Dual Currency Bonds: Definition, How It Works and More

A bond issued in one currency and paying coupon payments in another is termed a dual currency bond. Investors and issuers can agree on the terms and conditions, including fixing the conversion rate, maturity, and interest rate at the time of issuing the bond.

Dual currency bonds are lucrative fixed-income instruments for foreign investors. However, these bonds are not common among retail investors due to high-interest rates and currency exchange rate risks.

These bonds can take a few different forms depending on the currency conversion method. These bonds are risky and require sophisticated skills to execute the transactions smoothly.

What is a Dual Currency Bond?

A dual currency bond is a type of bond that comes with the principal amount in one currency and coupon payments in another. The bond can be denominated in the base currency of the issuer or the investor.

These bonds are fixed-income securities and have similar characteristics to other types of bonds. Initial investment and repayment of the principal amount are made in one currency while the interest payments are in another.

How Does a Dual Currency Bond Work?

Multinational companies and corporations can issue dual currency bonds to attract foreign investors or to attract investments in foreign countries. They issue bonds in one currency and make coupon payments in another.

These bonds offer higher coupon rates than the average return offered by straight bonds. The lower rate or weaker currency is usually chosen as coupon payment currency. The stronger or higher rate currency is chosen as the base currency. However, these are not set rules and both parties can customize the currencies according to their needs.

READ:  How to Prepare a Cash Budget? Step by Step Guides

A bond issuer in the US issuing a USD denominated bond and paying coupon payments in GBP will be termed as a dual currency bond. The issuer can use this bond to attract foreign investors from the UK or to fund a foreign project in the UK by offering returns in GBP currency.

Example

Suppose an American firm ABC issues a dual currency bond. The base currency of the bond is USD, and it will make coupon payments in GBP. The company ABC want to raise capital of $ 1 million. The bond matures in five years, and the coupon payment rate is set at 5% in GBP.

For simplicity, we assume that both parties agree to use a fixed currency conversion rate of $1 = £0.80

Initial Investment by the Investor = £ 1,250,000 ($1 million ÷ 0.80)

Coupon Payments = $ 1,000,000 × 5% = $ 50,000/0.80 = £ 62,500 per annum.

Principal Repayment at maturity = £ 1,250,000 ($1 million ÷ 0.80)

Both parties can agree to use the spot conversion rates instead of a fixed rate as well. Suppose the spot rate for repayment at maturity changes to $1 = £0.90, then:

Principal Repayment at maturity = £ 1,111,111 ($1 million ÷ 0.90)

Types of Dual Currency Bonds

These bonds can take different forms. All of the variations are derived from the use of base currency and foreign currency. Also, the variations would depend on how both parties determine the currency conversion rate.

Traditional Dual Currency Bonds

The principal payment and initial investment are made in the bond issuer’s domestic currency. The interest payments are made in the investor’s domestic currency.

READ:  What is Mortgage Bond? Definition and Types

Reverse Dual Currency Bonds

These bonds reverse the currency mechanism of traditional bonds. The principal payments are made in the investor’s domestic currency. The interest payments are made in the issuer’s domestic currency.

For currency conversion rates, both parties can agree to use a fixed currency conversion rate over the life of the bond. Both parties can agree to use a fixed rate for initial investment and a spot rate for coupon payments and the principal repayment as well.

Advantages of Using a Dual Currency Bond

These bonds offer several advantages to issuers and investors.

  • Investors in these bonds receive higher coupon payments than straight bonds.
  • Issuers can raise capital from foreign investors or in foreign jurisdictions.
  • These bonds can be traded as marketable securities or held to maturity for capital gains by the investors.

Disadvantages of Using a Dual Currency Bond

Dual currency bonds come with some disadvantages for both parties.

  • Dual currency bonds come with interest rate and currency exchange risks.
  • These bonds are complex and require special skills to complete the transaction.
  • These bonds are less common in the modern bond market, hence may face liquidity issues.
  • Pricing of these bonds can be difficult to calculate if the bonds embed other features such as using a spot exchange rate, Options, etc.

Final Thoughts

Dual currency bonds come with a base currency and a foreign currency. Principal payments are made in the base currency, while coupon payments are made in another. Therefore, these bonds offer currency exchange and interest rate risks.

Scroll to Top