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I．Teaching Points: 1. the definition of Eurocurrency 2. the basic characteristics of the Eurocurrency market 3. the origin of the Eurocurrency market 4. the reasons for the development of Eurocurrency market 5. the reasons for interest rate differences that exist between the Euromarket and the domestic market 6. how interest rates are quoted and charged under different situations II. Teaching Aim: 1. Understand the definition of Eurocurrency and the basic characteristics of the market 2. Understand the origin of the market and the reasons for its development 3. Understand the reasons for interest rate differences that exist between the Euromarket and the domestic market 4. Understand how interest rates are quoted and charged under different situations III. Teaching Periods: Totally 12 teaching hours IV. Teaching Process 1. Background Knowledge The Eurocurrency market plays an important role in international finance. // Because of the nature of the market and the absence of restrictions, it provides the most convenient financial service at the lowest possible cost. // This text is a general survey of the market. // (1). It begins with the definition of Eurocurrency and the basic characteristics of the market. (2). It then examines the origin of the market and the reasons for its development. (3). This is followed by a discussion of interest rate differences that exist between the Euromarket and the domestic market largely due to controls in the latter market. (4). This text concludes by illustrating how interest rates are quoted and charged under different situations. 2. Reading for gist Read the text with about 15 minutes, and then try to answer the following questions: 1．What is a Eurocurrency? 2．What are the characteristics of the Eurocurrency market? 3 ． In what way did Regulation Q and Regulation M affect the Eurodollar market respectively? 4．How did two other regulations，namely the interest equalization tax and the voluntary restrictions of 1965, influence the Eurodollar market? 5．How did the factor of cost contribute to the growth of the Eurocurrency market? 6．What is a bid—ask spread? What is the result of low spreads in Eurocurrency? 7．Why have there been substantial interest rate differentials between the domestic market
and the Euromarket? 8．What is a floating interest rate? How is it used in the Eurocurrency market? 9．In what way is the Eurocurrency market important to investors and corporations? 3. Detailed Study of the Text 3.1 Notes 1. a central bank (中央银行) A central bank is a national bank charged with the control of the general activities of the ordinary banks. The chief functions of a central bank are to act as the government's bank in the widest possible sense, anticipating where possible the banking problems that may arise and examining those that do arise. It then undertakes the appropriate operations in the money, capital, and foreign-exchange markets. 2. interbank Eurocurrency market (欧洲货币银行互联市场) The interbank market is the section of the money market in which finanacial institutions borrow and lend money among themselves for short periods. This has been a traditional operation among banks. Interbank Eurocurrency market is such a market that deals with Eurocurrency. The Eurocurrency market is so called because one of the parties involved is always a bank. The Eurocurrency market differs from the foreign exchanges market in that it is not concerned with buying and selling foreign exchanges but accepting deposits and making loans in Eurocurrency. For example, a deposit of German marks may be made with a British bank in London. The bank can lend this money to any company or bank, which can then use it to obtain any currency it needs on the foreign exchange market. Transactions in the Eurocurrency market are normally in sums of at least 6 figures and loans are made for periods ranging from overnight to a year (it can be several years now) . They are used to finance balance of payment deficits, for commercial transactions, and industrial development. Formerly known as the Eurodollar market, the Eurocurrency market has its main operations in Europe, with others in the Asian dollar markets in Singapore and Hong Kong and others in the Middle East and the Caribbean. Charaterized by its international nature, its enormous size, and its independence of the control of any particular country or organization, the Eurocurrency market has great impact on international finance. In terms of actual operation, banks in this market publically give a quotation of two interest rates — the bid interest and the ask rate. The bid rate (借款利率) is the interest rate at which the bank is wishing to borrow money, the ask rate (贷款利率) is the interest rate at which the bank lends money. The difference is called spread (利率差), which is the bank's gain from the business of borrowing and lending. These interest rates are commonly worked out on the basis of LIBOR (伦敦银行同业贷款利率) . For a corporation or investor that wishes to enter the market, the bank borrows money from them at the quoted bid rate less a commission, and lends money to them at the quoted ask rate plus a commission and a risk premium ( 贷款风险补贴，贴水 ) . For loans longer than a year, the bank applies the floating interest rate. 3. over-the-counter market (场外直接交易市场) This usually refers to the stock market outside the main, organized stock market place such as New York Stock Exchange and London Stock Exchange. It deals with stocks and other securities that are not quoted in the main market. Instead of a single trading floor where transactions are made, the OTC market consists of a nationwide network of thousands of registered dealers who
