Legal, Regulatory, and Tax Implications on Fixed-income Securities

Fixed-income securities depend on laws and regulations of the place of issuance, where bonds are traded, and the holders of bonds.

Classification of Bonds by Jurisdiction

1. Domestic BondsThese are bonds issued by entities incorporated within a country and traded within that country. For example, when a US company like Apple issues bonds in the US, these are domestic bonds.
2. Foreign BondsForeign bonds are issued by entities that are not native to the country in which they’re traded. The classic examples are the Yankee bonds (issued by foreign entities in the US) and Samurai bonds (issued by non-Japanese firms in Japan). For instance, if a French company like Renault issues bonds in the United States, these are foreign bonds.
3. EurobondsThese bonds are issued outside the jurisdiction of any single country and can be denominated in any currency. They were primarily introduced in the 1960s to sidestep certain regulations and are often named based on the currency they are denominated in. For instance, a Eurobond issued in US dollars is called a Eurodollar bond.
4. Global BondsGlobal bonds are a type of bond that are issued simultaneously in multiple markets, typically in the Eurobond market and at least one domestic bond market. They allow issuers to access a broader investor base and increase liquidity.

Emerging and Frontier Markets

Bonds from emerging and frontier markets can differ in characteristics and risk factors. In frontier markets, which are typically smaller and less mature than emerging markets, bond issuances are dominated by domestic sovereign bonds or bonds from local banks. Corporate financing in these markets is generally through bank loans. In contrast, larger emerging markets might have a mix of state-owned enterprises, private corporations, and sovereign entities issuing bonds.

The Role of Currency in Bond Markets

The currency in which a bond is denominated can significantly influence its price. This is because the currency will dictate the interest rate environment to which the bond is tied. For instance, a bond denominated in a high-inflation currency might have a much higher interest rate than a similar bond in a stable, low-inflation currency.

Tax Considerations for Bonds

Interest Taxation

Bond interest might be taxed at ordinary income rates. This tax treatment varies by country and can depend on the type of bond. For instance, municipal bonds in the US can provide tax-free interest income.

Capital Gains

If bonds are sold before maturity at a price different than the purchase price, they may generate capital gains or losses. These, too, can have specific tax treatments depending on the holding period.

Original Issue Discount (OID)

Bonds like zero-coupons are issued at a discount to their par value. This discount can be treated as interest, and the taxation of this interest can vary by country.

Question

PT Indonesia Infrastructure Finance (IIF) decided to issue a bond denominated in US dollars with terms that it would be available to a broader set of international investors and would be traded in the Eurobond market. This bond can best be described as:

1. Eurobond
2. Foreign bond
3. Global bond

Solution

The correct answer is A. Eurobonds are bonds issued outside the jurisdiction of any single country and can be denominated in any currency, including the issuer’s domestic currency. They are underwritten by a group of financial intermediaries from different jurisdictions and are typically sold to investors in Europe, the Middle East, and Asia. In the given scenario, IIF’s bond fits this description, given its US dollar denomination and its listing for broader international trading.

B is incorrect: A foreign bond is a bond issued in a domestic market by a foreign entity, denominated in the domestic market’s currency. Since the IIF bond is not necessarily issued in a foreign domestic market and is denominated in US dollars, it does not fit the description of a foreign bond.

C is incorrect: A global bond is a bond issued simultaneously in the Eurobond market and in at least one domestic bond market. While the IIF bond is issued in the Eurobond market, there’s no indication in the provided notes that it’s simultaneously issued in any domestic bond market.

This question encapsulates the understanding of different bond types and their respective markets, and it requires the respondent to differentiate between bonds based on issuance location, trading location, and currency denomination.