EUROCURRENCY MARKET

1

Chapter 1: INTRODUCTION TO THE EUROCURRENCY
MARKET

With the liberalization in the domestic regulations and globalization of financial
markets abroad, an increasing number of Indian companies are raising funds in
international financial markets. Typically the operations are in Eurocurrency
markets, which provide larger access at competitive cost.

Eurocurrency market is an international capital market which specializes in
borrowing and lending of currencies outside the country of issue. Thus, deposits
in dollars with a bank in London are Eurodollars. Similarly, Japanese yen held
by banks in London are Euro yen, pound-sterling held by banks in Germany is
Eurosterling, and so on. They are all Eurocurrencies. The main centres of
Eurocurrency are London and few other places in Europe. The growth of the
market has extended beyond these limits and now it includes a few centers of
Asia too, such as Singapore and Hongkong.

A Eurocurrency Market is a money market that provides banking services to a
variety of customers by using foreign currencies located outside of the domestic
marketplace. The concept does not have anything to do with the European Union
or the banks associated with the member countries, although the origins of the
concept are heavily derived from the region. Instead, the Eurocurrency Market
represents any deposit of foreign currencies into a domestic bank. For example,
if Japanese yen is deposited into a bank in the United States, it is considered to
be operating under the auspices of the Eurocurrency Market.

In the financial world, Eurocurrency is money that is deposited in foreign banks
outside of a country. When these foreign deposits are called eurocurrency, they
are primarily related to European countries, but over time, eurocurrency has
become a term for any funds deposited in a foreign bank. The term should not be
confused with the monetary unit known as the Euro. From the standpoint of the
domestic bank, eurocurrency refers to funds that are deposited in a currency
different from that country's own currency.

Some speculate that the term eurocurrency earned its kind of colloquial global
use because of the unique diversity of the European continent. Many small
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2

countries are packed into a very small space on the land mass, with various laws
and cultures meshing and colliding with each other. In modern times, the
diversity of Europe has led to the European Union, and the subsequent Euro, a
European unit of money that serves the entire EU community. In recent years,
the national currencies of most European Union member countries were phased
out to make way for the common Euro.

The extension of the word eurocurrency, which has nothing to do with the Euro,
means that a deposit from an Asian country to an African country would also
qualify as eurocurrency. The financial community has also coined terms for
specific foreign currency deposits, such as the Eurodollar, which also does not
refer to the European currency. A Eurodollar is a deposit of American money
still denominated in dollars that is in a bank outside of the U.S.
It is a market for borrowing and lending of currency at the centre outside the
country in which the currency is issued. It is different than the Foreign Exchange
Market, wherein the currency is bought and sold. Euro is a single currency which
was launched on 1
st
Jan1999 (With 11 of 15 member countries of the European
Union participating in the experiment). Now Euro is the official currency of 16
of the 27 member states of the European Union (EU). These 16 states include
some of the most technologically advanced countries of the European continent
and are collectively known as the Euro zone. The states, known collectively as
the Eurozone are Austria, Belgium, Cyprus, Finland, France, Germany, Ireland,
Italy, Luxemberg, Malta, The Netherlands, Portugal, Slovakia and Spain. The
currency is also used in a further five European countries with and without
formal agreements and is consequently used daily by some 327 million
Europeans. Over 175 million people worldwide use currencies which are pegged
to the Euro, including more than 150 million people in Africa.
The Euro is an important international reserve currency. Euros have surpassed
the US dollar with the highest combined value of cash in circulation in the
world. The name Euro was officially adopted on 16
th
Dec 1995. The Euro was
introduced to the world financial markets as an accounting currency on 1
st

Jan1999, replacing the former European Currency Unit (ECU) at a ratio of 1:1.
The currency was introduced initially in non physical forms, such as travellers
cheques and electronic bank in Euro coins and banknotes entered circulation on
1
st
Jan, 2002. The Euro is administered by the European Central Bank (ECB)
EUROCURRENCY MARKET
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based in Frankfurt, and the Euro system, comprising of the various central banks
of the Euro zone nations.
One of the factors that make the Eurocurrency Market unique compared to many
other money market accounts is the fact that it is largely unregulated by
government entities. Since the banks deal with a variety of currencies issued by
foreign entities, it is difficult for domestic governments to intervene, particularly
in the United States. However, with the establishment of the flexible exchange
rate system in 1973, the Federal Reserve System was given powers to stabilize
lending currencies in the event of a crisis situation. But one problem that arises is
that these crises are not defined by the regulations i.e. intervention must be
established based on each case and the Federal Reserve must work directly with
central banks around the world to resolve the matter. This adds to the volatility
of the Eurocurrency Market.

Despite its name, the Eurocurrency Market is primarily influenced by the value
of the American dollar. Nearly two-thirds of all assets around the globe are
represented by U.S. currency. The challenge with foreign banks revolves around
the fact that regulations enforced by the Federal Reserve are only enforceable
within the U.S. The taxation level and exchange rate of the American dollar
varies depending on the nation. For example, an American dollar in Vietnam is
worth more than it is in Canada, further influencing the market.

It's important for those dealing with these kinds of financial terms to understand
that the term eurocurrency is something that emerged from informal use.
Thinking that this term has to do with the currency of the European Union will
result in misunderstandings about foreign deposits in domestic banks. It's also
important to think about the way that some countries protect their national
economies by limiting foreign deposits or foreign holdings.
In some countries, foreign currency has historically been an illegal asset for
citizens. Though globalism has largely changed the way most of the world's
nations view financial freedoms, some countries still have restrictions in place
about changing denominations of funds, or moving them from one nation to
another. Looking at how eurocurrency is used can give one insight into the kinds
of rules and regulations that affect international money transfers.

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1.1 History

The Eurocurrency Market has its roots in the World War II era. While the war
was going on, political challenges caused by the takeover of the continent by the
Axis Powers meant that there was a limited marketplace for trading in foreign
currency. With no friendly government operations within the European
marketplace, the traditional economies of the nations were displaced, along with
the currencies. To combat this, especially due to the fact that many American
companies were tied to the well-being of business behind enemy lines, banks
across the world began to deposit large sums of foreign currency, creating a new
money market.

After World War II, the amount of US Dollars outside the United States
increased enormously, both as a result of the Marshall Plan and as a result of
imports into the USA. As a result, large sums of US Dollars were in custody of
foreign countries, including the Soviet Union, had deposits in US dollars in USA
banks.
After the invasion of Hungary in 1956, the Soviet Union feared that its deposits
in American banks could be frozen as retaliation. A British bank offered the
Soviets the possibility of receiving its US Dollar reserves as deposits, outside the
USA. This operation was considered the first to create so called Eurodollars.
Gradually, as a result of the successive commercial deficits of the United States,
the Eurodollar market expanded until today where it is available in virtually
every country. Today, Eurocurrency refers to deposits in any currency residing
in banks that are located outside the borders of the currencys country. For
example, a deposit denominated in Yen residing in an Australian bank is a
Eurocurrency deposit, or more specifically a EuroYen deposit. Similar external
deposits apply to EuroSterling, EuroEuro, EuroSwissFranc, etc.
While opening up of the domestic markets began only around the end of
seventies, a truly international financial market had already been born in the
mid-fifties and gradually grown in size and scope during sixties and seventies.
This refers to the well-known Eurocurrencies Market. It is the largest offshore
market. Prior to 1980, Eurocurrencies market was the only truly international
financial market of any significance. It is mainly an inter-bank market trading in
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time deposits and various debt instruments. What matters is the location of the
bank neither the ownership of the bank nor ownership of the deposit.The prefix
Euro is now outdated since such deposits and loans are regularly traded
outside Europe.
Over the years, these markets have evolved a variety of instruments other than
time deposits and short-time loans, e.g. certificate of deposit (CDs), euro
commercial paper (ECP), medium-to long-term floating rate loans, Eurobonds,
floating rate notes and euro medium-term notes (EMTNs). The difference
between Euro markets and their domestic counterparts is one of regulation.
Eurobonds are free from rating and a disclosure requirement applicable to many
domestic issues as well as registration with securities exchange authorities.

