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Euromarkets These can broadly be classified as Eurocurrency and Eurobond markets.

We want to focus on how MNCs can use these international markets to meet their financing requirements. A. Eurocurrency market Definition and background The Eurocurrency market consists of banks (called Eurobanks that acce!t de!osits and make loans in foreign currencies. " Eurocurrency is a freely con#ertible currency de!osited in a bank located in a country which is not the nati#e country of the currency. The de!osit can be !laced in a foreign bank or in the foreign branch of a domestic $% bank. &Note of caution' The !refi( Euro has little or nothing to do with the newly emerging currency in Euro!e.) *n the Eurocurrency market+ in#estors hold short,term claims on commercial banks which intermediate to transform these de!osits into long,term claims on final borrowers. The Eurocurrency market is dominated by $% - or the Eurodollar. .ccasionally+ during weak dollar !eriods (latter !art of /012s and /032s + the Euro%wiss franc and the EuroDM markets increased in im!ortance. The Eurodollar market originated !ost WW** in 4rance and England thanks to the fear of %o#iet 5loc countries that dollar de!osits held in the $% may be attached by $% citi6ens with claims against communist go#ernments' Thri#ing on go#ernment regulation 5y using Euromarkets+ banks and financiers are able to circum#ent 7 a#oid certain regulatory costs and restrictions. %ome e(am!les are8 a b c 9eser#e requirements 9equirement to !ay 4D*C fees 9ules or regulations that restrict com!etition among banks

Continuing go#ernment regulations and ta(es !ro#ide o!!ortunities to engage in Eurocurrency transactions. :owe#er+ ongoing erosion of domestic regulations ha#e rendered the cost and return differentials much less significant than before. "s a result+ the domestic money market and Eurocurrency markets are closely integrated for most ma;or currencies+ effecti#ely creating a single worldwide money market for each !artici!ating currency.

*llustration * <erman firm sells medical equi!ment to institutional buyer in the $%. *t recei#es a $%check drawn on Citicor!+ N=. *nitially this check is de!osited in a checking account for dollar working ca!ital use. 5ut to earn a higher return (or rate of interest on the - / million the <erman firm decides to !lace the funds in a time de!osit with a bank in >ondon+ $?. .ne million Eurodollars ha#e thus been created by substituting a dollar account in a >ondon bank for the dollar account held in N=. Notice that no $% - left N= but ownershi! of the $% de!osit has mo#ed from a foreign cor!oration to a foreign bank. The >ondon bank would not like to lea#e the funds idle in N= account. *f a go#ernment or commercial borrower is una#ailable+ the >ondon bank will !lace the - / million in the >ondon interbank market. The interest rate at which such interbank loans are made is called the >ondon interbank offer rate (>*5.9 . ,,, This e(am!le demonstrates that the Eurocurrency market is a chain of de!osits and a chain of borrowers and lenders. The ma;ority of Eurocurrency transactions in#ol#e transferring control of de!osits from one Eurobank to another Eurobank. >oans to non, Eurobank borrowers account for less than half of all Eurocurrency loans. The Eurocurrency market o!erates like any other financial market+ but for the absence of go#ernment regulations on loans that can be made and interest rates that can be charged. Eurocurrency loans Eurocurrency loans are made on a floating @ rate basis. *nterest rates on loans to go#ernments+ cor!orations and non!rime banks are set at a fi(ed margin abo#e >*5.9 for a gi#en !eriod and currency. E(am!le *f the margin is 1A basis !oints (b.!. and the current >*5.9 is BC+ the borrower is charged B.1AC for the rele#ant !eriod. >*5.9 is the underlying #ariable rate of interest+ usually set for a B month !eriod. ,,, The margin or s!read between the lending bankDs cost of funds and the interest charged by the borrower is based on the borrowerDs !ercei#ed creditworthiness 7 riskiness. The s!reads can range from /A b.!. to more than E22 b.!.+ the median of the range #arying from /22 to F22 b.!.

The maturity of the Eurocurrency loan can range from E to /2 years. Eurocurrency loans are made by bank syndicates. The bank originating the loan becomes the lead bank managing the syndicate+ in#iting one or two other banks to be co,managers of the loan. The borrower is charged a one,time syndication fee ranging from 2.FA C to F C of the loan #alue according to the si6e and ty!e of the Eurocurrency loan. The drawdown &!eriod o#er which the borrower may use the loan) of the loan and the re!ayment !eriod #ary in accordance with the borrowerDs needs. " commitment fee of about 2.A C !er annum is !aid on the unused balance+ and !re!ayments in ad#ance of the agreed u!on schedule are !ermitted but are sometimes sub;ect to a !enalty fee. i E"C of Eurocurrency loan " cor!orate borrower has arranged a DM A22 million+ fi#e,year EuroDM loan with a bank syndicate led by two managing banks. The u!front syndication fee is F C. Net !roceeds to the borrower G - A22 mn @ 2.2F ($% - A22 mn G DM H02 mn. The interest rate on the EuroDM loan is >*5.9 I /.1A C+ with >*5.9 reset e#ery B months. *f the initial >*5.9B rate for DM is B C+ the first semiannual debt ser#ice !ayment is8 &(2.2B I 2.2/1A 7 F) J DM A22 mn G DM /0.E1A2 mn Therefore the borrowerDs effecti#e annual rate (E"C for the first si( months is8 &DM /0.E1A2 mn 7 DM H02 mn) J F J /22 G 1.023F C This E"C changes in e#ery reset !eriod (in this case B months with >*5.9B. ii Multicurrency loans Though most Eurocurrency loans are Eurodollar loans+ these often come with a multicurrency clause. This clause gi#es the borrower the right (sub;ect to a#ailability to switch from one currency to another on any rollo#er (or reset date. This o!tion allows the borrower to match currencies with cash inflows and outflows (which is an effecti#e way of managing e(!osure to currency risk+ and thus an effecti#e risk,management technique . The o!tion also allows borrowers to take ad#antage of its own e(!ectations regarding currency changes and search for funds with the lowest effecti#e cost.

