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Brady bonds are denominated bonds created with a United States dollar value and supported by U.S. Treasury zero-coupon bonds. Named for U.S. Treasury Secretary Nicholas Brady, the main purpose of the bonds was to reduce the amount of international debt held by several countries, most notably countries located in Latin and South America. To this end, the Brady bond was to address the incidence of loan defaulting that had become an all too common phenomenon during the decade of the 1980’s.
The emergence of the Brady Bond occurred in 1989. In theory, the idea was to convert previous bonds issued by Latin American countries into new bonds. The process would essentially eliminate the default on older bonds and loans, and allow the countries to create new bonds to cover the outstanding principal of a new loan. Occasionally, the new Brady bond would also cover the unpaid interest as well. Because the new bonds were considered to be tradable on the international market, and due to the collateralization process that was possible due to the zero-coupon bond backing, the new Brady bond was often more valuable to the creditor than the original bonds that were involved in the defaulted loans.
Implementation of the Brady bond strategy occurred in two phases. During the first phase, creditors and debtors had to come to terms for the new bonds. The idea was to create a management of debt that was workable for the debtor, but would also provide enough incentive for the creditor to continue with the arrangement. This usually meant structuring the terms so there was a reduced amount of indebtedness from the older debt, while still providing assurances for the creditor that there would eventually be capital gains realized from the new bond. The second phase included the actual implementation of the new bonds, based on the terms that were worked out between creditors and debtors in the first phase.
Generally, the Brady bond is collateralized by a thirty year U.S. Treasury backed zero-coupon bond that is purchased by the debtor country. Two types of the Brady bond are common. The par bond carries the same face value as the original loan, but the coupon on the bond is below the market rate at the time of issue. Discount bonds are issued at a rate that is below the balance of the original bond, but the coupon is equal to the current market rate. With both variations of the Brady bond, the principal and interest payments are generally guaranteed.
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