1.2 Emergence of Eurocurrency Markets
1. During the 1950s, the erstwhile USSR was earning dollars from the sale
of gold and other commodities and wanted to use them to buy grain and
other products from the West, mainly from the US. However, they did
not want to keep these dollars on deposit with banks in New York, as
they were apprehensive that the US government might freeze the
deposits if the cold war intensified. They approached banks in Britain
and France who accepted these dollars and invested them partly in US.

2. Domestic banks in US (as in many other countries) were subjected to
reserve requirements, which meant that a part of their deposits were
locked up in relatively low yielding assets.


3. The importance of the dollar as a vehicle currency in international trade
and finance increased, so many European corporations had cash flows in
dollars and hence temporary dollar surpluses. Due to distance and time
zone problems as well as their greater familiarity with European banks,
these companies preferred to keep their surplus dollars in European
banks, a choice made more attractive by the higher rates offered by Euro
banks.

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The main factors behind the emergence and strong growth of the Eurodollar
markets were the regulations on borrowers and lenders imposed by the US
authorities who motivated both banks and borrowers to evolve Eurodollar
deposits and loans.

Added to this are the considerations mentioned above, viz. the ability of Euro
banks to offer better rates both to the depositories and the borrowers and
convenience of dealing with a bank that is closer to home, which is familiar
with business culture and practices in Europe.


1.3 The origin of the Eurocurrency market is that the market in currency
trading outside their respective domestic economy. Several factors were
behind their birth:

1. The centrally planned economies were reluctant to hold bank deposits in
the United States, so they put their dollar earnings on deposit in London.
Gradually other European dollar holders did the same, a tendency that was
particularly marked when the United States ran large balance of payments
deficits.

2. Balance of payments pressures made the United Kingdom government
limit British banks external use of sterling, so they had a strong incentive
to develop business in foreign currencies.


3. By the end of 1958 the main industrial countries had restored full
convertibility of their currencies. The new freedom produced a surge of
international banking business.
The growth of the Eurocurrency was also stipulated by certain monetary
regulations in the United States. For instance, Regulation Q put a ceiling on the
interest rates that banks operating in the United States could offer to domestic
depositors were naturally attracted to Eurobanks that were not bound by
Regulation Q. In addition, banks in the United States were required to hold non-
interest-bearing reserves. By diverting dollar deposits to their offshore branches
or subsidiaries, U.S. banks were able to avoid trying up so much of their funds in
reserve requirements at a zero rate.
EUROCURRENCY MARKET
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General controls on the movement of capital also helped to boost the
Eurocurrency markets. In 1965, of the Voluntary Foreign Credit Restraint
Program (VFCR) in the United States. The specified goal of the VFCR was to
limit the growth of foreign lending by U.S. banks. Instead, their foreign branches
which were not subject to the VFCR took deposits and onlent them outside the
ceiling. Between 1964 and 1973 the number of U.S. banks with overseas
branches increased from 181 to 699 over the same period
At the end of the 1960s and during the early 1970s the Eurocurrency markets,
which had been located in Western Europe (and centered in London), expanded
to a number of other offshore banking centers. These were typically small
territories that had tax, exchange control and banking laws favourable to
international banks. The business was entrepot in nature, with foreign currency
funds deposited by one foreign source and then onlent to another. Offshore
centers have been set up in the Caribbean area, Latin America, the Middle East
and establishment of international banking facilities (IBFs) in the United States
designed to bring the locus of American banking back onshore.
With the recent strong growth of domestic currency lending abroad, total
international lending is now the most meaningful lending aggregate and it
encompasses Eurocurrency market activity.
The foreign exchange market was formed back in 1971 when the gold standard
as removed and countries started using free floating currencies. At first only
banks and large investment actually traded on this exchange and the managers
that did it correctly ended up making millions and even billions of dollars from
it. Unfortunately the common man could not really play without an entrance into
the market from somebody higher up. That was until the internet came along and
made it so that anybody with a little bit of cash can start doing one foreign
currency trading and make really good money.
The laws of supply and demand are always at work. One thing that has been
playing on the news is the situation that Greece is finding itself in where they are
basically having the same problems that our system as having and banks from all
over the EU are trying to keep their economy afloat. This has caused the
weakening of the Euro (currency used in many European countries) while having
a strengthening effect on the dollar because people were afraid of losing in the
Euro. This is just an example that could go any which way.

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Chapter 2: EUROCURRENCY MARKETS
2.1 Features of the Market
The following are the special features of the Eurocurrency market:
1. Types of transactions:
Transactions in each currency take place outside the country if its issue.
For example, dollars earned by a Japanese firm from exports may be
deposited with a bank in London. The London bank is free to use the
funds for lending to any other bank. The bank may use it for lending to
French Bank. Thus the utility of the currency is entirely outside the control
of the central bank of the country issuing the currency. For this reason,
Eurcurrencies are also referred to as offshore currencies.

2. Huge amount of transaction:
Generally they are only in millions of USD. This has led to syndication of
loans, where large numbers of banks participate in the lending operations.
It also consists of pool of large number of short term deposits, which
provides the biggest single source of funds for commercial banks.

3. Highly competitive market:
Eurocurrency market is a highly competitive market with free access for
new institutions in the market. There are no entry barriers. The lending
rates are low and deposit rate are high, thus allowing a wafer thin margin
for operations. Consequently, the margin between the interest rates on
deposits and advances has narrowed down considerably. Consumers, i.e.
investors and borrowers derive advantage out of this situation.

4. Floating rates of interest based on LIBOR:
The rate of interest is linked to a base rate, usually the London Inter-Bank
Offered Rate (LIBOR). The interest on the deposit or the advance would
be reviewed periodically and changed in accordance with change, if any,
LIBOR.




EUROCURRENCY MARKET
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5. Dominance of Dollar denominated transactions:
US dollar remains the leading currency traded in the Eurocurrency market,
even though its share is declining. However, other currencies are now
emerging thus reducing the role of dollar. Other currencies traded in the
market on large scale are Deutsche mark, Japanese Yen, Pound Sterling
and Swiss France.

6. Four different segments:
The Eurocurrency market can broadly be divided into four segments:
i. Euro credit markets, where international group of banks engage in
lending for medium and long term
ii. Euro bond market, where banks raise funds on behalf o international
borrowers by issuing bonds
iii. Eurocurrency (deposits) market, where banks accept deposits,
mostly for short term
iv. Euro notes market, where corporate raise funds.

7. Control of the country of issue of the currency:
Even though the currency is utilised outside the country of its origin, it has
to be held only in the country of its issue. For example, the Japanese firm
deposits its dollar earnings with the bank in London. The London bank
will keep the funds in a New York bank in its own name. When the
London bank lends the amount to the French bank, it will give suitable
instructions to the New York bank. On receipt of the instructions, the New
York bank will debit the account of the London bank and credit it to the
account of the French bank. Thus ultimately the settlement of all dollars
transactions takes place in New York. Similarly, settlement of all
Eurosterling is made in London.


2.2 Characteristics of Eurocurrency Markets:
The Eurocurrency market has several interesting characteristics:
1. It is a wholesale rather than retail market, which means that transactions
tend to be very large. Public borrowers such as governments, central banks
and public-sector corporations tend to borrow most of the funds. Also,
EUROCURRENCY MARKET
10

nearly four fifths of the Eurodollar arket is interbank, which means that
the transactions take place between banks.

2. The market is essentially unregulated.

3. Deposits are primarily short term. Most of the deposits ae interbank, and
they tend to be very short term. This leads to concern about risk, since
most Eurocurrency loans are for longer period of time

4. The Eurocurrency market exists for savings and time deposits rather than
demand deposits. That is, institutions that create Eurodollar deposits do
not draw down those deposits into a particular national currency in order
to buy goods and services.

5. The Eurocurrency market is primarily a Eurodollar market. In addition to
ordinary deposits in the Eurocurrency market, there are also certificates of
deposits (CDs) available in dollars, sterling and yen. Although most are
traded in multiples of $1 million or more. The CDs are usually quoted at a
discount at a fixed interest rate, but they can also be quoted at floating
interest rates.

