Details

Case

The Dilemma of Oversubscription

Zaghum Umar

INDUSTRY :

AREA : Finance

ORGANIZATION :

LENGTH : 20

LUMS No : 02-633-2015-1

PUBLICATION YEAR : 2015

KEYWORDS:

Eurobond,Oversubscription,International Capital Market,Citibank,Deutsche Bank,Bank of America Merrill,KASB Bank,Barclays,Extended Fund Facility,IMF

DESCRIPTION:

Pakistan issued the Eurobond in April 2014 after a seven-year break from the international capital market. The Eurobond was subscribed about three times over;the initial intended amount was US$500 million whereas the amount subscribed was US$2 billion.The joint lead managers involved with the issuance of the Eurobond, which included Citibank, Deutsche Bank, Bank of America Merrill, KASB Bank and Barclays, decided that the five-year and ten-year tenure bonds have to be floated at a fixed rate of 7.25 and 8.25 percent, respectively. The officials of the Ministry of Finance indicated that the Eurobond was necessary to replenish the diminishing foreign exchange reserves, to meet IMF conditionalities of the Extended Fund Facility (EFF) and to make the rupee stronger in the international market. The Ministry of Finance conducted road shows to promote the intended issue of the Eurobond in April 2014. These road shows were conducted in Dubai, London, New York, Hong Kong, Singapore, Boston, Los Angeles and San Francisco. The Minister indicated that the investors showed confidence in the economic situation of Pakistan and announced that they have received an overwhelming response with the Eurobond oversubscribed almost three times over. Pakistan was successful in issuing five-year bonds worth US$ 1 billion and ten-year bonds worth another US$1 billion, against the total intended amount of US$ 500 million. The main subscribers of both types of bonds were from the US followed by the UK, majority of which were fund manager from the two countries. After the issue of the Eurobond, Pakistan was successful in shoring up its foreign reserves. The Finance Minister indicated that the longer maturity period (of the 10-year bond) will release pressure of debt payments from government and allow it to invest in immediate projects. Moreover, the premium for the Eurobond (7.25 and 8.25 percent) was much lower than the 12.28 percent interest on local investment bonds. Subsequently, the rupee strengthened against the US Dollar and in July 2014, Moody¿s revised country¿s position from negative to stable economic outlook.

LEARNING OBJECTIVES:

¿ The decision of the government to issue the Eurobonds in excess of the initial planned volume of USD 500 Million. One of the alternatives that the study highlights was to issue only the initial target and then improve the fundamentals of the economy. With better fundamentals, the spread would have been more favorable for subsequent issues. ¿ It inspires readers to think about the exogenous factors involved in issuance of sovereign bonds. It discusses the process involved in issuing sovereign bonds and discusses various risks associated with international bond issues from an emerging market perspective. In particular, the risk of sovereign default is discussed at length. It gives students an opportunity to discuss various factors that affect the pricing of sovereign bonds. ¿ The case study analyses the current Eurobond issue using the examples of the previous Eurobond issues in Pakistan as well as the Eurobond issue in other developing countries (Sub-Saharan Africa primarily). The comparative analysis can also be used to analyze the market pricing of bonds with similar risks and used as a benchmark for the fair pricing of the bonds. Although, the exact pricing and modelling of the sovereign bonds is beyond the scope of this case study. However, with adequate supporting readings and data, this case can be adopted for sovereign bond yields pricing. ¿ One of the important barometers to measure the improvement in fundamentals and economic outlook of the economy is the credit rating of the country. This case study looks at the improvement in Pakistan¿s credit rating by Moody¿s from a negative to stable outlook between April and July 2014. This case study is suited for a Module on International Bond Markets and Bond Yields forexecutives and MBA/EMBA students. The key issues of this case are the characteristics of the Eurobond, the current issue of Eurobond given Pakistan¿s public debt situation and how the Eurobond affects the overall policy of the government. Broadly, the aim is to help executives and students understand the difference between domestic, foreign and Eurobond. It elaborates on how Pakistan¿s issue of the Eurobond in the international capital market has been determined due to exogenous and endogenous factors.

SUBJECTS COVERED:

Finance