M. B. A.

II
INTERNATIONAL FINANCIAL MANAGEMENT

WORLD FINANCIAL MARKETS

AND INSTITUTUIONS

GUIDED BY
Ms. Jyoti Ghanchi
PREPARED BY
Dhiren Jethva (Roll No: 12)

MARCH / APRIL 2015

S. K. SCHOOL OF BUSINESS AND MANAGEMENT,
HEMCHANDRACHARYA NORTH GUJARAT UNIVERSITY
PATAN

INDEX
Ch.
No.

TITLE

TITLE PAGE
INDEX
1.

PART A : INTERNATIONAL BANKING AND MONEY MARKET

International Banking Market
1.1.
Introduction

Pg.
No.
**
**

2.

3.

1.2.
Reasons For International Banking
1.3.
International Banking Services
1.4.
Types Of International Banking Offices
1.5.
International Banking Facilities
International Money Market
2.1.
Introduction
2.2.
Eurocurrency Market
2.3.
Eurocredits
Practical Approach To International Banking And Money Market
3.1.
Introduction : Worlds Banking Market & Statistics
3.2.
Introduction : World Money Market & Statistics
3.3.
Some Information (I.E. Worlds Largest Banks, Special
Instruments, Etc.)
3.4.
Capital Adequacy Standards
3.5.
Prudential Norms (If Applicable)

PART B : INTERNATIONAL BOND AND EQUITY MARKET

4.
International Bond Market
4.1.
Introduction
4.2.
A Statistical Perspective
4.3.
Different Products And Features
I.
Foreign Bonds
II.
Eurobonds
III.
Bearer Bonds
IV. Registered Bonds
V. Straight Fixed Rate Issues
VI.
Euro Medium Term Notes
VII.
Equity Related Notes
VIII.
Floating Rate Notes
IX.
Zero Coupon Bonds
4.4.
Regulations And Recent Regulatory Changes

5.

International Equity Markets

5.1.
Introduction
5.2.
A Statistical Perspective
5.3.
Different Products And Features
5.4.
Market Structure
5.5.
Trading Practices
5.6.
International Equity Market Benchmarks
ABBREVIATIONS
SUMMARY
BIBLIOGRAPHY

International Banking Market

Introduction:
An International bank is a bank located outside the country of residence of the depositor,
typically in a low tax jurisdiction (or tax haven) that provides financial and legal advantages.
These advantages typically include:

Greater Privacy (see also bank secrecy, a principle born with the 1934
Swiss Banking Act)

Little Or No Taxation (i.e. tax havens)

Easy Access To Deposits (at least in terms of regulation)

Protection Against Local, Political, Or Financial Instability

While the term originates from the Channel Islands being "international " from the United
Kingdom, and most international banks are located in island nations to this day, the term is used
figuratively to refer to such banks regardless of location, including Swiss banks and those of
other landlocked nations such as Luxembourg and Andorra.
International banking has often been associated with the underground economy and organized
crime, via tax evasion[ and money laundering; however, legally, international banking does not
prevent assets from being subject to personal income tax on interest. Except for certain people
who meet fairly complex requirements, the personal income tax of many countries makes no
distinction between interest earned in local banks and those earned abroad. Persons subject to US
income tax, for example, are required to declare on penalty of perjury, any international
bank accountswhich may or may not be numbered bank accountsthey may have. Although
international banks may decide not to report income to other tax authorities, and have no legal
obligation to do so as they are protected by bank secrecy, this does not make the non-declaration
of the income by the tax-payer or the evasion of the tax on that income legal.
Following September 11, 2001, there have been many calls for more regulation on international
finance, in particular concerning international banks, tax havens, and clearing houses such
as Clear stream, based in Luxembourg, being possible crossroads for major illegal money flows.
Defenders of international banking have criticize these attempts at regulation. They claim the
process is prompted not by security and financial concerns but by the desire of domestic banks
and tax agencies to access the money held in international accounts. They cite the fact that
international banking offers a competitive threat to the banking and taxation systems in
developed

countries,

suggesting

that Organization

for

Economic

Development (OECD) countries are trying to stamp out competition

Co-operation

and

Reasons for International Banking

Migration of domestic customers,

notably MNEs growing foreign activities

Effects of

regulatory differences (structural and prudential) Input cost differences (e.g. in cost of domestic
funding) - Japanese in the past

Comparative advantages in retail banking

(Citibank)

Development of major financial centers offering benefits to banks:

Business contacts
Location of customers
Pool of skilled labor
Trades and professions
Liquidity and efficiency of markets (thick market externalities)
Interrelation of markets (e.g. derivatives and underlying) Potential for increasing returns
to scale and self sustaining growth of centers
There are many benefits to opening an international bank account, in particular if you travel or
work abroad and want to be able to manage your money in different currencies. We have pulled
together a list of the top five reasons we believe are key to opening an international account and
how they are beneficial to you:
1.

By having an account in a different currency or country you can react to currency

fluctuations to ensure your money is kept secure and continues to grow in a central location.

2.

The ability to make payments in multiple currencies provides an easy way for you to pay
bills overseas, giving you greater flexibility when it comes to your financial arrangements.

3.

The location of where your international account is held is often in a well regulated low
tax jurisdiction. This may mean you have the option to manage your money in a secure and
more tax efficient way.

4.

Most international banking options allow 24/ 7 worldwide access to your money, which
lets you stay in control of your finances wherever you are in the world.

5.

By having one central bank account, as opposed to several accounts for each currency,
you can take care of your finances in a simple and convenient way, which means less stress
and worry for you, and more time to enjoy your international lifestyle.