2.3 Functions of the Eurocurrency Markets
The Eurocurrency market serves several important functions:
Its very nature allows market forces a fuller play than the counterpart
domestic market constrained with regulations and laws. Thus, it gives a
more accurate reading of market forces. Indeed, the more opaque the
domestic market due to distortions, the more critical the role of the
Eurocurrency market as a barometer of market forces. A paradox should
be noted here. Since this market owes its existence to impediments in the
domestic markets, it stands to reason that any reduction (if not removal)
in regulations in the domestic markets in recent years should decrease the
relevance of the Eurocurrency market. However, its significance has
increased rather than diminished over time. It is likely that taxes and
transaction costs have assumed a much more pivotal role than ever before
because of pressures on bank profits created by intensified competition.
EUROCURRENCY MARKET
11

The Eurocurrency markets are well connected and efficient. As a result,
the market can be used for hedging purposes. Banks can buy and sell
foreign currency denominated assets and liabilities of different maturities
and amounts for managing their exposure to interest rate and currency
risk.

The Eurocurrency markets are well funded, and thus are convenient
sources for funding a banks domestic and international loans.

Finally, new products are needed by the banks clientele to contain
exposure resulting from globalization, and such products may have legal,
regulatory, or tax implications that make them unsuitable for introduction
in the domestic market.


2.4 Countries Responsible for the Growth of the Eurocurrency
Market
1. China (fear that its Fx in USD would be blocked).
2. Korea (War broke out in 1950)
3. Russia (erstwhile USSR){because of their banking presence in Paris
and London}
4. UK (policy of not granting sterling loan outside sterling area in 1957).
5. USA (indeed blocked identifiable Fx in USD in 1950, Federal Reserve
Act, regulation Q and M; control and restrictions on borrowing
funds in US in 1965 and introduction of interest equalization tax in
1963)

China, Korea And Russia:
Since 1949, China feared that its dollar earnings would be blocked by USA. So
China shifted its dollar earnings to Paris in the Russian Banks. Korean war broke
in 1950. So USA indeed blocked Chinese indentifiable dollar deposits in USA.
Russian banks in Paris and London started disguising their balances by placing
them in western European banks rather than in New York. So the communist
countries had dollar claim on the western European banks and western European
banks had similar claim on USA.
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12

United Kingdom
British Government in 1957, decided not to grant sterling pound loans
outside sterling area.
During the same period, however, Western European banks were
permitted to foreign currency deposits (say bank in London will accept
dollar deposit).
So the banks in London offered loans to their non-sterling area customers.

United States Of America (USA)
Federal Reserve Act: Regulation Q
This act was about restriction on payment of interest on dollar deposits as
well as other currency deposits.
No interest was payable on deposits having maturity of 30 days or less.
There were restrictions and ceilings on interest payments on deposits
having maturity above 30 days.
Therefore, the dollar deposits of Non Resident US citizens got shifted to
Europe as the banks in Europe offered higher rates of interest on dollar
deposits
Foreign (for US) investors also shifted their dollar deposits from US to
centres outside US, mostly to banks in London.
London Banks used these deposits for lending to its customers in non-
sterling areas.
Thus London got the prominence in borrowing and lending Euro-dollar.

Federal Reserve Act: Regulation M
This act was about reserve requirement of the banks on their deposits.
The act required US banks to block more money in reserves, than
European banks.
US banking regulation was not very tight then (and it is not so even now)
American banks found it beneficial to move the deposits of Non Resident
US citizens as well as those of resident citizens to banks in Europe.

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Eurocurrency Centers

A Eurocurrency or international banking center is a place where a number of
banks are concentrated to conduct transactions related to deposits and loans
denominated in various Eurocurrencies. Although Eurocurrency markets are
global in nature, the deposit and loan rates in each location are somewhat
different, reflecting the local risk and impediments.

1. Different time zones thrust different locations into the limelight during a
typical day.
2. Differing regulatory (e.g., disclosure or report filing) or tax (e.g., annual
registration fees) requirements may lead to development of new locations.
3. Locations that meet the infrastructure needs (e.g., communications network
and availability of skilled personnel) have always been a major drawing card for
well-established centers, such as London and New York.

There are five major Eurocurrency centers: Western Europe (represented by
London as the headquarters), the Caribbean and Central America, the Middle
East, Asia, and the USA. London is the oldest and foremost Eurocurrency center.
Its prominent position is the result of its history of financial expertise and lack of
government regulations for Eurocurrencies. The Bank of England does not have
reserve requirements on Eurocurrency deposits or capital requirements for the
branches of foreign banks. During the 1980s, Japanese and US banks dominated
the London market. Now banks from other European countries have a
respectable representation.

In the Caribbean and Central American currency center, the Cayman Island is
one of the most attractive locations for setting up shell branches for US banks
where transactions are booked or routed to for a variety of reasons such as
lenient disclosure requirements and low or no profit taxes. It is not difficult for a
large multinational bank to open a branch in the Cayman Islands. The minimum
capital requirement can be met by using the capital of the parent bank.
Furthermore, there are no reserve requirements for Eurocurrency operations.
Bahrain is the center of the Middle East market in terms of the foreign exchange
and Eurocurrency trading. Its close proximity to Saudi Arabia and Kuwait is
important for currency trading and lending activities in the region.
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14

Tokyo, Singapore, and Hong Kong are three major Asian currency centers. The
Japanese government has been widely known to have a stronghold on its
financial markets. Because of intense pressure from the USA and other
governments, the Japanese government has gradually deregulated its financial
markets. In late 1986, the Japanese government set up the Japan Offshore Market
(JOM) in Tokyo for booking accounts exclusively for non-resident transactions
(including transactions of foreign subsidiaries of Japanese
corporations).Transactions in JOM are exempt from reserve requirements,
withholding tax, and interest rate controls that apply to domestic banking. The
major beneficiaries of JOM are Japanese regional banks that do not have
overseas branches. Although Japan was attracting more attention through the
1980s in the Asian currency market because of liberalization of the Japanese
financial market and the prominent position of the Japanese banks globally,
several recessions in the 1990s coupled with political indecision has at least
temporarily removed the bloom of the JOM. Two major reasons for the existence
of Singapore and Hong Kong are:

(a) the abundance of the US dollar circulating among Far Eastern residents
during the Vietnam War; and

(b) the differences in time zones vis--vis the USA and Europe that create
inconvenience for conducting business transactions dealing in the US
dollar.

Thus, the combination of the Asian dollar market, European centers, and the US
market provides 24-hour service to customers all over the world.
Singapore is now the headquarters for the Asian dollar market. The Singapore
government, in an attempt to compete with Hong Kong for leadership in the
Asian dollar market, eliminated its 40 percent withholding tax on interest income
earned by non-residents in 1968, and reduced its tax on bank profits on offshore
loans in 1973. In addition, other taxes have also been reduced or eliminated
while the exchange control measures for promoting growth in the Asian dollar
market have been liberalized.
Since December 1981, the Federal Reserve System has permitted US banks and
branches of foreign banks in the USA to establish IBFs, which are exempt from
reserve requirements, federal taxes, and deposit insurance. The intent of setting
up IBFs was to attract offshore banking business to the USA. Many shell bank
EUROCURRENCY MARKET
15

branches in places like the Cayman Islands or the Bahamas really amounted to
nothing more than a small office and a telephone for booking loans and deposits.
The location of IBFs reflects the location of banking activity in general. Thus it
is not surprising that over 75 percent of the IBF deposits are in New York State.
IBFs do not require physically separate banking entities, as they are just the
booking facilities located in the USA and sharing basic characteristics of
Eurobanks outside the country. IBFs can do business with only non-bank foreign
residents; thus IBF s cannot lend to or accept deposits from US residents.

Although borrowing from a US bank is allowed, it is subject to reserve
requirements. At the same time, IBFs are not allowed to issue negotiable
instruments such as CDs. Because of these restrictions, IBFs are not a perfect
substitute for offshore deposit facilities. Still, to make them more competitive
with offshore banking, the minimum deposit maturity is overnight for interbank
IBFs and two business days for nonbank foreign residents. The minimum size of
deposits is in excess of $100,000; hence they are not subject to deposit
insurance.



(Source: International Financial Markets by Prof. Lan Giddy, Stern Business School, New York University.)



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Chapter 3: SEGMENTS OF EUROCURRENCY MARKETS

3.1 Segment 1: Euro-Credit Markets
Tenure: Medium and Long Term Loans [upto 10-15 years 10% of loans, 5-8
years 85% of loans, 1-5 years 5% of loans] provided by group of banks.
1. Amount: It is a wholesale sector of the international capital market.
2. Security: Loans are provided without any primary or collateral security.
Credit rating is the essence of lending
3. Type of loan: a) revolving [like cash credit]
b) Term Credit
4. Interest Rate: Generally 1% above the reference rate rolled over every 6
months
5. Currency: Generally USD, but can be any other currency as required bt
the borrower and ability of the lender.

