Brady bonds are a form of government bond. Governments of emerging or developing economies issue brady bonds in an attempt to minimize the nations external debt. Brady bonds are liquid in nature, that is, they are financial instruments that can be converted to cash easily, within a short period of time, and at a fair price.
Bardy bnds were named after Nicholas Brady, the secretary of the United States Treasury who proposed a debt-reduction agreement for developing countries in Brady bonds convert bank loans to new bonds as part of the attempt to revamp the emerging market debt. When it was first created, it was mostly issued by Latin American countries. After many countries, including Latin American countries, defaulted their debt in the s, Brady bonds were introduced.
It is a bailout strategy from the emerging market debt at that time, it was created in Primarily, Brady bonds allowed commercial banks to exchange their claims on developing countries, with the introduction of Brady bonds, developing countries are able to remove default debt usually called non-performing debt from their balance sheets.
Treasury securities. A portion of the interest payable on Par and Discount Bonds generally from 12 to 24 months coverage was also secured by the pledge of high-grade investment securities. While both Par and Discount Bonds were year collateralized bonds, a number of nations also issued uncollateralized bonds with shorter tenors e. Some nations also issued bonds in exchange for unpaid interest on defaulted loans e.
Each Brady country negotiated the specific terms and details of its Brady restructuring during discussions with its commercial bank creditors, who were offered a resulting 'Menu of Options' for their exchange of eligible debt. Mexico, the first nation to begin negotiating with its commercial bank creditors August , was also the first nation to restructure under the Brady Plan The large issue size of many Brady bond issuances helped to provide the Brady bond market with substantially greater liquidity than is found in many other financial marketplaces.
A Brady bond allows the commercial banks to replace their debt with these bonds. This way developing countries are able to remove their non-performing debt and replace it with new bonds. Basically, the issuing country buys zero-coupon bonds from the U. These bonds are of the same maturity as the Brady bonds. Now, these zero-coupon bonds are kept in the Federal Reserve escrow until maturity. At maturity, the issuing country sells these zero-coupon bonds to make the principal payment.
In the event of non-payment, the holder of the bond gets the principal at maturity. We can say that these bonds convert non-performing loans into zero-coupon bonds of the U. As said above, these bonds are collateralized and could be kept in Federal Reserve escrow till their maturity.
The U. Treasury zero-coupon bonds serve as collateral. Even though these bonds are an appealing option for investors, they are not risk-free. Investors in these bonds do face certain investment risks. And these could be credit failure, sovereign, and interest rate risk. The interest rate risk is unavoidable because of the inverse relation of the bond prices and interest rates.
Issuing countries purchase from the U. Treasury zero-coupon bonds with a maturity corresponding to the maturity of the individual Brady bond. The zero-coupon bonds are held in escrow at the Federal Reserve until the bond matures, at which point the zero-coupons are sold to make the principal repayments. In the event of default, the bondholder will receive the principal collateral on the maturity date.
While Brady bonds have some features which make them attractive to investors interested in emerging market debt, they also expose investors to interest rate risk , sovereign risk, and credit risk.
In view of these risks, emerging market debt securities generally offer investors a potentially higher rate of return than is available from investment-grade securities issued by U. In addition to the higher yield on Brady bonds, the expectation that the issuing country's creditworthiness will improve is a rationale that investors use when purchasing these bonds.
While appealing to some market participants interested in emerging market debt, Brady bonds are also risky in that they expose investors to interest rate risk, sovereign risk, and credit risk.
Mexico was the first country to restructure its debt under the Brady Plan. Other countries soon followed, including:. The success of these bonds in restructuring and reducing the debt of participating countries was mixed across the board. For example, in , Ecuador defaulted on its Brady bonds, but Mexico retired its Brady bond debt completely in Fixed Income Essentials.
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