So there you have it, five reasons to open an international account. If you already have an
international account we want to hear from you! What are the main reasons you opened an
account and are they different from the reasons listed above?
Low Marginal Costs
Managerial and marketing knowledge developed at home can be used abroad with low
marginal costs.
Knowledge Advantage
The foreign bank subsidiary can draw on the parent banks knowledge of personal contacts and
credit investigations for use in that foreign market.
Home Nation Information Services
Local firms in a foreign market may be able to obtain more complete information on trade and
financial markets in the multinational banks home nation than is obtainable from foreign
domestic banks.
Prestige
Very large multinational banks have high perceived prestige, which can be attractive to new
clients.

Regulatory Advantage
Multinational banks are often not subject to the same regulations as domestic banks.
Wholesale Defensive Strategy
Banks follow their multinational customers abroad to avoid losing their business at home and
abroad.
Retail Defensive Strategy

 Multinational banks also compete for retail services such as travelers checks, tourist and
foreign business market.
Transactions Costs
Multinational banks may be able to circumvent government currency controls.
Growth
Foreign markets may offer opportunities to growth not found domestically
Risk Reduction
Greater stability of earnings due to diversification

International Banking Services

It is possible to obtain the full spectrum of financial services from offshore banks, including:

Corporate administration

Credit

Deposit taking

Foreign exchange

Fund management

Investment management and investment custody

Letters of credit and trade finance

Trustee services

Wire- and electronic funds transfers

Not every bank provides each service. Banks tend to Polarise between retail services and private
banking services. Retail services tend to be low cost and undifferentiated, whereas private
banking services tend to bring a personalized suite of services to the client.

Types of International Banking Offices

Correspondent bank relationship
A correspondent bank relationship is established when two banks maintain a correspondent bank
account with one another. The correspondent banking system provides a means for a banks
MNC clients to conduct business worldwide through his local bank or its contacts.
Representative Offices
A representative office is a small service facility staffed by parent bank personnel that is
designed to assist MNC clients of the parent bank in its dealings with the banks correspondents.
It is a way for the parent bank to provide its MNC clients with a level of service greater than that
provided through merely a correspondent relationship.
Representative offices also assist with information about local business customs, and credit
evaluation of the MNCs local customers.
Foreign branch bank
A foreign branch bank operates like a local bank, but legally it is a part of the parent bank. As
such, a branch bank is subject to the banking regulations of its home country and the country in
which it operates. The primary reason a parent bank would establish a foreign branch is that it
can provide a much fuller range of services for its MNC customers through a branch office than
it can through a representative office

 Subsidiary bank
A subsidiary bank is a locally incorporated bank that is either wholly owned or owned in major
part by a foreign subsidiary. An affiliate bank is one that is only partially owned, but not
controlled by its foreign parent. Both subsidiary and affiliate banks operate under the banking
laws of the country in which they are incorporated. U.S. parent banks find subsidiary and
affiliate banking structures desirable because they are allowed to engage in security
underwriting.
Edge Act banks
Edge Act banks are federally chartered subsidiaries of U.S. banks which are physically located in
the United States that are allowed to engage in a full range of international banking activities. A
1919 amendment to Section 25 of the Federal Reserve Act created Edge Act banks. The purpose
of the amendment was to allow U.S. banks to be competitive with the services foreign banks
could supply their customers. Federal Reserve Regulation K allows Edge Act banks to accept
foreign deposits, extend trade credit, finance foreign projects abroad, trade foreign currencies,
and engage in investment banking activities with U.S. citizens involving foreign securities. As
such, Edge Act banks do not compete directly with the services provided by U.S. commercial
banks. Edge Act banks are not prohibited from owning equity in business corporations as are
domestic commercial banks. Thus, it is through the Edge Act that U.S. parent banks own foreign
banking subsidiaries and have ownership positions in foreign banking affiliates.
Offshore banking center
An offshore banking center is a country whose banking system is organized to permit external
accounts beyond the normal economic activity of the country. Offshore banks operate as
branches or subsidiaries of the parent bank. The primary activities of offshore banks are to seek
deposits and grant loans in currencies other than the currency of the host government. In 1981,
the Federal Reserve authorized the establishment of International Banking Facilities (IBF). An
IBF is a separate set of asset and liability accounts that are segregated on the parent banks
books; it is not a unique physical or legal entity. IBFs operate as foreign banks in the U.S. IBFs
were established largely as a result of the success of offshore banking. The Federal Reserve

desired to return a large share of the deposit and loan business of U.S. branches and subsidiaries
to the U.S.

International Banking Facilities

An International Banking Facility (IBF) is a separate account established by a U.S. bank, or a
US branch/subsidiary of a foreign bank, or an Edge Act Corporation in the United States to offer
services to only non-US residents and institutions. The services offered include deposit and loan
services. (Note, an IBF is not necessarily a separate legal entity.)
Banks may maintain IBFs in their existing quarters, but the IBF's accounting must be separate
from the bank's main books. Deposit and loan services provided by IBFs are free of Federal
Reserve System reserve requirements, and are not insured by the Federal Deposit Insurance
Corporation. Thus, deposits may earn greater interest than deposits made by U.S. residents.
The IBF concept was initially proposed to the Federal Reserve Board of Governors by the New
York Clearing House association in July 1978. It took until June 18, 1981 until the Board of
Governors approved establishment of IBFs from December 3. [2] IBFs were established to attract
some of the money flowing out to offshore banking centers.
In the early 1980s, New York competed with other states, such as Florida, to attract IBF business.
For instance, New York exempted the income of an IBF from New York bank franchise tax.
Florida, in turn, exempted the income of Florida IBFs from Florida corporate income tax and
also allowed Florida IBFs to deduct their losses.