iii *nterest rates *nterest rates in national and Eurocurrency markets are closely linked through arbitrage. $% - credit markets $% lending rate Eurodollar lending rate Eurodollar de!osit rate $% de!osit rate %terling credit markets $? lending rate Eurosterling lending rate Eurosterling de!osit rate $? de!osit rate

The difference between the Euro- de!osit rate and the Eurosterling de!osit rate is gi#en by the forward discount or !remium (which a!!ro(imates the e(!ected change in the dollar7!ound e(change rate .

B. Eurobond markets Eurobonds are bonds sold outside the country whose currency they are dominated in. They are similar in many ways to !ublic debt sold in domestic ca!ital markets. :owe#er+ the Eurobond market is entirely free of official regulation and is self,regulated by the "ssociation of *nternational 5ond Dealers. 5orrowers in the Eurobond market are ty!ically well known and ha#e im!eccable credit ratings (for e(am!le+ de#elo!ed countries+ international institutions+ and large MNCs . The Eurobond market has grown ra!idly in the last two decades+ and it e(ceeds the Eurocurrency market in si6e. i Currency denomination "bout 1A C of Eurobonds are dollar denominated. The most im!ortant nondollar currencies for Eurobond issues are DM and 44 (now ra!idly re!laced by the euro + the K= and the 5L &The %wiss central bank ban has led to the absence of %4 Eurobonds). ii 4i(ed @ rate Eurobonds 4i(ed,rate Eurobonds !ay cou!ons once a year+ unlike the semiannual cou!on+ domestic bonds in the $% market. 5orrowers com!are the all,in cost+ that is+ the effecti#e interest rate+ on Eurobonds and domestic bonds.

This interest rate is calculated as the discount rate that equates the !resent #alue of the future interest and !rinci!al !ayments to the net !roceeds recei#ed by the issuer+ or as the *99 of the bond. iii Com!aring Eurobond issue with a $% domestic issue To com!are a Eurobond issue with a $% domestic issue+ therefore+ the all,in cost of funds on an annual basis must be con#erted to a semiannual basis or #ice #ersa. Thus+ %emiannual yield G &/ I "nnual yield)M2.A @ /+ and "nnual yield G &/ I %emiannual yield)MF @ /. *llustration ** L N < !lans to issue a A,year bond with a face #alue of - /22 million. *ts in#estment banker estimates that a Eurobond issue would ha#e to bear a 1.A C cou!on and that fees and other e(!enses will total - 1E3+222 !ro#iding net !roceeds to L N < of - 00+FBF+222. E(hibit / shows the cashflows associated with the Eurobond issue. The all,in cost (*99 of this issue+ which is an annual rate+ is shown as 1.B3 C. "s a cross @ check+ the third column shows that the LO of the cashflows+ using a discount rate of 1.B3 C+ sum to L N < Ps net !roceeds of - 00+FBF+222. "lternati#ely+ L N < can issue a - /22 million+ A,year bond in the $% market with a cou!on of 1.H C. With estimated issuance costs of - 01H+222+ L N < will recei#e net !roceeds of - 00+2FB+222. E(hibit F shows the cashflows associated with this issue and its all,in cost (*99 of E.3F C. Note that the cashflows are semiannual+ as is the all,in cost. "gain+ the third column does a cross,check to confirm the E.3F C all,in cost. "ccording to Equation (/ abo#e+ the equi#alent semiannual all,in cost for the Eurobond issue is (/.21B3 M2.A @ / G E.11 C. Thus+ the all,in cost of the Eurobond is lower+ making it !referable if all other terms and conditions on the two bonds are the same. "lternati#ely+ using Equation (F abo#e+ we can con#ert the $% bond yield to its annual equi#alent and com!are that figure to the Eurobond yield of 1.B3 C. This com!utation would ha#e yielded an annuali6ed all,in cost of the $% bond issue equal to (/.2E3F MF @ / G 1.13 C. "s before+ the Eurobnd issue is !referable because its all,in cost is /2 basis !oints lower. (/ (F