational corporations and traders on the euro-bond market. Varieties of dual currency bonds are shogun bonds, Yen-connected bonds, different currency clause bonds, foreign interest payment bonds, and paradise and-damnation bonds.

Illustration of a Dual Currency Bond

Expect a bond is issued with a par value of $1,000 and has a maturity date of one year. Interest is to be paid in U.S. dollars and the principal repayment at maturity will be in euros. The speculative spot exchange rate is EUR/USD 1.24. Thus, principal repayment value per bond is set at (USD1000 x EUR1)/USD1.24 = EUR806.45.

Toward the finish of the principal year, then, the cash flow on this bond is $1,000r + \u20ac806.45. On the off chance that the one-year market rates are 4% in the dollar market and 7% in the euro market, the interest rate at which the bond ought to be issued is:

  • 1000 = (1000r/1.04) + 1.24 (806.45/1.07)
  • 1000 = (1000r/1.04) + 934.58
  • 1040 = 1000r + 971.96

Where:

  • r = 0.068, or 6.8%

Special Considerations

The exchange rate associated with the coupon and principal might be determined at the hour of bond issuance in the trust indenture. An issuer may likewise choose to make payments based on the spot rates at the time coupons and principals are paid.

A dual currency bond issuer will regularly set an exchange rate that permits payments in the more grounded currency to see the value in more. Also, the designated principal repayment amount at maturity considers some appreciation in the exchange rate of the more grounded currency.

Dual currency bonds are subject to exchange rate risk. Assuming that the currency in which the principal will be repaid appreciates, the bondholder will bring in money; assuming it deteriorates, they will lose money. Investors can utilize dual currency swaps, which have a fixed exchange rate at issuance, to offset the exchange risk of dual currency bonds. Dual currency bonds are likewise used to hedge exchange rate risks straightforwardly with next to no transactions in foreign exchange markets.

Features

  • A dual currency bond is a sort of debt instrument where the coupon payment is designated in one currency and the principal amount in another and can open the holder to exchange rate risk.
  • The two most common types of dual currency bonds are traditional dual currency bonds and reverse dual currency bonds.
  • Dual currency bond issues are most commonly initiated by multinational corporations and traders on the euro-bond market.