2. International Money Market

The International Monetary Market (IMM), a spin-off from the old Chicago Mercantile
Exchange and largely the creation of Leo Melamed, is today one of four divisions of the Chicago
Mercantile Exchange (CME), the largest futures exchange in the United States, for the trading
of futures contracts and options on futures. The IMM was started on May 16, 1972.Two of the
more prevalent contracts traded are currency futures and interest rate futures, specifically, 3month Eurodollar time deposits and 90-day U.S. Treasury bills. The other two CME divisions
includes the Index and Option Market (IOM) and Growth and Emerging Markets (GEM). All
products fall under one of these three divisions.
The international money market is the market that handles the international currency transactions
between the various central banks of the nations. In the international money market, the
transactions are carried out mainly in gold or in US dollar.

The international money market is governed by the international monetary transactions between
various nations currency. The international money market mainly handles the currency trading
between the countries. The trading of one country's currency for another one is also named as the
foreign exchange currency trading or forex trading. The international money market has grown
phenomenally over last few years and is expected to grow even more. It is the largest financial
market in the world and the participants in this large market are large banks, central banks,
governments,

multinational

corporations

and

currency

speculators.

A money market is the safest financial market available and is commonly used by the big
financial institutions, large corporations and governments. The investment made in a money
market is generally for a very short period of time and hence they are often referred as cash
investments. The basic performance of the international money market involves the money
borrowing or lending by a government or some large financial institutions. Unlike share markets,
the international money market deals with much larger fund and the players of the market are big

financial institutes. The international money market allows investing in a less risk while the
return that comes from that is also less. The best way to invest in the international money market
is

by

money

market

mutual

funds

or

treasury

bills.

Everyday the international money market regulates a huge amount of international currency
trading. According to the reports given by the Bank for International Settlements, the daily
turnover in a traditional exchange market estimated is $1880 billion.
Introduction
The Eurocurrency market owes its existence to differences in national financial
regulation combined with declining barriers to international capital movements. The
Eurocurrency market and its offspring - the Eurobond, Eurocommercial paper, and
Euroequity markets - comprise some of the most important financial innovations of
the last 40 years.
These innovations are examples of unbundling, in this case, separating the
exchange risk of one currency (the US $, for example) from its indigenous
regulatory environment, and combining it with the regulatory climate and political
risk of another financial center (such as London). The Eurocurrency and Eurobond
markets, virtually nonexistent until the late 1950s, have grown to become major
centers of activity and in many instances the preferred market for raising or
investing funds.

A. Eurocurrency market
Definition and background
The Eurocurrency market consists of banks (called Eurobanks) that accept deposits
and make loans in foreign currencies. A Eurocurrency is a freely convertible
currency deposited in a bank located in a country which is not the native country of
the currency. The deposit can be placed in a foreign bank or in the foreign branch of
a domestic US bank.
[Note of caution! The prefix Euro has little or nothing to do with the newly emerging
currency in Europe.]

In the Eurocurrency market, investors hold short-term claims on commercial banks

which intermediate to transform these deposits into long-term claims on final
borrowers.

The Eurocurrency market is dominated by US $ or the Eurodollar. Occasionally,

during weak dollar periods (latter part of 1970s and 1980s), the EuroSwiss franc and
the EuroDM markets increased in importance. The Eurodollar market originated
post WWII in France and England thanks to the fear of Soviet Bloc countries that
dollar deposits held in the US may be attached by US citizens with claims against
communist governments!

Thriving on government regulation

By using Euromarkets, banks and financiers are able to circumvent / avoid certain
regulatory costs and restrictions. Some examples are:

a) Reserve requirements
b) Requirement to pay FDIC fees
c) Rules or regulations that restrict competition among banks
Continuing government regulations and taxes provide opportunities to engage in
Eurocurrency transactions. However, ongoing erosion of domestic regulations have
rendered the cost and return differentials much less significant than before. As a
result, the domestic money market and Eurocurrency markets are closely integrated
for most major currencies, effectively creating a single worldwide money market for
each participating currency.
Illustration I
German firm sells medical equipment to institutional buyer in the US. It receives a
US$ check drawn on Citicorp, NY. Initially this check is deposited in a checking
account for dollar working capital use. But to earn a higher return (or rate of
interest) on the $ 1 million the German firm decides to place the funds in a time
deposit with a bank in London, UK.

One million Eurodollars have thus been created by substituting a dollar account in a
London bank for the dollar account held in NY. Notice that no US $ left NY but
ownership of the US deposit has moved from a foreign corporation to a foreign

bank. The London bank would not like to leave the funds idle in NY account. If a
government or commercial borrower is unavailable, the London bank will place the
$ 1 million in the London interbank market. The interest rate at which such
interbank loans are made is called the London interbank offer rate (LIBOR).
This example demonstrates that the Eurocurrency market is a chain of deposits and
a chain of borrowers and lenders. The majority of Eurocurrency transactions involve
transferring control of deposits from one Eurobank to another Eurobank. Loans to
non-Eurobank borrowers account for less than half of all Eurocurrency loans.