match buyers and sellers with the help of computerised communication devices. The Eurocurrency market does not have a regular market place like London Stock Exchange. Transactions are conducted directly among its participants by telephone and telex. So it works as an over-the-counter market. 4. the gold exchange standard (金汇兑本位制) It is necessary to first understand what the gold standard is (金本位) . The gold standard is the use of gold as the common basis for establishing exchange rates. It was used in the early part of this century. Under the gold standard, nations defined the value of their currencies in terms of gold. The purchase and sale of gold was unrestricted, and countries were free to import and export gold to settle international balance of payment. A nation on the gold standard stood ready to convert its currency into gold on demand. Therefore, the amount of gold each nation held affected its money supply and its level of domestic economic activity. This system was brought to an end during the Great Depression of the 1930s. After a period of chaos of non-unified practice in converting different currencies, the International Monetary Fund was set up at the Bretton Woods Conference in 1944 to maintain a stable system of fixed exchange rates. The system is generally labeled the gold exchange standard, as opposed to the gold standard. Under this system, the U.S. dollar, as the world's key currency, was convertible into gold at a fixed price. And since other currencies could be converted into dollars at fixed exchange rates, other currencies were convertible indirectly into gold at a fixed price. This system seemed to work reasonally well during early postwar period. But as time went on, many of the war-torn countries had rebuilt their economies and begun competing successfully with the United States in world markets. As a result, many nations began accumulating dollar reserves, and the United States was confronted with a serious outflow of gold. This unfavorable situation led President Nixon to announce in 1971 that the United States would no longer convert dollars into gold for foreign central banks, and had dollars devalued for the first time. In 1973, the dollar devalued again, and representatives of the major trading nations met in Paris to establish a system of floating exchange rates, thus abandoning the gold exchange standard. 5. arbitrage (套汇，套利): This is the transaction of buying and selling currencies, stocks, bonds, or the like, at the same time in different markets, in order to profit from differences in price, interest rates or ' exchange rates between markets. For example, if the exchange rate of Hong Kong dollar to U.S. dollar is lower in Hong kong than that in the United States, then it would be profitable for an arbitrageur to buy a certain amount of U.S. dollars in Hong Kong and at the same time sell that amount in the United States for Hong Kong dollar. He would obtain a larger amount of Hong Kong dollars. This is known as arbitrage of exchange ( 套汇). Interest arbitrage ( 套利 ) is to take advantage of the difference in interest rates between financial markets. If the 3-month interest rate in London is higher than the rate in New York, it would pay arbitrigeurs to borrow dollars in New York, exchange them for pounds, lend the pounds in London, and then convert the principal and interest into dollars at the duration date. 3.2 Text
A Eurocurrency is any freely convertible currency, such as a dollar or a mark, deposited in a bank outside its country of origin (货 币 发 行 国 ， 商 品 原 产 地 ). Thus, a mark held on deposit with a bank in Paris is a Euromark and a dollar held on deposit with a bank in London is a Eurodollar. It is the residency of a bank (the location of the bank) and not its nationality that determines the "Euro" nature of the deposit so the Euromark could be held with a Paris branch of a German bank and the Eurodollar could be held with a London branch of an American bank. The term Eurocurrency also refers to this type of deposit held in non-European financial centres, although the term "offshore currency' ( 离 岸 货 币 ， This refers to Eurocurrency held in such financial centers as Tokyo, Hong Kong, Singapore and Kuwait) is sometimes used in its place. Eurocurrency deposits are typically conventional term deposits of one day to one year's duration (期 限 为 一 天 到 一 年 的 定 期 存 款 ). Conventional term deposits are non-negotiable bank deposits (bank deposits that cannot be transferred, 不 可 转 让 的 银 行 存 款 ) with a fixed term where the interest rate is fixed for the duration of the deposit. In Eurocurrency transactions the currency that is used is always a foreign currency to at least one of the two parties, and one of the two parties is always a bank. The other party can be another bank, a central bank, a government or a large corporate entity (a large existing organization in the form of corporation, 一 个 大 的 公 司 实 体 ). In fact, transactions between banks and other financial institutions constitute the core of the Eurocurrency market (form or make up the central and most important part of ). This interbank Eurocurrency market ( 欧 洲 货 币 银 行 互 联 市 场 ， The interbank market is the section of the money market in which finanacial institutions borrow and lend money among themselves for short periods. This has been a traditional operation among banks. Interbank Eurocurrency market is such a market that deals with Eurocurrency. The Eurocurrency market is so called because one of the parties involved is always a bank. The Eurocurrency market differs from the foreign exchanges market in that it is not concerned with buying and selling foreign exchanges but accepting deposits and making loans in Eurocurrency. Formerly known as the Eurodollar market, the Eurocurrency market has its main operations in Europe, with others in the Asian dollar markets in Singapore and Hong Kong and others in the Middle East and the Caribbean. Charaterized by its international nature, its enormous size, and its independence of the control of any particular country or organization, the Eurocurrency market has great impact on international finance.In terms of actual operation, banks in this market publically give a quotation of two interest rates — the bid interest and the ask rate. The bid rate <借 款 利 率 > is the interest rate at which the bank is wishing to borrow money, the ask rate <贷 款 利 率 >is the interest rate at which the bank lends money. The difference is called spread <利 率 差 >, which is the bank's gain from the business of borrowing and lending. These interest rates are commonly worked out on the basis of LIBOR <伦 敦 银 行 同 业 贷 款 利 率 > . ) is organized as an international over-the-counter market whose members are linked by telephone and telex. Access to this market is reserved to institutions of top quality. The sums involved are huge, with a million dollars the usual minimum transaction. Eurocurency markets are outside the jurisdiction of any single regulatory authority (Eurocurrency markets are not adminiztrated by any single regulatory authority) and the interest rates are determined by pure supply and demand.
