Learning from Argentina's downfall continues.
Dear International Friend,
We have been looking at why Argentina has run into an economic quagmire, what we can learn from this as investors and what opportunities we might gain from this now. In our last message we looked at Argentine par bonds that are guaranteed by zero coupon U.S. Treasury bonds and that pay 13% per annum interest till 2023 when purchased at 46 cents on the dollar.
Today we look at other benefits and risks of these bonds.
Steve Rosberg (our eClub advisor in Buenos Aires) explained additional benefits of these par bonds when he explained:
THE POSITION THE PREVIOUS GOVERNMENT WAS NEGOTIATING WITHTHE BONDHOLDERS WAS TO TRY TO REACH AN INTEREST RATE OF 7% ON its DEBT.
AS THIS PAR BOND PAYS BELOW THAT INTEREST RATE (6% ON THE $1000 FACE VALUE), IT WAS NOT TO BE INCLUDED IN THE DEBT RENEGOTIATION..
IT COULD CONCEIVABLY STILL BE LEFT OUT OF ANY RESCHEDULING.SO, EVEN IF THE YIELDS AREN'T POTENTIALLY AS ASTRONOMICAL AS OTHER BONDS,THERE IS SUBSTANTIALLY LESS RISK WHICH, IN MY OPINION, IS STILL WELLREMUNERATED.
Steve's points make sense yet there are some other risks to take into account.
The market price for a face value of the bond is about 46 cents on the dollar.
When one buys the Par bond, one gets two collaterals inside the deal:
– one year interest is deposited with foreign custodians, so in principleyou could say that you do not have an interest collection risk for the first12 months.
– a US treasury zero coupon that matures in 2023, covering the principal ofthis obligation – face value (future value) 100 cents on the dollar.
There are additional risks though on the deposited interest. There is always one year of advance interest on deposit with a custodian to guarantee that the next 2 interest payments will be made. This deposit, at this time, should be 6 cents on the dollar. There is the question of whether the Argentine Government can withdraw that deposit. This is unlikely, but before investing have your banker look into the issuing documents to ascertain it – several thick booksfull of legalese.
The second question is regarding the valuation of the zero coupon. Today,because US interest rates are low, that zero coupon in worth about 35 centson the dollar. That, 35 plus about 5% interest per annum compounded, in21 years becomes 100. If the long interest rate in the US goes up to 7%, that zero coupon will fall in value to half (in fact it falls to about 23.5%.
These points have to be taken into account. If we are buying abond at 45 and it contains guaranteed interest of 6 plus collateral of 35,it's not the same as if the 6 disappeared and the present value of thecollateral fell from 35 to 17.5.
With the new change in government, Argentina is open to morevolatility. It will likely get worse before it gets better. There is some great opportunity in taking risks there now, but prudence needs to be exercised if one is planning on entering this market at this time.
On the other hand if you buy the safest investment in the world today, 30 year US government bonds, and then US long interest rates rise 2% you will also suffer enormous losses. If you invest in the Dow, you are likely to suffer losses as well. That which appears to be rock solid (like the energy company Enron) may demand a premium price, but have a foundation built upon sand that everyone has ignored. High risk bonds at least sell at a discount and you enter the market knowing that there is risk, so you'll be looking and take care.
Whether you prefer investments such as Argentine bonds or investments that appear safer, there is much to be learned in these last four messages about risk and risk assessment which I hope will help you have better global investing and business!