Syndcation of Loan:
Managing banks, as desired by the borrower
Lead bank, generally who takes the largest share of lending
Agent bank, as required to take interest of the banks in syndication and
comply with the procedure
Common assessment of the borrower and his country
Common documentation
In very few cases co-financing with IMF and IBRD is possible.

3.2 Segment 2: Euro-Bonds
Euro-Bonds are unsecured securities
They are therefore issued by borrowers of high financial standing
When they are issued by government corporation or local bodies, they are
guaranteed by the government of the country concerned
Euro-Bond is outside the regulation of a single country. The investors are
spread worldwide.
EUROCURRENCY MARKET
17

However, foreign bonds are issued in only one country and are subject to
the regulation of the country of issue.
Selling of EB is through syndicates of the banks
Lead manager advices about size, terms and timing of the issue.
Entire issue is underwritten.
Lead managgers fees, underwriting commission is somewhere between
2% and 2.5% of the value of the issue
Lead manager allocates the bonds to all members of the selling group at
face value less their commission.
Thereafter every member is on is own.
They can sell to investors at whatever price they can obtain
Thus no two investors in the Euro-Bond market need to pay the same price
for the newly issued bonds.

Features of Euro-Bonds:
Most Euro-Bonds are Bearer securities
Most bonds are denominated in USD 10,000
Average maturity of the Euro-Bond is 5-6 years
In some cases maturity extends to 15 years

Types of Euro-Bonds:
Straight or fixed rate bonds
1. These are fixed interest bearing securities
2. Interest is normally payable yearly
3. Year is considered of 360 days
4. Maturities range from 3-25 years
5. Right of redemption before maturity may be there or may not be
there
6. If the right of redemption is there then redemption is done by
offering a premium

Convertible bonds
1. These are fixed interest bearing securities
2. Investor has an option to convert bonds into equity shares of
borrowing company
3. The conversion is done at the stipulated price and during the
stipulated period.
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18

4. Conversion price is normally kept higher than the market price.
5. The rate of interest is lower than the rate of interest on comparable
straight bond.
6. Sometimes the bonds are issued in a currency other than the
currency of the share. This provides an opportunity to diversify
the currency risk asthese bonds are issued with fixed exchange
rate of conversion.
7. Bonds with warrants: warrant is part of the bond but is detachable
and traded separately, when the conversion takes place. The
investor can keep the bond and trade the warrant for shares.

Currency option bonds
1. They are similar to straight bonds
2. Generally issued in one currency and option to take interest and
principal in another currency
3. Exchange rate is either fixed (generally not) or is spot rate
prevailing in the market three business days before the due date of
payment of interest and principal.

Floating rate notes:
1. FRN is similar to straight bonds with respect to maturity and
denomination
2. Rate of interest however varies and is based on LIBOR+1/8%,
1/4%, 1.5%...
3. Rate of interest is adjusted every 6months
4. Minimum interest rate clause may be included
5. Drop lock clause may also be included, which means if
minimum interest rate happens to be paid then it is locked for the
remaining period of the bond
6. Generally it is found that banks issue and invest in FRNs





EUROCURRENCY MARKET
19

3.3 Segment 3: Euro-currency Deposits
1. Euro-bonds represent the funds amassed by the bank on behalf of
international borrower. Euro-currency deposits represent the funds
accepted by the bank themselves.
2. The Euro-currency market consists of all deposits of currencies placed
with the banks outside their home currency.
3. The deposits are accepted in Euro-currencies aa well as currency cocktails
(SDR, ECU etc.)
4. The deposits are placed at call (overnight, two days or seven days notice)
for USD, Sterling Pound, Canadian dollars and Japanese Yen and of two
days in any other currencies
5. Time deposits are accepted for periods of 1,3,6 and 12 months for ll
currencies
6. USD and Sterling pound can be placed for a period of 5 years
7. Minimum size of deposit is USD 50,000 or its equivalent

Euro-Currency Deposits Certificate of Deposit
1. It is a negotiable instrument
2. They are bearer instrument and can be traded in the secondary market
3. Period: 1 year(1month through 12 months)
4. Minimum amount: USD 50,000
5. Currencies: USD, Sterling Pound, Yen
6. Interest rate: 1/8% below LIBOR
7. Tranche CD: carries different rates of interest for cash tranche
8. Discount CD: they are issued at discount.

3.4 Segment 4: Euro- Notes Market
1. This market constitutes the instruments of borrowing issued by the
corporate in the Euro-currency market
2. The instrument issue may be underwritten or may not be underwritten
3. The borrowers directly approach the lenders without the intermediation of
the banks or financial institution
4. Instruments are of the following categories:
i. Commercial paper
ii. Note issuance facilities
iii. Medium term notes
EUROCURRENCY MARKET
20

Commercial paper
1. It is a promissory note with maturity less than a year, generally the
period varies between 90days to 180 days
2. Generally issue is not underwritten
3. Amount: USD 100,000 or equivalent
4. Issued on Discount to Yield basis, but interest rate works out
lesser than that is paid on bank borrowing nd higher than that is paid
by the bank on deposits
5. They are unsecured instrument

Note Issuance Facilities (NIF)
1. Borrowers place short term notes of 3-6 months maturity directly with the
investors and the notes are rolled over on maturity
2. The banks underwrite at the time of issue as well as when the note are
rolled over
3. With slight variation they are lso known as:
i. Revolving underwriting facility(RUF)
ii. Standby Note Issuance Facility(SNIF)
iii. Note Purchase Facility (NPF)

Medium Term Notes
1. MTN represents Long Term, Non Underwritten and fixed interest rate
source of raising finance
2. It can be comparable with Euro-bonds with a difference that Eurobonds
issue is underwritten, where as MYN issue is ot underwritten
3. Their maturity is somewhere between short term CPs(less than one year)
and long term Euro bonds(more than 5 years)
4. They are privately placed and have great flexibility





EUROCURRENCY MARKET
21

Chapter 4: THE EUROCURRENCY AND EURODOLLAR
MARKETS

The discussion of the international financial aspects of the "energy crisis"
brought into public focus the Eurodollar market as an important channel for
moving funds from the oil-exporting countries to borrowers. The recycling of
"petro-dollars" has been merely one of many functions performed by the
Eurodollar market over the years of its existence.

The Eurodollar market, as such, has no specific location. Its physical dimension
is a network of international telecommunications media which link financial
centers around the world and through which Eurodollar transactions are
conducted. Eurodollars are dollar-denominated claims on commerical banks
located outside the United States, largely but not exclusively in Europe. They are
dollar funds placed with foreign banks by either U.S. or foreign residents, and
maintained on the books of these banks as dollar-denominated liabilities to the
depositors. Dollars deposited with the foreign banks may be in the form of U.S.
currency, but they seldom are. In virtually all instances, they are dollars held on
deposit in U.S. banks. In establishing a Eurodollar deposit, the depositor, in
effect, transfers the ownership of his deposit in a U.S. bank to the receiving
foreign bank. When the foreign bank lends these dollars, it transfers their
ownership to the borrower. Finally, when the original depositor "withdraws" the
deposit, he in effect exchanges the dollar-denominated claim on the foreign bank
for a dollar-denominated claim on a U.S. bank.

Eurodollars, while by far the largest, are merely one of several types of foreign-
currency denominated deposits maintained by commercial banks around the
world in currencies other than that of the country where the bank is located.
Deposits denominated in British pounds (Eurosterling), German marks
(Euromarks), Swiss francs (Eurofrancs), and others are also held and traded by
banks domiciled outside the countries issuing these currencies.

