Brady Bonds Pallavi Rao Morris Chen

Brady Bonds

        Buy Mexican par or discount bonds Buy Venezuela par or discount bonds Fair opening price of Costa Rican Principal Series A Hold or sell Mexican Brady Bond at Nov. 2003 Useful Diversification Tool?

Method & estimate of country risk with Brady Bond Hedge Mexican exposure Probability of default in the Future

What is a Brady Bond?

 􀂾 Principal collateral  􀂾 Rolling-interest guarantee  􀂾 Value recovery rights  􀂾 Par bonds 

􀂾 Discount bonds

Mexico Par/Discount

Par Data        T-Bond 30 Yrs YTM T-Bill 1 Yr Country Risk CCC Bond YTM Coupon Interest Face Value Prob of Default 8.56% 8.35% 5.00% 13.35% 6.25% 100 4.00% Discount Data        T-Bond 30 Yrs YTM T-Bill 1 Yr Country Risk CCC Bond YTM LIBOR + 13/16 Face Value Prob of Default 8.56% 8.35% 5.00% 13.35% 9.31% 100 4.00%

Mexico Par/Discount

 Mexico Par  NPV = 40.88

Mexico Discount NPV = 56.72

Recommendation: Buy Mexico Par

Venezuela Par/Discount

Par Data        T-Bond 30 Yrs YTM T-Bill 1 Yr Country Risk C Bond YTM Coupon Interest Face Value Prob of Default 8.24% 7.05% 8.00% 15.05% 6.75% 100 6.00% Discount Data        T-Bond 30 Yrs YTM T-Bill 1 Yr Country Risk C Bond YTM LIBOR + 13/16 Face Value Prob of Default 8.24% 7.05% 8.00% 15.05% 9.31% 100 6.00%

Venezuela Par/Discount

 Venezuela Par  NPV = 36.66

Venezuela Discount NPV = 47.03

Recommendation: Buy Venezuela Par

Costa Rica Principal Series A

Principal Series A Data        T-Bond 30 Yrs YTM T-Bill 1 Yr Country Risk CC Bond YTM Coupon Interest Face Value Prob of Default 7.73% 8.32% 6.50% 14.82% 6.25% 100 5.00%

Costa Rica Principal Series A

 Costa Rica Principal Series A NPV = 49.15

Hold or Sell Mexico Brady Bond

       Par Data as 11/2003 T-Bond 30 Yrs YTM T-Bill 1 Yr Country Risk BB Bond YTM Coupon Interest Face Value Prob of Default 5.15% 1.71% 4.50% 6.21% 6.25% 100 3.00%

Hold or Sell Mexico Brady Bond

 Mexico Par as of 11/2003 NPV = $68.83

Current Selling Price = $100.00

Recommendation: Sell Mexico Par

Useful Diversification Tool?

 Approx. 60% variance in Mexican par prices is attributable to changes in US Treasury.

Conclusion: High correlation between Mexican Brady Bonds and US Treasury. Therefore, not a good diversification tool.

Estimate Country Risk with Brady Bond

 Brady Bond YTM = US T-bill + Spread Therefore, Country Risk = Brady Bond YTM – Risk Free YTM

Hedge Mexican Exposure

 Brady Bond has two risk components Sovereign Risk (Country’s political & econ. Risk) Interest Rate Risk (US Interest rate fluctuations) Solution: Hedge Interest Rate Risk with CBOT bond futures Hedge Sovereign Risk with put options in Mexico

Probability of Default

 Country Risk Ranking = 47 (100 most risky)  Brady Bond buybacks  Political Risks = C  Economic Policy Risk = B  Economic Structure Risk = C  Liquidity Risk = C  Overall Risk = C