The Eurocurrency market operates like any other financial market, but for the
absence of government 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. Interest rates on loans to
governments, corporations and nonprime banks are set at a fixed margin above
LIBOR for a given period and currency.
Example
If the margin is 75 basis points (b.p.) and the current LIBOR is 6%, the borrower is
charged 6.75% for the relevant period. LIBOR is the underlying variable rate of
interest, usually set for a 6 month period. The margin or spread between the
lending banks cost of funds and the interest charged by the borrower is based on
the borrowers perceived creditworthiness / riskiness. The spreads can range from
15 b.p. to more than 300 b.p., the median of the range varying from 100 to 200 b.p.
The maturity of the Eurocurrency loan can range from 3 to 10 years. Eurocurrency
loans are made by bank syndicates. The bank originating the loan becomes the
lead bank managing the syndicate, inviting one or two other banks to be comanagers of the loan. The borrower is charged a one-time syndication fee ranging
from 0.25 % to 2 % of the loan value according to the size and type of the
Eurocurrency loan.
The drawdown [period over which the borrower may use the loan] of the loan and
the repayment period vary in accordance with the borrowers needs. A commitment
fee of about 0.5 % per annum is paid on the unused balance, and prepayments in
advance of the agreed upon schedule are permitted but are sometimes subject to a
penalty fee.

I) EAC of Eurocurrency loan

A corporate borrower has arranged a DM 500 million, five-year EuroDM loan with a
bank syndicate led by two managing banks. The upfront syndication fee is 2 %.
Net proceeds to the borrower = $ 500 mn 0.02 (US $ 500 mn) = DM 490 mn.
The interest rate on the EuroDM loan is LIBOR + 1.75 %, with LIBOR reset every 6
months. If the initial LIBOR6 rate for DM is 6 %, the first semiannual debt service
payment is:
[(0.06 + 0.0175) / 2] * DM 500 mn = DM 19.3750 mn
Therefore the borrowers effective annual rate (EAC) for the first six months is:
[DM 19.3750 mn / DM 490 mn] * 2 * 100 = 7.9082 %
This EAC changes in every reset period (in this case 6 months) with LIBOR6.

ii) Multicurrency loans

Though most Eurocurrency loans are Eurodollar loans, these often come with a
multicurrency clause.
This clause gives the borrower the right (subject to
availability) to switch from one currency to another on any rollover (or reset) date.
This option allows the borrower to match currencies with cash inflows and outflows
(which is an effective way of managing exposure to currency risk, and thus an
effective risk-management technique). The option also allows borrowers to take
advantage of its own expectations regarding currency changes and search for funds
with the lowest effective cost.
iii) Interest rates
Interest rates in national and Eurocurrency markets are closely linked through
arbitrage.

US $ credit markets

US lending rate

Eurodollar lending rate

rate

Sterling credit markets

UK lending rate

Euro sterling lending

Eurodollar deposit rate

deposit rate

US deposit rate

Euro sterling

UK deposit rate

The difference between the Euro$ deposit rate and the Euro sterling deposit rate is
given by the forward discount or premium (which approximates the expected
change in the dollar/pound exchange rate).

Euro credits
A loan whose denominated currency is not the lending bank's national currency. A euro credit
loan would be made by a U.S. bank to a lender requiring a denominated currency which differs
from the bank's local currency (USD) for specific reasons, most likely some sort of business
operations or trade requirements. Despite the inclusion of the word "euro," a euro credit is not
immediately derived from the euro.

Short- to medium-term loans of Eurocurrency to corporations, governments, nonprime

banks or international organizations.

Loans are often too large for one bank to underwrite; a syndicate of banks share the risk
of the loan.

Adjustable rate - Rollover 3-6 mo

On Euro credits originating in London, the base rate is LIBOR + X% based on the
creditworthiness of the borrower.

For Example
Euro credit helps the flow of capital between countries and the financing of investments at home
and abroad. These trades add liquidity to both currencies as the U.S. bank accounts for the
incoming payments from the loans in U.S. dollar terms, and are often large and function in a
long-term basis. A U.S. bank lending a corporation 10 million Russian rubles is an example of
Euro credit.

3 Practical Approaches to International Banking and Money Market

1 Introduction Worlds Banking Market & Statistics

Global Banking Industry

The global banking industry is expected to exceed $143 trillion in 2014 for a 58% increase in
five years, according to research from Market Line. Bank credit represents the leading market
segment, with around 60% of the overall market in terms of value. The EU is the largest regional
market, with over 57% of the global market.
The economic recession that began in 2008 resulted in the crash of several financial institutions,
which in turn led to the examination of practices and deployment of new guidelines in the
banking industry. The sector is beginning to rebound, and cross-border investment is one area
contributing to recovery, with a few large banks dominating certain national markets. Advantages
of cross-border practices include economies of scale, though institutions must compete with
established domestic banks.

Key Market Segments

The world retail lending sector was worth close to $31.4 trillion in 2010, reports Market
Line. Market growth is expected to exceed a yearly rate of 5% between 2010 and 2015, to
reach almost $40.4 trillion. Mortgage lending represents the leading market segment, and
reached close to $24 trillion in 2010, accounting for almost 76% of the overall market in
terms of value.

The global smart card shipment market is forecast to record yearly growth of 12%
between 2011 and 2014, reports RNCOS. The market is benefiting from Long Term
Evolution rollout worldwide, state support and migration to Euro pay, MasterCard &
VISA (EMV). Secure microprocessor contactless smart card shipments are expected to
record 22% yearly growth between 2011 and 2014.

The global mobile payments market is expected to exceed 1.5 billion customers by 2012,
reports Vision gain. It is forecast there will be close to 5.5 billion handsets used in the
mobile subscriber sector in 2015. Obstacles to market growth include the low penetration
of contactless terminals and handsets in mature markets.

