When individuals are considering their investing options, they often fail to consider foreign currency bonds. A foreign bond functions under the same fundamental premise as a government bond or a municipal bond.
When a country is in need of funds, it will issue foreign currency bonds. The money that a country receives through foreign bonds will be traded in its own national market and may be utilized to fund essential projects. Often, there are higher interest rates attached to foreign bonds due to the increased risk associated with loaning funds internationally.
Therefore, an investor may yield a larger profit by purchasing foreign currency bonds. Also, by purchasing an international bond, a lender is increasing the diversity of his/her investment portfolio.
Statistics indicate that a diverse portfolio of investments generally yields a greater return. This is often because, while the economic stability of one government or country decreases, the economy of another country may flourish. If a lender invests all of his/her financial assets in one entity, then he/she may not receive any compensation for his/her loans in the event that the borrower experiences financial trouble. Therefore, many experienced investors stress the importance of diversifying investments.
Despite the apparent advantages of investing in foreign currency bonds, it is important for a lender to analyze all of the potential risks associated with these types of loans. Foreign bonds are issued in a foreign currency. If an individual purchases a foreign currency bond from England, the currency of the bond will be in British pounds.
Because of the fluctuation in international exchange rates, it is easy for an investor to lose money instead of turning a profit. For example, at this writing, if an individual wished to purchase a bond for £500, he/she would be investing $758 into a foreign government because the exchange rate is currently $1.52 United States dollars to £1 British pound. Exchange rates may fluctuate a great deal from one year to the next, due to changes in the global economy.
Foreign bonds require numerous years to mature, and by the time a lender receives compensation for the value of the loan, the exchange rate may have plummeted. If a lender receives £500 as compensation for his/her loan, but the exchange rate drops to $1.4 United States dollars to £1 British pound at the time of repayment, then the lender will only receive $700. Therefore, he/she will have lost $58 for his/her efforts.
There are other considerations that an individual must acknowledge before investing in an international bond. When a lender purchases a corporate bond, he/she is provided with various forms of legal protection in the event that the business files for bankruptcy.
However, if a foreign country defaults on a loan, there is nothing that can be done to compensate the lender for his/her loss. If a nation experiences an uprising or a shift in governmental control, foreign lenders may be refused payment for their loans outright. Quite simply, this is a risk that individuals accept when investing in international bonds.