International Financial Markets and Intsruments

Eurocurrency Market

Prior to 1980 Eurocurrency markets are the only international financial market of any significance. They are offshore markets where financial institutions conduct transactions which are denominated in currencies of countries other than the country in which the institutions currencies of countries other than the country in which the institutions are located. The Eurocurrency market is outside the legal preview of the country in whose currency the finance are raised in the market.

Eurocurrencies are bank deposits denominated in currencies other than the currency of the country in which the bank is located. The bank deposits and loans are denominated in Eurocurrencies, particularly dollars. Eurodollars are dollar denominated time deposits held by financial intuitions located outside the US., including such deposits by branches of U.S.,including such deposits held by branches of U.S.,banks. Thus a dollar with a bank in London or Paris is a Eurodollar deposit. Similarly, a Deutsche mark deposit with a bank in London is Euro mark deposit, even a deposit made by a U.S., firm with a Paris subsidiary of a U.S. bank is still a Eurodollar deposit. Similarly a Eurodollar loan made by bank or branch of a bank outside U.S.A. is a Eurodollar market and the deposit are termed as Eurodollar deposits and the loans are called Eurodollar loans. The terms’ euro’ is affixed to denote offshore currency transactions.

Origin and Growth of Eurodollar Market

The Eurodollar market originated in the 1950s. Soviet Union and Eastern European countries, which earned dollars by gold exports and other means, wanted to keep their dollars as deposits with European banks. They avoided the banks in U.S.A. out of the fear that U.S. Government may block deposit in the U.S. banks. Subsequent growth of the market may be attributed to the emergence of dollar as the principal international currency after the World War II. Since 1965 there has been a phenomenal growth of this market. The fast growth of the Eurodollar market during 1965-1980 periods may be attributed to four major factors.

Large balance of payments deficits of U.S.A particularly during 1960s resulted in the accumulation of dollars by foreign financial institution and individuals.

The Various regulations, which prevailed in the U.S. during 1963-74, encouraged capital outflows. The interest equalization tax of 1963 was lifted and the Eurobond market started flourishing. Side bys side there was a revival of the market for foreign bonds in the U.S. regulation Q regulated the interest rates that U.S. banks can pay on time deposits and regulation M required U.S. banks to keep a stipulated percentage of cash reserves against deposits, These restrictions encouraged U.S. banks and multinational corporations to keep dollar deposits and borrow dollars abroad.

Thus the main factors behind the emergence and growth of Eurodollar market were the regulations imposed on borrower and lenders by the U.S. authorities that motivated both banks and corporation to evolve Eurodollar deposit and loans. The European and U.S. banks take deposits out of USA.

To place them in free centers in Europe. They for short-term lending or for investment used these deposits with outside banks.

The Massive balance of payment surpluses realized by OPEC countries due to sharp increase in oil prices (1973 and 1978) gave rise to what are called “petrodollars”. These countries preferred to deposit such dollar with financial institutions outside the US.

The efficiency with which it works and the lower cost has also contributed to the growth of Eurodollar market. Large amounts of funds can be raised in this market due to lower interest rated and absence of credit restrictions that market much domestic market. The Eurocurrency loans are generally cheaper due to small lending margins as a result of exemption from statutory cash reserve requirements, absence of restrictions on lending rates, economies of scales etc., Thus these markets are not subject to national controls.

In sum Eurodollar market is the market for bank time deposits denominated in U.S. dollar but deposited in bank outside the United States. Similarly European, euro sterling, and so forth are simply deposits are denominated. The Eurocurrency market is the market for such bank deposits. The Eurocurrency market thus permits the separations of the currency of denomination from the country of jurisdiction

Eurocurrency market that started in London found its way in other European cities and in Singapore, Hongkong, Tokyo, the Cayman Island and Bahamas. These markets consist of beside Eurodollar market. Asian dollar market Rio dollar Market, European market as well as Euro sterling. Euroswiss francs euro French Franc euro-D marks markets etc.,

International banks and foreign branches of domestic banks, private banks and merchant’s banks are the main dealers on the market. In fact, most of the U.S. banks deal in this market. The commercial banks in each of these markets accept interest-bearing deposits denominated in a foreign currency and they lend their funds either in the same country or in a foreign country in whose currency the deposit is denominated. Over the years these markets have evolved instruments other than time deposits and short-time loans. Those instruments are certificates of deposits, euro commercial paper; medium to long-term floating rate loans, Eurobonds etc., the market is of wholesale nature, highly competitive and well connected by network of brokers and dealers

Eurocurrency Finance

The table below shows different types of finance available in euro currency market.

Short-Term Finance

Euro Loans: These loans are made to the corporations in the requisite currency by banks. These loans are essentially short-term accommodation for periods less than one year. They are mostly provided in euro dollars. The interest rates on these loans are based on the London Inter Bank offered rates (LIBOR) for their respective currencies. LIBOR- represents a rate of interest used in interbank transactions in London. The rate for each currency is arrived at as an average of the lending rates charged by six leading London banks in the interbank market. The borrowers of euro-loans are charged on the basis of LIBOR + depending upon the six months floating interest rates is charged. If these loans are for periods beyond six months, the loan is rolled over and interest is charged on the LIBOR prevailing at the time of rollover.

Euro commercial Paper (ECP): Euro commercial paper is a floating euro-commercial promissory note. These notes are issued at discount on their face value and such discount represents the profit to the investor. These ESP’s are also issued for less than one year between 7 to 365 days. They offer a high degree of flexibility to the borrower with wide ranging choice of amounts and maturities. They are thus tailor made to take into account the specific needs of the borrower. It is quite common for an ECP issuer to follow it up with Euro Bond/Equity Issues. ICICI was the first Indian Institution to obtain finance through ECP in 1987.

A certificate of deposit is similar to traditional term deposit but it is negotiable and hence can be traded in the secondary market. It is often a bearer instrument. There is only one single payment of principal and interest. The bulk of the deposits have a short duration of 1,3 or 6 months. For CDs these is a fixed coupon or floating coupon. For CDs with floating rate coupons its life is subdivided into periods usually of 6 months. Interest is fixed at the beginning of each period. The rate of interest is based on the prevailing market rate, which is usually the LIBOR.

Medium Term Finance

Syndicate Loans: These are loans given by syndicates of banks to the borrowers. They carry a variable rate of interest (LIBOR). They are tied to specific project in case of corporations. Government can also borrow syndicate loans. But such loans are not tied to specific projects. They can be even used to meet balance of payment difficulties.

Revolving underwriting facility (RUF): A RUF is a facility in which a borrower issues on a revolving basis bearer notes, which are sold to investors either by placing with an agent or through tenders. The investors in RUF undertake to provide a certain amount of funds to the borrowers up to a certain date. The borrowers is free to draw down repay and redraw the funds after giving due notice. The London branch of the State Bank of India to an Indian borrower provided the first RUF in 1984.

Euro –Medium term notes (MTNs): The medium term notes have maturity from 9months to 20 years. There is no secondary trading for MTNs. Liquidity is provided by the commitments from dealers to buy back before maturity at prices, which assure them of their spreads. These are issued just like Euro-commercial paper. The issuer enjoys the possibility of issuing them for different maturity periods. Companies use these notes. The sums involved vary between $2 &$5 million.

Long Term Finance

The long-term credit may be in the form of euro-bonds and euro-equities, which are known as euro-issues. We discuss here under the market for Eurobonds and euro equities