Origins and Development
The Eurocurrency market is not really a new phenomenon. Before and after the First World War banks in most European countries accepted deposits in many different currencies. The origin of today's Eurocurrency market is usually credited to (is usually regarded as coming from) countries of the former Soviet bloc during the height of the Cold War who feared that their dollar reserves (美 元 储 备 ) might be frozen if held in the United States. This was the heyday of (the time of greatest prosperity) the gold exchange standard and the Soviet bloc countries were obliged to accept dollars if they wanted to do business with the West. To avoid having their dollar balances (美元结存) blocked by the Americans, they held them with banks located in England and France. The threat of sanctions may have created the post-Second World War Eurodollar market, but it was the reality of regulations that made it prosper. Two US Federal Reserve Board regulations were especially influential in the development of the Eurodollar market : Regulation Q and Regulation M (Q 号条例和 M 号条例) . * Regulation Q set interest rate ceilings on deposits in the United States. European banks, of course, were not subject to this regulation and, consequently, could pay higher rates for dollar deposits than American banks. This made it attractive to deposit dollars in the European markets where the rates were higher. In fact, many American banks set up overseas branches to take these funds. * A major instrument of monetary policy is the reserve ratio that requires commercial banks to hold a proportion of their deposits in an account with the central bank. Regulation M established the reserve ratio (储备比率) requirement for the US banking system. Reserves pay no interest (The central bank does not pay interest on the required reserves held with the central bank) and, hence, represent a high cost for banks. Consider, for example, a situation where the reserve ratio is 5% and the interest rate on deposits is 10 % . If a bank receives a deposit of $ 1,000, it pays interest on the full $ 1,000. However, it only has effective use of $ 950 because 5 % of the deposit must be held without interest with the central bank. Thus, the total cost of the funds is 10.53%, the $ 100 of interest divided by $950, the amount it can effectively use. European banks were under no obligation to maintain fractional reserves on dollar deposits. This lowered their costs relative to domestic banks and made it possible for them to pay higher rates of interest to attract deposits. Two other regulations that contributed to the development of the Eurodollar market came about as a result of the failing gold exchange standard. The US monetary authorities refused to take the painful step of reining in (rein in: restrain, control, tighten) the US money supply in order to save the gold exchange standard. Instead they tried regulations as a means of improving the capital account (improving the capital account in the balance of international payment): * To discourage non-residents from borrowing in the United States the interest equalization tax ( 利 息 平 衡 税 ) was passed in 1963. It was a tax on US residents' earnings on foreign securities. To compensate for the tax, foreign borrowers were obliged to pay higher interest rates, which made it costly for foreign firms and governments to borrow in the US. Many turned to the Eurodollar market where no such restrictions existed. * To discourage US corporations from lending overseas, restrictions were placed on nondomestic uses of domestically generated funds. The voluntary restrictions of 1965 on borrowing funds in the US for reinvestment abroad became mandatory in 1968. Under these restrictions many US firms with plans for overseas projects simply shifted their financing requirements to the Eurpdollar market.