The world near field communication (NFC) payment market is expected to record close
to 70% yearly growth between 2010 and 2014, reports TechNavio. Market growth will be
fuelled by the increased availability of NFC-enabled handsets. While NFC enabled
payment pilot trials have proved successful, additional infrastructure will be necessary to
fulfill growth potential. Key companies operating in the global NFC payments industry
include Discover Financial Services, MasterCard and Visa.

The global private banking sector has been seriously impacted by the economic crisis,
following which partnerships, organic growth, and mergers and acquisitions went into
decline, according to research from Data monitor. Since 2010, private banks have been
struggling against commoditization. Industry players will continue to concentrate on
customer segmentation, gearing their products to consumer groups based on factors such
as nationality, social status and ethnicity. Leaders operating in the market include Wells
Fargo, Pictet, HSBC, UBS, Credit Suisse and RBC.

Regional Market Share

Following the negative impact of market volatility on Asia-Pacifics high net-worth consumer
base, the banking industry is expected to recover and expand in 2012, reports Data monitor.

Recovery will be fuelled by resolution of the EU debt crisis and rising investor confidence in
financial assets. Affluent consumer numbers in Asia Pacific climbed less than 1% in 2011 due to
low stock market returns. Japan holds solid potential as close to 42% of the overall population is
categorized as affluent.
The US banking sector is expected to reach $14 trillion by 2015, in terms of assets, while the EU
should reach $88 trillion, reports Global Industry Analysts. Market growth will be driven by
cross-border expansion due to the breaking down of obstacles to cross-border investment.
Competition between international banks is also forecast to fuel market growth along with the
introduction of new products, reduction of costs and launch of new services.

Market Outlook
Research from Global Industry Analysts shows that mobile and internet banking are becoming
increasingly intertwined. This is largely due to the success of smart phones, which afford
consumers convenient access to internet banking. The global mobile internet market will
continue to drive the expansion of the mobile banking services sector. Financial institutions are
responding by launching downloadable applications and encouraging consumers to bank online
and through mobile devices by rolling out mobile and internet banking services.

2 World Money Market & Statistics

3.1.

Some Information

(I.E. Worlds Largest Banks, Special Instruments, Etc.)

Worlds Largest Banks

By total assets
Relbanks 2014 statistics on largest banks in the world by total assets: Please note, that the
accounting treatment affects the assets reported. For example, the United States uses GAAP (as
opposed to IFRS), which only reports the net derivative position in most cases, leading to US banks
having fewer derivative assets, than comparable non-US bank.

Rank

Bank name

Total assets
(US$ billion)

Industrial & Commercial Bank of China (ICBC)

3,181.88

HSBC Holdings

2,758.45

China Construction Bank Corporation

2,602.54

BNP Paribas

2,589.19

Mitsubishi UFJ Financial Group

2,508.84

JPMorgan Chase & Co

2,476.99

Agricultural Bank of China

2,470.43

Bank of China

2,435.49

Crdit Agricole Group

2,346.56

10

Barclays PLC

2,266.82

11

Deutsche Bank

2,250.64

12

Bank of America

2,149.85

13

Japan Post Bank

1,968.27

Rank

Bank name

Total assets
(US$ billion)

14

Citigroup Inc

1,894.74

15

Socit Gnrale

1,740.75

16

Mizuho Financial Group

1,708.86

17

Royal Bank of Scotland Group

1,703.96

18

Banco Santander

1,607.24

19

Sumitomo Mitsui Financial Group

1,569.99

20

Group BPCE

1,567.88

By market capitalization
Relbanks 2014 statistics on largest banks in the world by market capitalization

Rank

Bank name

Market capitalization
(US$ billion)

Wells Fargo & Co

261.72

JP Morgan Chase & Co

229.90

ICBC

196.21

HSBC Holdings

191.43

Bank of America

181.77

China Construction Bank

160.83

Citigroup Inc

144.63

Agricultural Bank of China

126.41

Bank of China

115.92

10

Commonwealth Bank of Australia

115.35

11

Banco Santander

110.57

12

Allied Irish Banks plc

100.61

13

Westpac

99.22

Rank

Bank name

Market capitalization
(US$ billion)

14

BNP Paribas

96.03

15

Royal Bank of Canada

95.18

16

Lloyds Banking Group

90.92

17

Toronto-Dominion Bank

86.49

18

Australia and New Zealand Banking (ANZ)

83.25

19

Mitsubishi UFJ Financial Group (MUFG)

78.45

20

US Bancorp

78.11

3 Capital Adequacy Standards

Bank capital adequacy = equity capital and other securities a bank holds as reserves
against risky assets
How much bank capital is enough to ensure the safety and soundness of the banking
system?
Basle Accord 1 (1988): Rules-based approach + VAR

 Basle Accord 2 (2003 - 2009) - 3 pillars

-min. cap. Requirements

-supervisory review process
-market discipline

Basle Accord 3 (2010 - 2011)

Strengthens bank capital requirement and introduces new regulatory requirements on
bank liquidity and bank leverage
Basle Accord I: minimum bank capital adequacy ratio (rules-based)
Banks involved in cross-border transactions.
Min. Cap. Adequacy = 8% [risk weighted assets]
Tier I Core capital = shareholder equity + retained earnings
Tier II Supplemental capital = internationally recognized non-equity items
Tier II < 50% total bank capital

Asset Weights:

Government obligations = 0%; short-term interbank assets = 20%

Residential mortgages = 50%; other assets = 100%
Basle

Accord

I:

Risk-focused Cap. Adequacy

1996 amendment allows banks to use modern portfolio models to specify adequate Cap.
Adequacy.

VAR (value-at-risk) = loss exceeded with a specified probability over a specified time
period.