The emergence and growth of the Eurodollar market may be viewed as a classic
example of free market forces at work, overcoming obstacles created by
regulations, and responding to market incentives to accommodate various needs.
After World War II, when the dollar emerged as the major trading currency, the
initial impetus to the growth of the Eurodollar market was given by certain
EUROCURRENCY MARKET
22

Eastern European countries. Anxious to hold dollars to finance their badly
needed imports from the West, but concerned that their dollar balances might be
blocked or confiscated in retaliation for their expropriation of American-owned
properties if such balances were held in banks under U.S. Government
jurisdiction, these countries began placing their dollar balances with commercial
banks in Western Europe. Since the late fifties, when most major countries
removed restrictions on the holding of foreign exchange (including dollars) by
their residents, higher interest rates offered by foreign banks, relative to interest
rates offered by the U.S. banks, provided the main incentive for holders of dollar
funds to place these with foreign banks rather than banks located in the United
States. The ability and willingness of foreign banks to offer a more attractive
return than U.S. banks has been predicated on several factors. The U.S. banking
authorities do not allow commercial banks in the United States to pay interest on
deposits of less than 30 days, and they regulate the rate of interest that may be
paid on deposits of longer maturity. Commercial banks abroad are mostly
exempt from such restrictions. Also, unlike U.S. banks, commercial banks in
countries where the growth of the Eurodollar market has been the most
spectacular are not subject to reserve requirements on their dollar denominated
liabilities. As a result, the net cost of such funds to these banks is reduced, and
they can offer a higher yield. On the other hand, the willingness of foreign banks
to offer a higher return has been predicated on the strong demand for dollar loans
that has not been fully met by the U.S.-based banks, particularly when such
lending was impeded by the existence of the Voluntary Foreign Credit Restraint
Program and the Interest Equalization Tax.

Given these constraints, the U.S.-based banks were able to compete for dollar
deposits with foreign-based banks through foreign subsidiaries and branches that
were not subject to the same restraints as their parent institutions in the United
States. Through these media, the U.S. banks have maintained significant
participation in the Eurodollar market. The elimination or suspension of certain
U.S. regulations in 1970 and 1974 has removed most of the impediments to the
direct participation of U.S. banks in the global trade in dollars. By this time,
however, the Eurodollar market had acquired a momentum of its own that
assured its continued existence for years to come.



EUROCURRENCY MARKET
23

4.1 Measuring the size of the Eurodollar Market

For a number of years, the Bank for International Settlements (BIS) in Basle,
Switzerland, has been providing the most comprehensive set of statistics on the
Eurodollar market, based on reports of foreign-currency denominated assets and
liabilities of commercial banks in Belgium-Luxembourg, France, Germany,
Italy, the Netherlands, Sweden, Switzerland, the United Kingdom, Canada, and
Japan. The original reports include all foreign currency denominated liabilities to
residents (banks, individuals, and corporations) of countries other than the
country in which the reporting bank is located, that is, all external liabilities.
These totals are published as gross Eurocurrency positions.

For the end of 1973, the BIS reported that total external liabilities in foreign
currencies of banks in the reporting European countries identified in the table
amounted to $191 billion; roughly two-thirds of these liabilities were
denominated in dollars.














EUROCURRENCY MARKET
24

4.2 Eurocurrency Interest Rates

There are three aspects of Eurocurrency interest rates namely;
1. the term structure of the Eurocurrency interest rates.
2. the potential for bank runs; and
3. the causal relationship between the Eurocurrency (offshore) interest rate
and their domestic (onshore) counterparts

1. Term structure of interest rates

Profitability of lending and borrowing across maturities for an individual bank
depends on the spreads between the bid and ask rates in the interbank market,
and the premium added to the reference rate for
(a) the credit risk of the borrowers and
(b) the interest rate risk due to mismatched maturities of loans and deposits.

The mismatch of maturities of loans and deposits depends to a great extent on
the values of interest rates for different maturities or, the term structure of
interest rates. the concept of the term structure plays a significant role
in understanding instruments such as the forward rate agreement (FRA).

The term structure refers to the relationship of the spot interest rate with the
maturity. An upward (downward)-sloping term structure connotes the interest
rate increasing (decreasing) with the maturity term. For a flat term structure, the
interest rate is constant across the maturity dimension. The spot interest rate
refers to a loan that pays both the principal and accumulated interest charges
only at the maturity. It is also known as the pure discount rate.

Suppose a bank is considering two alternatives.The first option is to lend the
money for two months; the second option is to loan its money initially for one
month and then re-lend the proceeds from the first months investment for an
additional month. If the two-month spot interest rate is i0,2 and the current one-
month spot interest rate is i0,1, the bank can compute the implied forward
interest rate for the second month as:

(1 +i0,2)
2/12
= (1 + i0,1)
1/12
(1 + f1,1)
1/12


EUROCURRENCY MARKET
25

where f1,1 is the one-month (implied) forward interest rate starting one month
from now.
Example
Suppose the two-month annualized interest rate, i0,2, is 10 percent and the one
month annualized interest rate, i0,1, is 8 percent, then the one-month forward
rate f1,1 is given by

(1 +0.10)
2/12
= (1 + 0.08)
1/12
(1 + f1,1)
1/12

f1, 1 = [(1.10)
2/12
/ (1.08)
1/12
)] 12 - 1
= (1.0160119/1.006434)12 - 1
=12.04%
If the (spot interest rate) term structure is rising (upward-sloping), the term
structure of the forward (interest) rate is also rising and is above the spot interest
rate term structure as shown in Figure (a). By the same token, if the term
structure is downward sloping, the implied forward interest rate term structure
will also be downward sloping, and lies below it as shown in Figure (a)

If the two alternative courses of actions [Figures (a) and (b)] give the bank
identical payoffs, then the bank will be indifferent between the two alternatives.
If the bank borrows for two months at the two-month interest rate at 10 percent
and loans the funds out for one month at 8 percent and then for another month at
12.4 percent, the bank will break even.

This example suggests that if the bank borrows long term and loans in the
short term, the bank will break even, if the actual rate for the second month is
equal to the implied forward interest rate. Alternatively, the bank will also break
even if it loans long term but borrows short term and refinances at the implied
forward interest rate. When the banks expectations are different from the
implied forward interest rate, the bank can anticipate to make some money by
lending and borrowing for mismatched maturities. As the swap transaction
suggests, when the bank loans for long maturity and funds it initially with shorter
maturity, the bank is betting that by the time funds are needed to cover the loan,
it will be able to obtain them at a lower rate, that is, the actual future borrowing
rate is expected to be below the implied forward interest rate.


EUROCURRENCY MARKET
26


Figure (a) Rising Term Structure of Spot and Forward rates.




Figure (b) Declining Term Structure of Spot and Forward rates.

(source: Internationl Bank Management by Dileep Mehta and Hung Gay Fung.)

EUROCURRENCY MARKET
27

2. Potential bank runs

In a single economy with a large number of banks, if one bank fails, other
healthy banks are also likely to be adversely affected by such failure. In the first
place, the failing bank might have obligations to other banks that become
worthless, thus affecting the value of other healthy banks assets as well as their
net worth. When depositors perceive this danger and start withdrawing their
deposits, other banks liquidity as well as net worth (through untimely
liquidation of assets) plummet. A high degree of financial leverage exacerbates
the situation. This is the essence of the contagion effect resulting in bank runs.
When economies are not integrated, the impact of a bank run in one economy
will not be fully transmitted to other economies. Eurocurrency markets change
the situation, however. Since Eurocurrency markets in different currencies are
closely interrelated a bank run in one currency would be quickly transmitted to
other currencies. If monetary authorities do not act in a timely fashion, the
viability of the financial markets on a global scale would be endangered. Thus
Eurocurrency markets amplify the potential for bank runs. At the same time,
participants in Eurocurrency markets may be better informed than monetary
authorities on a banks failing health and thus better prepared to mitigate the
danger of bank runs on a global scale.

3. Causal relationship between offshore and domestic interest rates

The causality linkage between interest rates in the offshore and domestic markets
has two alternate plausible explanations. The first one traces the impact from
domestic to the offshore market by relying on evidence pointing to
(a) greater volatility in the offshore interest rates, and
(b) relative immunity of the domestic market from volatile offshore forces.

The central bank influences the short-term rates domestically lends credence to
the assertion that the transmission process originates domestically. The alternate
explanation contends that interest rates in the domestic markets are constrained
by regulatory and other roadblocks and thus are unable to respond to the market
forces as quickly and fully as the offshore market; hence, volatility in itself does
not establish the causality. More recent studies provide
EUROCURRENCY MARKET
28

evidence that shocks in domestic interest rates lead interest rates in offshore
Eurodollar markets, and observe weaker feedback from Eurodollar to domestic
markets. The interest rate relationship may be changing over time as the
financial markets become more mature or integrated. Thus, we may observe
some elements of market segmentation in earlier periods that may disappear over
time.

