Are you an Accredited Investor looking for an enhanced yield opportunity? Here’s a trade idea you might be interested in.
Jaguar Land Rover (JLR), a subsidiary of Tata Motors, offers a EUR denominated bond maturing in the year 2026 (ISIN XS1881005976), offering a yield of around 5.8% annually, and a USD denominated bond maturing in the year 2023 (ISIN USG50027AE42), offering a yield of around 5.6% annually. Investors can hedge the EUR bond into USD to generate an additional yield pickup of roughly 280 basis points for a 3-year extension in maturity.
Let us tell you more about this trading strategy!
The trading strategy involves taking advantage of the cross-currency basis between EUR and USD, thereby enhancing the realized yield once the EUR proceeds are swapped back into USD.
The strategy involves a few steps. We have detailed them below:
- Use USD currency to purchase Euros at the spot rate.
- Using the purchased Euros, buy 2026 EUR JLR bond.
- Simultaneously, enter a forward rate agreement to convert the proceeds from the Euro investment into U.S. dollars, using a forward exchange rate at the end of the investing period.
Here’s an illustration to depict how this would work in real life:
If the investor looks to purchase 100,000 notional of the 2026 EUR bond, then assuming a price of 93, the investor needs 93,000 Euros to make the purchase. If the spot rate of EUR-USD is 1.13, then this translates to 105,090 US Dollars.
The following table summarises yearly cash flows generated on 100,000 notional of the 2026 EUR bond that gives coupon payments of 4.5% –
Assuming forward EUR-USD rates for the years, following table projects the cash flows in USD if the investor decides to convert the EUR proceeds into USD as and when they arise.
Thus, if the investor began with USD 105,900, and generated USD cash flows as projected in the table above, the investor would have generated an annual yield of roughly 8.4%.
Hence, for a 3-year difference in maturity, the EUR bond when hedged into USD, generates a 280 basis points pickup over its USD counterpart. Currently in the market, the EUR bond offers roughly 200 basis points pickup for 2-year extension in maturity.
Note that the example above is for illustrative purposes only. Actual results may vary because the trade would be based on rolling the EUR exposure on a 1-year future basis.
Interested? Please reach out to our Advisory Desk at firstname.lastname@example.org for further details or queries.
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