1% chance: maximum loss over 10 days > banks capital

VAR = (PV)(s)(Z.01)(D1/2)
PV = portfolio value;
s = standard deviation of return(daily);
Z.01 = standard normal value for 1-tail confidence interval;
D = days

PART B: INTERNATIONAL BOND AND EQUITY MARKET

International Bond Market

Introduction to International Bond Markets

This chapter focuses on international bond market but predominantly from Indian companies
point of view. International bond market has a long history but Indias entry to this arena is not
very old. Since liberalization of Indian capital market many Indian companies have tapped
international market and have raised both debt i.e, Eurobonds, foreign bonds, as well as quasi
debt instruments like FCCBs ( Foreign Currency Convertible Bonds). Many of these bonds and
international debts are also issued with varying features like FRNs (Floating Rate Notes). These

aspects are extensively discussed. No discussion on bond is complete without understanding the
bond rating mechanism. Also a company international bond or debt rating is influenced by the
sovereign rating. Hence both ratings at company level and sovereign rating aspects are discussed
in this module. International Bond Market has long history. It dates back several centuries. Many
wars have been fought by kings funded by borrowing money from other royal houses from
different countries. Though it is beyond the scope of this session to discus the long history of
bond market in detail, one interesting study in worth mentioning here. Fergusons 2006 paper
studied impact of political risk on international bond market during two distinct periods 1843
between the 1880 and during 1880-1914. This clearly indicates that international bond market
was active even during middle of nineteen century.
Debt certificates have been traded internationally for several centuries. Kings and emperors
borrowed heavily to finance their wars. In the 14th century, for example, Edward I financed his
wars through bond issues launched in Italy by the then big banking families. Centuries later, the
great coalition against Louis XIV led by William of Orange was financed by a group of Dutch
families operating from The Hague. Later, the Rothschilds became famous for supporting the
British war effort against Napoleon I through their European family network. Although debt
financing has always been international in nature, there is still no unified international bond
market. The international bond market is divided into three bond market groups:

A Statistical Perspective
Currency

(U.S.

$ Percent

U.S.

billions)
22,423.2

43.6

Dollar
Euro
Yen
Other
Total

13,270.9
8,633.6
7,068.1
51,395.8

25.8
16.8
13.8
100

Amounts of Domestic and International Bonds Outstanding

Currency

Domestic Internationa

U.S.

$17,930.

Dollar
Euro

7
$ 8,436.4

Pound
Yen
Other
Total

$ 1,274.6
$ 8,145.0
$ 4,506.6
$40,293.
3

Total

l
$ 4,492.5

$ 4,834.5

22,423.2
$

$ 778.7
$ 488.6
$ 508.2
$ 11,102.5

13,270.9
$ 2,053.3
$ 8,633.6
$ 5,014.8
$
51,395.8

http://athene.mit.csu.edu.au/~hskoko/subjects/fin340/lect08.pdf

Different Products And Features

X. Foreign Bonds
XI.
Eurobonds
XII.
Bearer Bonds
XIII.
Registered Bonds
XIV. Straight Fixed Rate Issues
XV. Euro Medium Term Notes
XVI.
Equity Related Notes

Foreign Bonds
Foreign Bond: Foreign Bond is a bond where foreign company issues bond denominated in the
currency denomination of the foreign country. For example, an US company issues bond and
raises capital in Japan denominated in Japanese Yen. In other words, the Japanese investors are
not exposed to foreign exchange risk while investing in a foreign bond. At this junction it is
important to understand that a Japanese company may also issue bond and raise capital in Japan
denominated in Japanese Yen.

They are issued on a local market by a foreign borrower and are usually denominated in the local
currency. Foreign bond issues and trading are under the supervision of local market authorities
Amoco Canada, a foreign corporation, issues bonds in the U.S. for placement in the U.S. market
alone. The issue is underwritten by a syndicate of U.S. securities houses. The issue is
denominated in the currency of the intended investors, i.e., USD.

Eurobonds
.INTRODUCTION
After last years sovereign crisis, the euro area is still far from sailing in safe waters.
Severe reforms have to be undertaken to guarantee the future of the Economic and
Monetary Union (EMU). This has to start with the enlargement of the temporary
stability fund to at least EUR 700 billion. Fortunately, this is currently a major point
on the EMU political agenda. However, we simultaneously need a strengthening of
the fiscal rules in the Stability and Growth Pact (SGP), especially when it comes to
enforcement2 . This should be a prerequisite for moving to the last reform, namely a
permanent defense mechanism for the euro area. This would be a move towards
making EMU a more integrated fiscal union. In December 2010, the European heads
of state and government and the economics and finance ministers decided to
introduce a permanent European Stability Mechanism (ESM) from 2013 on to
replace the European Financial Stability Facility (EFSF). Recently, though, other
ideas to guarantee the stability of the euro area have been put forward. In what
follows, I am focusing on 'Eurobonds', to be defined as 'pooled' sovereign debt
instruments of the Member States of the euro area. These have been the object of
intense political debate lately. Proposals span from the possibly most cited Blue-Red
Bond proposal by Bruegel to political manifests such as the one in December 2010
by Tremonti and Juncker. However, there is a need to understand the features and
the policy implications of the different proposals, including their differences, more
fully. To this end, let us first establish what a Eurobond solution should offer.
Boonstra3 has summarised this in five points. The introduction of Eurobonds could
contribute to the better functioning of EMU in different ways: 1) Market discipline:
the markets should be able to correctly discipline governments for good and bad
behavior, instead of acting very erratically as they did last year. However, some
authors doubt whether or not the markets are able to correctly discipline
governments. 2) Fiscal discipline: these bonds will have to contribute to
strengthening the enforcement of budgetary rules, i.e. those from the SGP. Some
authors believe that Eurobonds could also weaken fiscal discipline. 3) Speculation
deterrence: by guaranteeing stability of the Euro, the bonds should help to shelter
from speculation in financial markets. However, Blommestein4 concludes that there
is no solid empirical evidence against speculation (short-selling) and that it should