A recent study investigates the Eurodollar and domestic interest rate relationship
in terms of both the mean and volatility of the interest rate movements. The
results show that the contemporaneous feedback from the domestic market to the
offshore market in both the mean and volatility is stronger than that from the
offshore to the domestic market.

A study on the Euroyen and domestic yen interest rate markets suggests that in
the earlier period causality is strongest from the Euroyen market to the domestic
yen interest rates. However, strong feedback effects are observed in both
directions in more recent years. In brief, the dominance of the US domestic
market and the prominent role of the US dollar in the Eurocurrency market to
date have allowed the transmission of influence from domestic to offshore
markets. On the other hand, for relative latecomers like the Japanese
yen, the offshore interest rates have strongly affected the domestic interest rates,
as the alternative hypothesis suggests. However, in both instances, as time
progresses, the strong causality is weakened as the domestic and offshore
markets become more integrated.


4.3 Eurocurrency Futures

The Eurocurrency market, which is a market for short-term deposits, or
Eurodeposits. The most popular instrument in this market is the certificate of
deposit (CD), which is a negotiable and often bearer instrument. For long-term
CDs (up to ten years), there is the possibility of selecting a CD with floating-rate
coupons. For CDs with floating-rate coupons, the life of the CD is divided into
subperiods of usually six months. The interest earned over such period is fixed at
the beginning of the period, the reset date. This interest rate is based on the
prevailing market interest rate at the time instruments, especially Eurocurrency
futures, to hedge interest rate risk.
EUROCURRENCY MARKET
29


Eurocurrency Futures
Eurocurrency futures are very simple futures contracts. To see this simplicity,
consider a domestic futures contract on a time deposit (TD), where at expiration
day, T1, of the futures precedes the maturity date T2 of the TD, by typically
three months. This futures TD contract locks you in a 3-month interest rate at
time T1.

Example: In June you agree to buy in mid-September a TD that expires in mid-
December. The value of the TD is 100, and the price you agree to pay is 96. The
return you will realize on the TD during the last three months of its life is (100-
96)/96 = 4.167% (or 16.67% on yearly basis).

Eurocurrency futures work in the same way as the above mentioned time deposit
futures. A Eurocurrency futures contract calls for the delivery of a 3-month
Eurocurrency time deposit at a given interest rate (LIBOR). Eurocurrency time
deposits are the underlying asset in Eurocurrency futures. Actually, you can
consider the interest rates (LIBOR) on the future Eurocurrency deposit as the
underlying asset. The Eurocurrency futures contract should reflect the market
expectation for the future value of LIBOR for a 3-month deposit. Like with any
other futures a trader can go long a Eurocurrency futures (an agreement to make
a future 3-month deposit) or short Eurocurrency futures (an agreement to take a
future 3-month loan). A trader can go long a Eurocurrency futures -assuring a
yield for a future 3-month deposit- or go short a Eurocurrency futures -assuring a
borrowing rate for a future 3-month loan.
Eurocurrency futures contracts are traded at exchanges around the world. As we
mentioned above, the reset rate is based on the prevailing market interest rate.
This market rate is usually the LIBOR or the Interbank Offer Rate in the
currency's domestic financial center.

In the late 1990s, Eurocurrency futures contracts included:

i.Eurosterling (at LIFFE, the London International Financial Futures Exchange).

ii. Euroyen (at TIFFE, the Tokyo International Financial Futures Exchange,
LIFFE, and the Singapore International Monetary Exchange, SIMEX).
EUROCURRENCY MARKET
30


iii.Euroswiss Franc (at LIFFE).

iv. Eurodollar (at the CME in Chicago, LIFFE, SIMEX, and TIFFE).

v.Euribor (at LIFFE, MATIF in Paris, MEFF, the Mercado Espaol de Futuros
Financieros, in Barcelona, and Belfox in Brussels).

vi. Euro (LIBOR) (at LIFFE).

vii. HIBOR (at the Hong Kong Futures Exchange).

viii. JIBOR (at SAFEX, the South African Futures Exchange in Johannesburg).

ix. SIBOR (at SIMEX).

4.4 DETERMINANTS OF MARKET CONDITIONS IN THE
EUROCURRENCY MARKET- WHY A BORROWERS
MARKET?
The doubling of oil prices and the heightened political uncertainty since the end
of 1979 have taken much of the controversy concerning the Euro-currency
market, shifting the focus of attention to the question of whether and how the
commercial banks can smoothly recycle the oil surplus which is expected to rise
dramatically. However, it would seem worthwhile pursuing some aspects of the
debate further, for they are closely associated with the question of how the
market mechanism operates and are no less valid even if a change in climate
calls for a different role for the banks.
A major issue has been whether the banks might have lent too readily to deficit
countries, delaying the adjustment process, creating too much international
liquidity and making the banks own position vulnerable in the process. Different
answers to these questions have been put forward, but there seems to have been a
general consensus that the contituation of the borrowers market was
undesirable both because of its macro-economic consequences and because of
EUROCURRENCY MARKET
31

the prudential concerns to which it gave rise. A borrowers market exists when
larger amounts of funds are available on easier terms.
Opinions diverge, however, on the reasons for the recent borrowers market, and
this results in widely different policy prescriptions. In extreme terms, one view
holds that the Eurocurrency market can grow independently of outside factors
because it is largely free from regulatory constraints. According to this view, it is
the endogenous nature of the markets growth, coupled with an increased degree
of competition among banks, that is responsible for the present borrowers
market. Another view stresses the effect of outside factors, such as world
payments imbalances and national monetary policies, on global flow of funds
and hence on the international credit market, maintaining that the latters role is
simply thar of a messenger. Thus, the question of why a borrowers market has
emerged is central to an understanding of the mechanism at work.

The Hypothesis of independent growth of the Eurocurrency market
It is sometimes argued that the credit-creating capacity of the Eurocurrency
market is beyond the control of national monetary authorities. Proponents of this
view point to the rapid rate of growth of the Eurocurrency market, both in
absolute terms and in relation to other magnitudes such as world income and
trade and often cite the absence of a minimum reserve requirement and the large-
scale central-bank depositing of reserves as factors boosting the credit-creating
capacity coupled with increased competition among banks for international
business that is responsible for the present borrowers market.
There are a number of difficulties in accepting this view, however. First,
although it is true that the absence of a reserve requirement gives Euro-banking a
competitive edge over domestic banking, this advantage is more or less a
permanent feature and cannot explain the recent borrowers market. It is well
known that Euro-dollar interest rates move closely in line with US money-
market rates adjusted for the existence of the reserve requirement, and that any
significant deviation from the parallel rates is quickly corrected by arbitrage.
This applies also to non-dollar Eurocurrency rates on a covered basis. It follows
then that national monetary authorities, and the US authorities in particular, can
exert quite a strong influence on the level of Eurocurrency interest rates and, by
implication, on the demand for and supply of funds.
EUROCURRENCY MARKET
32

Chapter 5: INTERNATIONAL BOND MARKET
Bonds are an important source of long term capital for firms. A bond is a debt. A
firm (or government) issues a certificate, called a bond, that states that the firm
will make coupon payments to the holder of the bond and will, at maturity pay
the holder the par value of the bond. Coupon payments are simply the interest
payments on the debt and the par value is the principal. Firms sell these bonds to
investors (thereby borrowing money). The key difference between borrowing
money by issuing bonds rather than borrowing directly from a bank is that there
exists a secondary market for bonds. That is, if you buy a bond from a firm
(lending that firm money) you can later sell the bond to another investor. The act
of firms selling bonds directly to investors is termed the primary market, while
investors trading bonds among themselves is the secondary market.
There exists a well developed domestic market for bonds (Canadian firms
issuing bonds denominated in Canadian dollars and selling them in Canada).
However, there also exists an international bond market. The international bond
market is really a set of loosely connected individual markets around the world.
There are many different bond markets in many countries, taken together as a
whole they constitute the international bond market.

The international bond market can be broken down into two parts:
1) Foreign Bonds
2) Eurobonds


1) Foreign bonds are simply bonds issued in a bond market by a foreign
company. For example, a Japanese firm issuing a U.S. dollar denominated bond
in the U.S. is issuing a foreign bond.

