Exchange Rates and the Currency Denominations of International Bonds

In international loan transactions, both lender and borrower may be reluctant to assume the risks associated with uncertain future exchange rates. If most of their revenues and expenditures are concentrated in their respective domestic currencies, they will tend to attribute less portfolio risk to loans denominated in domestic, rather than foreign, currency. Since opportunities to hedge long-term commitments often do not exist, the unit-of-account choice will be of particular importance in the international bond market, and exchange rate considerations will be crucial in this choice. This article examines the effects of exchange rate instability on the composition of the international bond market and attempts to provide a partial explanation of the relative predominance of different currencies. The underlying hypothesis is that, in an analogy with domestic financial principles, the market prefers stable to unstable currencies, because greater stability suggests greater predictability of future currency values, and hence of future real returns and debt-service costs. This attitude ought to affect the marketability and the actual volumes of bonds denominated in different currencies

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