be banned. 4) Market stability: the market for government bonds will be larger and
more stable, sheltering from large swings in market sentiment. 5) Benefits for both
strong and weak Member States: this is very important politically, as a large
participation rate is vital for the Eurobond proposals to succeed. All proposals
discussed in this paper satisfy these demands, at least to some degree. In the next
section, the most important proposals will be analysed and discussed with their
advantages and disadvantages respectively.

OVERVIEW OF THE VARIOUS PROPOSALS FOR INTRODUCING EUROBONDS Favero

and Missale5 have summarised the most recent proposals for Eurobonds. They
conclude that the proposed Eurobonds can improve on liquidity and default risk over
sovereign debt, while these bonds also ensure continued market access for all
Member States. Moreover, they are able to protect against speculative attacks and
improve the position of the Euro as an international reserve currency. Concerning
economic governance, the bonds can lead to improved budget discipline, reduce the
probability of a bailout and, ultimately, lower costs for the taxpayer. However, the
realisation of these benefits hinges on credible cooperation and commitment, a high
enough participation rate and the credibility of fiscal discipline and the no-bailout
clause. Additionally, flexibility in debt management is reduced and set-up costs may
be very high. Let us now consider the various Eurobond proposals, and describe
their basic concepts and differentiating features (summarised in Table 1). The first
proposal for the introduction of Eurobonds has been made by Boonstra.6 It is also
one of the most detailed and analysed proposals. He proposes to move from
national to central financing for all public debt, thereby abolishing the possibility for
countries to separately raise debt on financial markets. A newly to be established
independent EMU fund will issue Eurobonds, and lend the funds raised to the
participating EMU countries at a premium over the Eurobond rate. This premium will
be based on deficit and debt deviations from the average levels of Germany and
France. Only countries performing worse than Germany and France will pay a
premium. The formula for this premium looks as follows: R(i) = a[O(i) - O(m)] +
b[S(i) - S(m)], where R(i) is the margin payable by country i over the funding costs
of the EMU fund, O(i) is the government deficit ratio of country i, S(i) is the
government debt ratio of country i, the variables O(m) and S(m) represent the
average for French and German government deficit and government debt, and the
parameters a and b are coefficients, used to determine the weight of the relative
performance. These coefficients have to be determined ex ante; see also below.
Figure 1 illustrates the hypothetical case where the EMU fund is introduced in 2000
and a and b are set to 0.25 and 0.02, respectively. The total premium over the EMU
fund rate is for Belgium, Italy, Portugal and Spain since the start of the financial
crisis in 2008 around 100 basis points or less. For the countries that were bailed out
by the EFSF Greece and Ireland the total premium spiked to respectively 300 and
700 basis points in 2009 and 2010 to decline to less than 200 basis points at the

beginning of 2011. It should be noticed that the total premium over the EMU fund
rate is very much depending on the setting of the parameters a and b.
This proposal is very straightforward, and has several advantages: average
borrowing costs will decrease, fiscal policy quality is reflected in interest rates, and
countries face a more gradual discipline from the EMU fund instead of that of erratic
financial markets. However, the proposal also has some strong requirements. First,
participating countries have to agree not to engage in monetary financing or
directly approach financial markets for funding. This behaviour, like defaulting on
the debt to the EMU fund, will be punishable by sanctions imposed by the fund.
Second, participation is voluntary. However, Boonstra argues that the large liquidity
and stability benefits of participating will ultimately convince all countries to
participate. When countries have decided voluntarily to participate, then they are
fully committed to the costs and benefits of the EMU fund. Additionally, not joining
this program will be a bad signal to financial markets, thereby increasing borrowing
costs. Finally, credibility of the EMU fund has to be very high, so as not to break with
the nobailout clause introduced by the Maastricht Treaty. This is also essential to
generate enough fiscal discipline. Some other issues with this proposal may be the
setting of the parameters and the base rate, and the practical and political
implementation; mainly the transition from the current regime to the new one.
Fortunately, many studies have looked into the first issue and as such we can draw
from this literature to set the values for the parameters7 . The practical
implementation will have to be dealt with in the political arena, in particular the
setting of the parameters. Notice that these parameters are also depending on the
enforcement of the revised SGP (automatic sanctions). The proposal by De Grauwe
and Moessen8 is formulated in a simpler and more modest way. They propose a
scheme in which an EU institution, i.e. the European Investment Bank (EIB), issues
Eurobonds.
The share of Member States in this scheme will be based on the EIB equity share,
and the coupon rate on these bonds is a weighted (by the same shares) average of
the yields in the national government bond market. Then, the proceeds from this
issue will be allocated to Member States in the same way. Finally, the participating
countries will pay the same rate as they pay on their own government bonds,
thereby eliminating free-riding possibilities. This proposal will guarantee funding for
all Member States, and safety for investors in these bonds, while there can be no
free-riding by weaker countries. However, it may also raise issues such as the
sharing of collective responsibilities, the possible existence of implicit guarantees by
stronger countries participating in the scheme (they will not want to let it break
down) and the determination of the yield to be paid, as national bond markets may
be distorted when Eurobonds are introduced. Furthermore, Delpla and von
Weizscker9 propose another variant of the Eurobond, in a scheme that is lies
between the abovementioned two proposals. Their proposal states that EU countries
should pool their debt to a maximum of 60% of GDP (the Maastricht limit), in so-