Because foreign bonds are simply a part of the domestic bond market, the only
real difference is their treatment under the law. In many countries, foreign bonds
are subject to different tax treatment, registration requirements etc.
EUROCURRENCY MARKET
33

The most important foreign bond markets are located in Zurich, New York,
Tokyo, Frankfurt, London and Amsterdam.
The reasons that a company may go to another country to issue bonds include the
simple fact that there may not be enough demand in the domestic market. Going
to a foreign market opens up a whole new set of potential investors to the firm.
For instance, a German pharmaceutical firm may wish to borrow DM 500
million. However, its investment bank tells it that there is only demand for DM
250 million of its bonds. In order to float the rest it would have to offer a much
higher yield. But, for some reason there is demand in the US for the debt of
pharmaceutical firms, and that demand is not being met by US companies. The
German firm could then float an issue in Germany (in DM) and also float an
issue in the US (in $US) in order to sell all of the bonds it wants. Of course, the
firm may choose to swap its new $US debt for DM debt at the same time.
Note that issuing a bond in Zurich (for instance) does not mean that the firm is
necessarily borrowing from Swiss lenders. Generally, a foreign firm issues a
Swiss Franc denominated bond in Zurich and most of the buyers of that bond
will also be foreign. Basically, the Sfr is simply a unit of account for the
transaction between the buyer and the lender.
A taxonomy has arisen for foreign bonds. Foreign bonds issued in the U.S. are
termed Yankee bonds, in Japan they are called Samurai bonds, in England
Bulldog bonds and in the Netherlands Rembrandt bonds.

2) Eurobonds are bonds denominated in one currency but issued in a country that
is not the home of that currency. For example, a bond denominated in $Can but
issued in London is a Eurobond. Similarly, a Sfr denominated bond issued in
Germany is a Eurobond.
Most countries have very few regulations governing the issuance of Eurobonds
(since they are not denominated in that countrys currency, the government does
not care all that much about them). While some countries have tried to control
issues of bonds denominated in their currency even if issued in a foreign country,
this is very hard to do for obvious reasons. One thing that this means is that
interest paid on Eurobonds is usually free of all withholding taxes.
A withholding tax is when the government takes a portion of each interest
payment before the lender gets it. The borrower (the firm issuing the bond)
EUROCURRENCY MARKET
34

withholds a part of the interest and gives it to the government. With a
withholding tax, the firm issuing the bonds would have to pay a higher rate of
interest in order to compensate lenders. In the eurobond market, therefore, firms
can often pay a lower rate by avoiding the tax.
Most eurobonds are bearer bonds. The owner of the bond is not registered with
the firm that initially issued the bond. Actually having physical possession of the
bond is evidence of ownership. This makes eurobonds attractive to investors who
wish to remain anonymous (to avoid taxes or for other reasons).
Eurobonds have been popular as a source of funds for firms because they allow
borrowers and lenders to avoid taxes and government regulations. The rate of
growth in the eurobond market has slowed over the last 8-10 years because of
reductions in these factors in the domestic bond market. Governments realized
that securities issues were going offshore to avoid regulations and therefore were
forced to reduce the regulatory burden for domestic issues. This is best
exemplified by the introduction in the early 1980s of the Prompt Offering
Prospectus method of issuing securities in Canada which reduced the time
needed for established firms to register and issue new securities from weeks
(sometimes months)to a few days (the Prompt Offering Prospectus was
introduced in response to similar legislation in the U.S. known by the term shelf
registration).
The eurobond market is still large and is driven in large part by firms ability and
desire to engage in swaps.

5.1 European Central Bank
The European Central Bank (ECB) is the institution of the European Union (EU)
that administers the monetary policy of the 17 EU Eurozone member states. It is
thus one of the world's most important central banks. The bank was established
by the Treaty of Amsterdam in 1998, and is headquartered in Frankfurt am
Main, Germany. The current President of the ECB is Mario Draghi, former
governor of the Bank of Italy.
The primary objective of the European Central Bank is to maintain price
stability within the Eurozone, which is the same as keeping inflation low. The
Governing Council defined price stability as inflation (Harmonised Index of
Consumer Prices) of around 2%. Unlike, for example, the United States Federal
EUROCURRENCY MARKET
35

Reserve Bank, the ECB has only one primary objective with other objectives
subordinate to it.
The key tasks of the ECB are to define and implement the monetary policy for
the Eurozone, to conduct foreign exchange operations, to take care of the foreign
reserves of the European System of Central Banks and promote smooth
operation of the financial market infrastructure under the payments system and
the technical platform for settlement of securities in Europe. Furthermore, it has
the exclusive right to authorise the issuance of euro banknotes. Member states
could issue euro coins, but the amount must be authorised by the ECB
beforehand.
On 9 May 2010, the 27 member states of the European Union agreed to
incorporate the European Financial Stability Facility. The EFSFs mandate is to
safeguard financial stability in Europe by providing financial assistance to
Eurozone Member States.
The bank must also co-operate within the EU and internationally with third
bodies and entities. Finally it contributes to maintaining a stable financial system
and monitoring the banking sector. The latter can be seen, for example, in the
bank's intervention during the 2007 credit crisis when it loaned billions of euros
to banks to stabilise the financial system.
Although the ECB is governed by European law directly and thus not by
corporate law applying to private law companies, its set-up resembles that of a
corporation in the sense that the ECB has shareholders and stock capital. Its
capital is five billion euro which is held by the national central banks of the
member states as shareholders. The initial capital allocation key was determined
in 1998 on the basis of the states' population and GDP, but the key is adjustable.
Shares in the ECB are not transferable and cannot be used as collateral.
The bank is based in Frankfurt, the largest financial centre in
the Eurozone (although not the largest in the European Union). Its location in the
city is fixed by the Amsterdam Treaty along with other major institutions. In the
city, the bank currently occupies Frankfurt's Eurotower until its purpose-built
headquarters are built.
The owners and shareholders of the European Central Bank are the central banks
of the 27 member states of the EU. The ECB should not be confused with
the European Investment Bank (EIB), the development bank owned by the EU
member states.
EUROCURRENCY MARKET
36

The European Central Bank had stepped up the buying of member nations
debt. In response to the crisis of 2010, some proposals have surfaced for a
collective European bond issue that would allow the central bank to purchase a
European version of U.S. Treasury Bills. To make European sovereign debt
assets more similar to a U.S. Treasury, a collective guarantee of the member
states' solvency would be necessary. But the German government has resisted
this proposal, and other analyses indicate that "the sickness of the Euro" is due to
the linkage between sovereign debt and failing national banking systems. If the
European central bank were to deal directly with failing banking systems
sovereign debt would not look as leveraged relative to national income in the
financially weaker member states.
On 17 December 2010, the ECB announced that it was going to double its
capitalisation. (The ECB's most recent balance sheet before the announcement
listed capital and reserves at 2.03 trillion.) The sixteen central banks of the
member states would transfer assets to the ledger of the ECB. In banking, assets
(loans) are used to offset liabilities (deposits and currency).
]
If some of the
sovereign debt held as an asset by the ECB becomes non-performing, the asset is
"bad" and the deposits, in this case, currency, are not appropriately backed.
This inequality means that liabilities exceed assets and therefore the bank is in
trouble. One response is to use the bank's capital to offset the losses. The use of
capital to offset a loss transfers the loss to the bank's shareholders: the member
banks. The increased capitalisation of the ECB against potential sovereign debt
default means that the sixteen member banks are also exposed to potential losses.
In 2011, the European member states may need to raise as much as US$2 trillion
in debt. Some of this will be new debt and some will be previous debt that is
"rolled over" as older loans reach maturity. In either case, the ability to raise this
money depends on the confidence of investors in the European financial
system. The ability of the European Union to guarantee its members' sovereign
debt obligations have direct implications for the core assets of the banking
system that support the Euro.
The bank must also co-operate within the EU and internationally with third
bodies and entities. Finally it contributes to maintaining a stable financial system
and monitoring the banking sector. The latter can be seen, for example, in the
bank's intervention during the 2007 credit crisis when it loaned billions of euros
to banks to stabilise the financial system. In December 2007, the ECB decided in
conjunction with the Federal Reserve under a program called Term auction
EUROCURRENCY MARKET
37

facility to improve dollar liquidity in the eurozone and to stabilise the money
market.

