Non-U.S. Market Debt Securities

The Series 7 also covers debt securities issued outside the United States. These instruments introduce additional risks that domestic bonds do not carry, particularly currency risk and political risk.

Sovereign Debt

Sovereign debt consists of bonds issued by foreign national governments.

Key characteristics:

• Subject to political risk (government instability, policy changes, expropriation)
• Subject to currency risk (exchange rate fluctuations) if denominated in a foreign currency
• Credit quality varies widely by country; a bond from a stable developed nation carries very different risk than one from an emerging market
• May be denominated in the issuer's local currency or in U.S. dollars

Think of it this way: Currency denomination is the switch that turns currency risk on or off. If a foreign government issues a bond in U.S. dollars, you receive dollar payments and never worry about exchange rates. If the bond pays in the local currency, every coupon payment is worth more or less depending on exchange rates at the time.

Exam Tip: Gotchas

• Sovereign debt carries political risk even for highly rated countries. A stable government today does not guarantee stable policies tomorrow.
• Dollar-denominated sovereign debt eliminates currency risk but not credit risk or political risk. The denomination only addresses one of the three risks.

Foreign Corporate Debt

Foreign corporate bonds are issued by companies domiciled outside the United States.

Additional risks include:

• Currency risk (if not dollar-denominated)
• Political risk (regulatory changes, capital controls)
• Potentially less regulatory oversight than U.S. corporate bonds
• Different accounting standards may make credit analysis more difficult

Yankee bonds:

• Foreign bonds issued in the U.S. and denominated in U.S. dollars
• Subject to SEC registration requirements
• Allow U.S. investors to invest in foreign issuers without currency risk
• Named for the U.S. market where they are sold

Exam Tip: Gotchas

• Yankee bonds eliminate currency risk but not credit risk. The investor still bears the foreign issuer's default risk.
• Yankee bonds must be registered with the SEC because they are sold in the U.S. market.

Eurodollar Bonds

Eurodollar bonds are U.S. dollar-denominated bonds issued outside the United States. Despite the name, they are not limited to Europe; "Euro" simply means the bond is issued outside the currency's home country.

Key characteristics:

• Denominated in U.S. dollars, so U.S. investors face no currency risk
• Issued and traded outside the U.S.
• Not registered with the SEC (issued in foreign markets)
• Typically sold to institutional investors
• Often issued in bearer form (no registered owner on record)

Exam Tip: Gotchas

• Yankee bonds vs. Eurodollar bonds is a common exam distinction. Yankee bonds are foreign-issued but sold in the U.S. (SEC-registered). Eurodollar bonds are dollar-denominated but sold outside the U.S. (not SEC-registered). Both eliminate currency risk for U.S. investors, but only Yankee bonds require SEC registration.
• "Euro" does not mean European. A Euroyen bond is a yen-denominated bond issued outside Japan. The prefix simply means "outside the home country of the currency."