Special regulations are not the only reason for the development of the Eurocurrency market. By the mid-1970s Regulation Q was inoperative, the interest equalisation tax was abolished and most restrictions on overseas investment had been lifted. Still, the Eurocurrency market continued to grow. Its nature is such that some cost savings are inherent. As a wholesale market dealing in large quantities, economies of scale can be achieved, which lower costs. Since the participants are also all professionals, costly regulatory oversight (watchful care by way of regulations) ; and consumer protection such as deposit insurance are unnecessary. Furthermore, Eurocurrency transactions are simply more convenient in today's global economy. The development of crossborder commercial transactions has generated multiple currency cash flows that corporate treasurers are obliged to manage. It is impractical to deal with a different bank in a different country for each separate currency. Alternatively, dealing with one bank would also be costly and inefficient if it meant systematically converting all foreign currency cash flows into domestic currency when they arrived only to reconvert into foreign currency when payments must be made. The Eurocurrency market makes it possible to deal with an easily accessible, well-known bank that can handle all currency needs (needs for payments of purchases in trade, for investment, and so on.) . Thus, the factors of cost and convenience are behind the emergence and growth of all the Eurocurrencies. Depositors want to receive the highest yield and borrowers want to pay the lowest cost. The nature of the Euromarket and the absence of restrictions make it possible to fulfill these requirements. Eurocurrency Interest Rates Eurocurrency rates are closely related to the rates in the currency's home market but because of lower costs, spreads are lower. Spreads ( 利 率 差 ) refer to the difference between borrowing rates and lending rates. Lower spreads mean that the Eurocurrency markets offer slightly higher interest rates to lenders and slightly lower rates to borrowers than are available in the home market. Because of arbitrage (套 汇 ,套 利 . This is the transaction of buying and selling currencies, stocks, bonds, or the like, at the same time in different markets, in order to profit from differences in price, interest rates or ' exchange rates between markets. For example, if the exchange rate of Hong Kong dollar to U.S. dollar is lower in Hong kong than that in the United States, then it would be profitable for an arbitrageur to buy a certain amount of U.S. dollars in Hong Kong and at the same time sell that amount in the United States for Hong Kong dollar. He would obtain a larger amount of Hong Kong dollars. This is known as arbitrage of exchange (套 汇 ). Interest arbitrage ( 套 利 ) is to take advantage of the difference in interest rates between financial markets. If the 3-month interest rate in London is higher than the rate in New York, it would pay arbitrigeurs to borrow dollars in New York, exchange them for pounds, lend the pounds in London, and then convert the principal and interest into dollars at the duration date.), interest rates in the domestic and Eurocurrency markets can only differ in so far as there are additional costs, controls or risks involved in moving funds between one market and the other. Otherwise, arbitrageurs would borrow in the market where funds were cheaper and lend them where they were more expensive, thereby causing the difference to disappear. Since the cost of shifting funds from one market to another is negligible, substantial interest rate differentials between the domestic market and the Euromarket suggest the presence of differences in perceived risk or effective controls. For many years Euro-French franc rates were
considerably higher than domestic rates due to French restrictions on loaning abroad combined with domestic credit controls (国 内 信 贷 控 制 ) . With the supply limited, credit-starved French borrowers dodging the domestic controls maintained the differential by borrowing Eurofrancs whenever the interest rate began to fall. On the other side of the coin (in the other aspect of the matter; on the other hand) , Euromark and Euro Swiss franc rates have seen periods when they were considerably lower than domestic rates because of measures seeking to discourage capital inflows. One such measure was minimum reserves on certain types of non-resident deposits. The minimum reserve requirement raised the cost of funds for domestic banks borrowing abroad. This caused them to lower the rate they were willing to pay for foreign funds to bring their total cost into line with the cost of domestic funds. In both cases controls caused considerable interest rate differentials between the two markets. Controls designed to restrict capital outflows will tend to push the Euro-rate above the domestic rate while controls designed to restrict capital inflows will tend to push the Euro-rate below the domestic rate. Anticipating controls that do not yet exist can also cause an interest rate differential. If there is a possibility that at some future date funds will be unable to cross the border, investors will require a premium (require an additional reward) for holding assets in the domestic market. In this case the interest rate differential is due to higher perceived risk on assets held in the domestic market. Quotes and Spreads Table 5.2 shows some Eurocurrency interest rates as found in International Herald Tribune(国际 先驱论坛 报 ). These rates refer to the interbank market and are quoted as a bid-ask spread. For example, the interest rate on 6-month Eurosterling is quoted ......(......as for the rest of the text, please refer to the textbook, page 203, 204, 205.......) (from International Finance by Ephraim Claark, Michel Levasseur, and Patrick Rousseau, 1993)
V. Exercises: 1. Exercise II, V. 2. Oral Work: Retell the text
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