European sovereign debt crisis
From late 2009, fears of a sovereign debt crisis developed among fiscally
conservative investors concerning some European states, with the situation
becoming particularly tense in early 2010. This included euro zone members
Greece, Ireland and Portugal and also some EU countries outside the area.
Iceland, the country which experienced the largest crisis in 2008 when its entire
international banking system collapsed has emerged less affected by the
sovereign debt crisis as the government refused to bail the banks out, and has
begun to prosecute those involved in the collapse.
In the EU, especially in countries where sovereign debts have increased sharply
dueto bank bailouts, a crisis of confidence hs emerged with the widening of bond
yield spreads and risk insurance on credit default swaps between these countries
and other EU members, most importantly Germany. To be included in the
eurozone, the countries had to fulfil certain convergence criteria, but the
meaningfulness of such criteria were diminished by the fact they have not been
applied to different countries with the same strictness.











EUROCURRENCY MARKET
38

Chapter 6: CURRENT SCENARIO OF EUROCURRENCY
MARKET
In every economic crisis there comes a moment of clarity. In Europe soon,
millions of people will wake up to realize that the euro as we know it is gone.
Economic chaos is awaited.
Europes crisis to date is a series odd supposedly decisive turning points that
each turned out to be just another step down a steep hill. It is already nearly
impossible to save Greek membership in the euro area: depositors flee banks, tax
payments, and companies postpone paying their suppliers either because they
cant pay or because they expect soon to be able to pay in cheap drachma.
The troika of the European Commission (EC), European Central Bank (ECB),
and International Monetary Fund (IMF) has proved unable to restore the
prospect of recovery in Greece and any new lending program would run into the
same difficulties. Particularly as the Greek failure mostly demonstrates how
wrong a single currency is for Europe. The Greek backlash reflects the enormous
pain and difficulty that comes with trying to arrange internal devaluations (a
euphemism for big wage and spending cuts) in order to restore competitiveness
and repay an excessive debt level.
Faced with five years of recession, more than 20 percent unemployment, further
cuts to come and a stream of failed promises from politicians inside and outside
the country, a political backlash seems only natural. With IMF leaders, EC
officials and financial journalists floating the idea of a Greek exit from the
euro, Greeces economy can only get worse. Greeces exit is simply another step
in a chain of events that leads towards a chaotic dissolution of the euro zone.
During the next stage of the crisis, Europes electorate will be rudely awakened
to the large financial risks which have been foisted upon them in failed attemptst
keep the single currency alive. If Greece quits the euro later this year, its
government will default on approximately 300 billion euros of external public
debt, including roughly 187 billion euros owed to the IMF and European
Financial Stability Facility (EFSF).
More importantly and currently less obvious to German taxpayers, Greece will
likely default on 155 billion euros directly owed to the euro system (comprised
of the ECB and the 17 national central banks in the euro zone). This includes 110
EUROCURRENCY MARKET
39

billion euros provided automatically to Greece through the Target2 payment
system which handles settlements between central banks for countries using
the euro. As depositors and lenders flee Greek banks, someone needs to finance
that capital flight, otherwise Greek banks would fail. This role is taken on by
other euro area central banks, which have quietly leant large funds, with the
balances reported in the Target2 account. The vast bulk of this lending is, in
practice, done by the Bundesbank since capital flight mostly goes to Germany,
although all members of the euro system share the losses if there are defaults.
The ECB has always vehemently denied that it has taken an excessive amount of
risk despite its increasingly relaxed lending policies. But between Target2 and
direct bond purchases alone, the euro system claims on troubled periphery
countries are now approximately 1.1 trillion euros. This amounts to over 200
percent of the capital of the euro system. No responsible bank would claim these
sums are minor risks to its capital or to taxpayers. These claims also amount to
43 percent of German Gross Domestic Product, which is now around 2.57
trillion euros. With Greece proving that all this financing is deeply risky, the
euro system will appear far more fragile and dangerous to taxpayers and
investors.
The calamity of a Greek default is likely to result in a flight from banks and
sovereign debt across the periphery, and that to avoid a greater calamity all
remaining member nations need to be provided with unlimited funding for at
least 18 months. The ECB is not prepared to provide such a firewall, and no
other entity has the capacity, legitimacy, or will to do so.
The most likely scenario is that the ECB will reluctantly and haltingly provide
funds to other nations an on-again, off-again pattern of support and that
simply wont be enough to stabilize the situation. Having seen the destruction of
a Greek exit, and knowing that both the ECB and German taxpayers will not
tolerate unlimited additional losses, investors and depositors will respond by
fleeing banks in other peripheral countries and holding off on investment and
spending.




EUROCURRENCY MARKET
40


Chapter 7: CONCLUSION
The creation and growth of the Eurocurrency market has been an important side
effect of the increase of international economic activity over the past few
decades. The market has expanded largely as a means of avoiding the regulatory
costs involved in dollar-denominated financial. Due to the size and importance
of the foreign exchange market, it remains largely unregulated. There is no
international organization to look over it or any institutions that sets rules. The
name Eurocurrency market is given to any bank deposits in any country held in a
different countrys currency. An example of this is United States dollar
depositing in a British bank. These banks are called Euro banks. The emergence
of eurobanks has facilitated trade and investment between countries. A
Eurocurrency is any currency that is deposited outside of the home
country. Since approximately two thirds of Eurocurrency is U.S. dollars, central
banks and regulators are concerned about Eurocurrency because they are
stateless money. Eurocurrency market has very little regulation, such as taxes,
restrictions on capital movements and exchange controls. Thus, the market
attracts more investors. It is easier for banks around the world to use the
Eurocurrency market to move and store funds more profitably than they could in
many countries. Since the market is relatively free of regulation, Eurodollar
market must operate on narrower margins than banks in the United States. The
Eurocurrency market gives investors the opportunity to hold short-term claims
on commercial banks, which also act as intermediaries to transform these
deposits into long-term claims on final borrowers. Not only does Eurocurrency
market allow for more convenient borrowing, it also improves the international
flow of capital for trade between countries and companies. This market also
attracts domestic deposits because it offers a higher interest rate. The largest
Eurocurrency markets are located in London, New York, and Tokyo.
This report discussed various issues related to the Eurocurrency market.
Specifically, it explained development as well as the features of the
Eurocurrency market. The growth of the Eurocurrency results from government-
induced impediments and it requires sustenance from benign indifference on
the part of the government issuing the currency. Institutional setting of various
geographic centres was described to highlight the requisite ingredients for
development of such centres. The traits of interest rates were discussed with
EUROCURRENCY MARKET
41

respect to time (term structure), space (other currencies), and impediments
(domestic versus offshore). Interrelationships among the three were brought out
through arbitrage activities facilitated by new tools based on conventional
concepts of term structure and interest parity theories. Finally, the role of the
Eurocurrency market in the development of new products was discussed with
illustrations of NIFs, Euro-CP, asset securitization, and Eurobonds. It was
suggested that it is not the far-reaching novelty of these products that is
important, but what they symbolize: a change in the bank attitude that marks a
break with the past.
The main problem for the Euro crash was not sub-optimal currency areas nor
profligate government spending but fatal flaws in monetary design and an
appalling series of policy mistakes by the European Central Bank (ECB). The
inflation-targeting regime established by the ECB right at the start, coupled with
the reckless dismantling of the old Bundesbank's monetary framework,
contributed decisively to the ensuing gross failures. Further factors in the fatal
cocktail included long-term French monetary nationalism, empowered by a
French President at the head of the ECB, and the succumbing of euro officials to
the same deflation phobia which had gripped the Federal Reserve. There is only
one way which has any real prospect of salvaging European monetary
integration - that is to start again.










EUROCURRENCY MARKET
42


BIBLIOGRAPHY
BOOKS:
1. International Bank Management by Dileep Mehta and Hung Gay
Fung.

2. The Eurocurrency Interbank Market: Potential for International
Crises? Federal Reserve Bank of Philadelphia, Business Review.

3. A Note to Euroyen and Domestic Yen Interest Rates Journal of
Banking and Finance.
.
WEBSITES:
1. www.investopedia.com
2. www.scribd.com
3. www.managementparadise.com
4. www.baseinscenario.com
5. www.wisegeek.com
6. www.tradecurrencies.com