Parallel bonds

Parallel bonds

A back-to-back loan is today referred to as a parallel loan or parallel bond, an earlier currency exchange. Two parent firms with different legal domiciles can protect themselves against currency risk by entering into a parallel loan. This kind of loan makes it very clear how long the corporations will borrow each other’s currencies and when they must repay them. 

What are parallel bonds? 

This involves two enterprises, two local lenders, and a mutual benefit arrangement known as a parallel loan. So, there are four parties participating in this bond. In this arrangement, two-parent corporations from separate nations borrow money in their home currencies and then lend it to the local subsidiary of the other. 

A parallel loan prevents international borrowing, which may be subject to limitations and penalties. So, each corporation may, of course, secure their money in the appropriate currency immediately through the currency market (forex), but doing so would expose them to exchange risk. 

Understanding parallel bonds 

In order to avoid taxes that were intended to make foreign investments extra expensive, the first parallel loans or parallel bonds were put into place in the United Kingdom in the 1970s. These days, currency swaps, equivalent to back-to-back loans, have largely superseded this method. 

As an illustration, let’s imagine that a UK corporation has a branch in Singapore and vice-versa. Each company’s subsidiary needs 10 million British pounds to fund its operations and investments. The two parent companies entered into a parallel loan contract rather than having each borrow money in its own currency and, after that, convert it to the other. 

How do parallel bonds work? 

A parallel loan’s primary goal is to prevent borrowing money from crossing international borders. In doing so, we expect to avoid any costs or limitations that apply. The main objective of a parallel loan is to reduce currency fluctuations between two businesses in separate nations. 

The loan is repaid at a certain future date and fixed exchange rate when two firms come to a parallel lending arrangement. Parallel loans also enable businesses to get around limitations and expenses associated with borrowing money internationally. Parallel loan agreements minimize the need to convert one currency to another, eliminating the risk of currency volatility or exchange rate. 

Businesses can also lend money to one another directly as an alternative to using banks. To protect itself against currency risk during the loan’s tenure, the corporation repays its loan at the fixed rate decided upon at its inception. 

Advantages of parallel bonds 

The main benefit of a parallel loan is that it lessens the currency or risk of exchange rates to which businesses may be exposed when borrowing internationally. Since local firms could find it beneficial to borrow from their own ground, they also allow for lower interest rates. 

Additionally, when two firms enter into a parallel loan agreement, it is a win-win arrangement that lowers their respective borrowing costs and interest rates. 

Disadvantages of parallel bonds 

When looking for parallel loans, the firms’ main obstacle is finding counterparties with equivalent financial standards. Even if they find a suitable company, each side’s desired terms and circumstances might not coincide. Some parties may want to use a broker, but the bond cost will need to go up to cover the broker costs. 

Also, because the parent company is foreign, the subsidiary’s credit score may not be as good, and it may be considered a riskier business. 

Another problem is the danger of default. This is so as both parties are responsible for the debt if one side fails to return the loan on time. A new financial structure or a contingency clause in the initial loan agreement will limit this risk. 

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