How To Manage International Debt

International debt management has plenty of pitfalls. Each country has its own politics and economics and tax laws to factor into ones decision-making.

For an individual investor, buying mutual funds or exchange-traded funds investing in foreign debt might be the best bet, for most investors are ill-equipped to deal with foreign bond markets and exchange rate issues personally.

One thing to remember is that high interest rates on foreign debt usually mean high inflation; if a country has interest rates higher than in your home country, the country's currency will tend to go down in value by a percentage equal to the difference between interest rates. Interest rate parity is the international econ term for that; for instance, if US interest rates are at 1% and British interest rates are at 4%, we can expect the pound to go down 3% a year vis-a-vis the US dollar. That will reduce the value of your debt securities; what you'll gain in extra interest you'll lose in the value of your principal.

You can hedge exchange rate risks on international debt by using futures contracts. However, the future contracts will be priced using that interest rate parity concept. If the pound is worth $1.50 today, a futures contract for a year from now would have the pound priced at about $1.45 to reflect the 3% difference. In addition, futures contracts require large deposits to insure that you make good on your side of the trade.

If you're looking to lock in the value of your interest and principal on your international debt, you might consider a forward contract; those are specialized futures contracts done generally through your bank and can be customized to the time and amount needed. Since your bank already has a big chunk of your cash on hand, they don’t have to worry about deposits. However, since it is customized, a forward contract is more expensive.

You’ll need to find a broker to make the bond trades through; not every broker is positioned to make bond trades overseas. Where possible, try to find a discount broker, since if you want to pay for bond-trading expertise, you’d have went the mutual fund route.

Lastly, you'll want to keep track of the politics of the countries you're investing in. If a country starts running up a big deficit, that can be inflationary and do a double-whammy on your investment due to inflation and exchange rate changes.


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