euro currency market(unit 1)

7/30/2019 Euro Currency Market(Unit 1)

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EURO CURRENCY MARKET


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Euro Currency

Euro currency is the term used to describe

deposits residing in banks that are located

outside the borders of the country that issues

the currency, the deposit is denominated in-

For example- a deposit denominated in US

Dollars residing in a Japanese bank is a EURO

currency deposit or more specifically a EUROdollar deposit


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How it originated?

After the second world war, the amount of US dollarsoutside the United States increased enormously.

As a result enormous sums of US dollars were incustody of foreign banks outside the United States.

During the Cold war period, especially after theinvasion of Hungary in 1956, the Soviet Union fearedthat its deposits in North American banks would befrozen as a retaliation.

It decided to move some of its holdings to MoscowNarodny bank, a soviet union bank with a Britishcharter.


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The British bank than deposit that money in US banks.There will be no chance of confiscating that money becauseit belonged to British bank and not directly to Soviets. OnFeb, 28, 1957, the sum of dollar 800,000 was transferredcreating the first Eurodollars.

Gradually as a result of successive commercial deficits ofunited stated, the Eurodollar market expanded worldwide.

Thus the currencies involved in Eurodallar market are in noway different from currencies deposited in banks of home

country. It is not Eurodollar not under the orbit orsurveillance of monetary policy, where the currency in thehome country is under the regulation of national monetarypolicy.


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It is highly competitive and sensible market:

Highly Competitive: this market is characterized

as highly competitive because the market is

growing and accepted internationally

Sensible: The Eurodollar market is highly

sensible because it responds faster to the

changes in demand and supply of the funds

and also reacts to changes in the interest rates


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Relaxation of Exchange control andresumption of currency convertibility:

Resumption of currency convertibility was seen

in Europe (1958)

Surplus Euromarket Deficit


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Balance of payment deficit of US

It means that the outflow of dollars from US

increased to other nations.

It was in 1950 that US started facing the

problem of deficit, but it was in 1958 that

problem reached to saturation point.

The outflow of USD contributed as a factor for

expanding Eurocurrency market.


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Regulation Q

Regulation Q was a united states government

regulation which fixed the maximum interest

payable by banks in US and restricted thepayment of interest on deposits less than30

days.

Unlike US, Eurodollar market paid interest onthe deposits of less than 30 days.


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Participants have contributed in demand and supplyin the following ways;

Supply

Central banks of various countries are suppliers;they channel the fund through BIS.

Increase in the Oil revenue of the OPEC hadadded to the fund.

MNCs and traders place their surplus funds forthe short term gains.

Demand Govt. demand these funds to meet the deficit

arising due to the deficit in balance of paymentand the rise in the oil prices.

Commercial banks need extra funds for lending.


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Advantages

It helped the economies to solve the liquidity

problems.

It provided better investment opportunities.

Funds are also by the commercial banks of

various countries for domestic credit creation and

window dressing.

This facilitated the growth and development ofvarious countries like Brazil, south Korea, Taiwan,

and Mexico etc

Its international acceptance had helped in the


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Growth of Eurodollar market caused byrestrictive US govt. policies, especially

Reserve requirements on deposits

Special charges and taxes

Required concessionary loan rates

Interest rate ceilings

Rules which restrict bank competition

Eurocurrency creation involves

A chain of deposits

Changing control/ usage of deposit


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Eurocurrency market uses floating rate pricing

Low interest rate risk Interest rate tied to variable rate base such as LIBOR

Low default risk

Traded between large commercial banks, investment banks and multinationalcorporations

Relatively short maturities

Banks making a market in eurocurrencies quote bid rates at which they will takedeposits and offer(or ask) rates at which they will make loans to othereurocurrency banks

LIBID and LIBOR (the London Interbank Bid and offer rates)

LIBID is the bid rate that a Euromarket bank pays on deposits of other euromarket bank.

LIBOR is the offer rate that The Euromarket bank receives on deposits from ( or loans to)

other Euromarket banks. The difference between the banks offer and bid rates is called the Interbanks

spread and is typically one eighth percent for large interbank transactions inmajor currencies.


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Another popular benchmark Euribor (the Euro

interbank offer rate) is the interest rate on

euro denominated term deposits between

euro zone banks.


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Eurocurrency market has few regulations

Typically there areNo reserve requirements

No interest rate regulations or caps

No withholding taxes

No deposit insurance requirement

No credit allocation requirements

Less stringent disclosure requirements

Active trade in eurocurrency deposits and loansensures competitive bid and offer prices.

With daily volume in hundreds of billions of

dollars and little outside interference, the


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Eurocredit Market

The interbank spot and forward foreign

exchange markets allow pounds sterling and

dollars to be exchanged at competitive rates.

The Eurocurrency markets (e.g., Eurosterling

and Eurodollars) provide competitively priced

interest rates in each currency.

Because of the close association between the

foreign exchange and Eurocurrency markets,

international banks usually conduct trading in

these markets out of the same trading room.


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Spreads in domestic and Eurocurrency

credit markets

Euromarket transactions between major money-

center banks are traded in a very competitive

market and have very low bid-ask spreads.

Eurocurrency lending rate is lower than domesticlending rate and Eurocurrency deposit rate is

higher than domestic deposit rate.

Banks set slightly lower deposit rates and slightly

higher loan rates for the Eurocurrency

transactions of non-bank customers


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Eurobond Market

There are two types of international bonds.

Bonds denominated in the currency of thecountry where they are placed but issued byborrowers foreign to the country are calledforeign bonds or parallel bonds .

Bonds that are sold in countries other than thecountry represented by the currencydenominating them are called Eurobonds .

The emergence of the Eurobond market is partiallydue to the 1963 Interest Equalization Tax imposed inthe U.S.

The tax discouraged U.S. investors from investing in

foreign securities, so non-U.S. borrowers lookedelsewhere for funds.


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Eurobond Market

Eurobonds are underwritten by a multi-nationalsyndicate of investment banks and simultaneouslyplaced in many countries through second-stage, and inmany cases, third-stage, underwriters.

Eurobonds are usually issued in bearer form, payannual coupons, may be convertible, may have variablerates, and typically have few protective covenants.

Interest rates for each currency and credit conditions in

the Eurobond market change constantly, causing thepopularity of the market to vary among currencies.

About 70% of the Eurobonds are denominated in theU.S. dollar.

In the secondary market, the market makers are often


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Attraction of Eurobond

No govt. interference

Few disclosure requirements

Favourable tax status

euro currency market(unit 1)

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