Updated July 4, 2023
Definition of Yankee Bonds
The bonds are debt obligation bonds issued by foreign entities, specifically foreign banks or financial institutions. Which are not traded in other countries than the united states bearing the US dollar currency under the governance of the Securities Act, 1933, and the registration of which requires a lot of paperwork along with the credit ratings under the shadow of Moody’s, S&P is called as the Yankee Bonds.
Explanation
The US market popularized Yankee bonds after the 2008 global crisis because they offered higher returns than other well-performing investments, based on the principle that higher risk yields higher returns while lower risk results in lower returns. These bonds trade exclusively in the US market and are denominated in US currency.
Example of Yankee bonds
Let’s take one Yankee bond with the below details:
| Particulars | Value |
| Face value | $100 |
| Coupon rate | 5% |
| YTM | 3% |
| Maturity | 3 years |
If YTM falls to 2% in the above example, the value of the Yankee bonds will rise, and if the YTM rises to 5%, the value of the Yankee bond will decrease. Also, the coupon rate and the YTM are the factors that decide whether the bond will be at a premium or discount. Hence, there is an inverse relationship between the price of the Yankee bond with the YTM.
Risk of Yankee Bonds
If the company’s performance, in which the investment is made, becomes unfavorable, other factors can affect the returns of the Yankee bond. The country’s economic conditions and other factors often impact the company’s performance. Hence, the country’s situation can indirectly be a risky factor for the Yankee bond’s value. Also, the investor should have the risk-bearing capacity for investing in Yankee bonds, as these are not risk-free.
Advantages
- It provides the opportunity to diversify the portfolios for those investors who hold their investments in different sectors, and their bond issuers are also different entities. Those different entities are not part of the US investing in the US bonds market.
- It can sometimes be available at a lower cost than the other bonds in the market. Again, this provides the benefit of cost efficiency over other bonds.
- It provides the opportunity for the highest liquidity in the US market as they are active traders in the US debt markets compared to other bonds.
- The prices of the Yankee bonds are not dependent on other influencing factors like political, economic, and other changes that may prevail in the US.
- It offers a more significant yield than the other yields on other investments in American portfolios.
- They are issued in the US in the US currency itself, i.e., in USD, along with the repayment in the same USD currency, there is protection against the currency risk in the market, or there is minimum currency risk in the market.
- The tenure of the Yankee bonds is longer than the other bonds in the market; hence, they can be available for a more extended period.
- Registering Yankee bonds under the SEC involves completing numerous documentation and meeting stringent and complicated requirements, enabling the issuer to gain access to the US market.
- If purchased longer, they can act as a natural hedge in the US market.
Disadvantages
- The Yankee bonds act on the general principle of the investment, i.e., the higher the risk, the higher the return, and if there is a lower risk, the lower the return. Hence, if the investor wants to earn a higher return from the Yankee bonds, he must have a higher capacity for risk holding; otherwise, he can bear huge losses.
- The returns of the Yankee bond also depend on the company’s performance. If some companies do not have excellent or satisfactory financial performance, they can turn into Junk bonds. The company’s performance is often under the influence of the many unfavorable economics and other changes in the country.
- There can be a scenario of a currency mismatch in foreign companies. Generally, the company’s borrowings are in US currency; however, the companies’ gains and incomes from the investments can be in a currency other than the US. This can result in a loss if there is a depreciation in the company’s earnings currency against the US currency. Hence, the holders of the Yankee bonds have to be risk-takers in terms of currency fluctuations.
- As discussed above, the bond issuer must undergo complicated procedures and documentation to register under the SEC. This involves lots of time and costs in the process of registration.
- The Yankee funds are favored compared to the other American funds; hence, they are sold by the US market when the interest rate is generally lower.
Conclusion
The US market did not popularize Yankee bonds before 2008 when a global crisis occurred. The ability to bear higher risks is a requirement for investors who opt for Yankee bonds. Acquiring Yankee bonds necessitates a wealth of knowledge, an understanding of local laws, and other information. Before investing in Yankee bonds, one should thoroughly study their numerous advantages and disadvantages.
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