Russia’s Alternative-Currency Bonds

  1. Short questions and definitions. Briefly define the following objects or terms (at most 100 one sentence) and provide examples if necessary: (a) Define and give an example of relative purchasing power parity. (b) Are implied forward rates good predictors of future spot rates? Explain. (c) Define and give an example of reciprocal arbitrage. (d) What is uncovered interest parity used for? (e) What is the most important difference between an FX forward and futures contract? (f) What are American quotes? Give an example. (g) Explain what is meant by a money market hedge. (h) Define synthetic debt and give an example. (i) What is the difference between FX risk and exposure? (j) Define and give an example of translation exposure.
  2. Russia’s Alternative-Currency Bonds. On March 17, 2018, the Russian Federation 100+20 issued USD 4bn in eurobonds (what are they?) with an unusual provision. The issuer reserves the right pay bondholders principal and interest in EUR, GBP, or CHF should the Russian Federation be unable to make payment in USD for “for reasons beyond its control..” Working for the chief investment officer (CInvO) of NoNaCaPa (No-Name Capital Partners), a prominent hedge fund, you are analyzing the bonds to determine what their risk and rewards are. Your company is USD based but not averse to taking on foreign currency risk to enhance a position’s return potential. Your starting point is the attached Financial Times article which you can also supplement by your own research. In particular, you wonder about the alternative-currency clause in the indenture (debt contract) and how it might affect the investment performance of the bonds.

(a) Research dual- or multiple-currency debt securities which are typically issued in the eurobond market. • What are eurobonds? • What are dual- or multiple-currency bonds? What do they consist of and how can you unbundle the bonds into their constituent parts? (b) In comparison to multiple-currency bonds, what does the alternative-currency payment provision effectively amount to? (c) What motivates the alternative currency payment provision and how does it affect the pricing of the bonds? (d) What risk factors do investors face? Present the risks in tabular form distinguishing between financial from nonfinancial risks which obviously translate into financial risks at a later stage. Identify each risk’s origin and nature,who bears it, its impact on bond pricing, and whether and how investors can hedge or not against it. 2 (e) What investment recommendation would you give to your CInvO? Explain your advice and motivate your investment thesis, i.e., the rationale why or why not you should participate in the transaction. (f) Bonus problem. To what precise purpose is the Russian Federation issuing these 20 debt securities? Research the question and explain the strategy behind Russia’s recent eurobond offerings and how it ties in to both the management of its foreign-currency reserves and the Russian national debt.

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