called 'blue bonds'. Beyond the 60% level, countries will have to go to the capital
market on their own, which will lead to higher borrowing costs. This part of the debt
is called the 'red debt'. This leads to a tranching of debt: the blue bonds will be
senior, more liquid (as they are pooled) and subject to lower default risk, while the
red bonds will be junior, illiquid and subject to the same default risk as before. As
the red debt carries higher costs, countries will have an incentive to consolidate
their budget as to bring their debt to below 60% of GDP. Several institutional details
will have to be arranged for. First, the distribution of gains and costs will have to be
stipulated, preferably on the basis of fiscal positions. This can for instance be
achieved by linking the blue bond quota to fiscal discipline, with a minimum of zero
and a maximum of 60% of GDP. Second, an agreement to not borrow on the side
has to be signed, to guarantee the credibility of the schemes discipline. Third, an
orderly and stable process for allocation of blue bonds has to be set up, preferable
in an independent body that can decide on the credibility the participating
countries fiscal policies. This also pertains to the no-bailout guarantees that have to
be built into this scheme: an orderly bankruptcy procedure has to be arranged for
countries defaulting on their red debt, so as to prevent another sovereign crisis.
Finally, the transition from the current situation to the blue/red bond system has to
be arranged. Delpla and von Weizscker propose a phasing out of national debt, by
letting blue and red bond issues replace national bonds. They state that a debt
restructuring is also possible if the scheme has to be implemented faster. As a final
point, the authors argue that countries have several incentives to participate. First,
the liquidity of a large part of their debt improves, leading to lower borrowing costs.
Second, countries with weak fiscal policies can use the scheme as a commitment
device for improving their budget. Finally, they state that strong countries do not
have to worry about having to pay for a bail-out anymore. However, this advantage
completely depends on the credibility of the set-up. A last proposal has come from
the political arena, and is a very practical approach to Eurobonds. Juncker and
Tremonti10 propose that an independent European Debt Agency (EDA), a successor
to the current stability fund, issues Eurobonds. It should finance up to 50% of EMU
member issues, to guarantee a deep and liquid market. Furthermore, the EDA
should offer a transition from national bonds to Eurobonds.

This transition should take place at a discount on national bonds (higher for
countries with weak budgets), to make the Eurobonds attractive for investors. This
will immediately force countries to improve deficits. The proposal again leads to
lower borrowing costs, shelter from market shocks and speculation, and reduction of
moral hazard through automatic fiscal discipline. Moreover, the authors argue that
taxpayers will not have to foot the bill, as the EDA will realise a profit from
converting national bonds at a discount. However, the proposal is quite ad hoc: the
set-up of an EDA is not discussed in detail, and no estimates of the discount or the

EDAs interest rate are given. More in-depth analysis is necessary to assess the
merits of this proposal.

Eurobonds:

Some Descriptive Statistics

1Borrowers
According to the BIS, in 1999, the total amount borrowed in the international
bond market was USD 1,152.7 billion. The major borrowers on the
international bond markets were industrial countries (93% of total amount
borrowed in 1999). The U.S. (39%), and the Euro area (40%) were by far the
XII.6 heaviest borrowers. The heaviest largest borrowers were financial

institutions, with a 51% share. The corporate sector issues and the public
sector governments and state agenciesissued 30% and 17% of the
international bond debt, respectively. Supranational corporations the World
Bank, European Investment Bank, Asian and African Development Banks, the
European Community-- had seen their participation substantially decreased
in the last 5 years: from 4.22% in 1995 to 2% in 1999.

2 Size and Instruments

Few investors would consider an investment strategy that systematically
excludes the fixed-income market from his or her portfolio. Yet, U.S. investors
routinely ignore non-USD bonds, which account for almost 70 % of the world
bond market.

TABLE
INTERNATIONAL BOND MARKETS
(Nominal Value of New Offerings (Net), Billions of U.S. Dollars, 1999)

Bond Market
USD
EUR area
JPY
GBP
CHF
Total
Source: BIS

Straight
430.4
291.4
-11.8
N.A
N.A
785.4

Floating
108.0
205.1
2.7
N.A
N.A
336.2

Equity- Related
5.5
24.7
0.8
N.A
N.A
31.1

Total
543.9
521.2
-8.3
79.1
4.0
1152.7

According to the BIS, governments and state agencies mainly borrow in the
straight (fixed) rate market (92%). Corporations also tend to borrow in the
straight rate market (74%). On the other hand, financial institutions have a
more balanced borrowing portfolio: 54% in the straight rate segment, and
44% in the floating rate segment

Bearer Bonds

Domestic bonds. They are issued locally by a domestic borrower and

are usually denominated in the local currency
Eurobonds. They are underwritten by a multinational syndicate of
banks and placed mainly in countries other than the one in whose

currency the bond is denominated. These bonds are not traded on a

specific national bond market.

(A) Domestic bonds.

Amoco Canada issues a bond in Canada for placement in the Canadian domestic
market, i.e., with investors resident in Canada. The issue is underwritten by a
syndicate of Canadian securities houses. The issue is denominated in the currency
of the intended investors, i.e., CAD.

(C) Eurobonds.
Amoco Canada, a foreign corporation, issues bonds, in a major international
financial center, to be placed internationally. The issue is underwritten by an
international syndicate of securities houses. The issue is denominated in any
currency, including even the currency of the borrower's country of incorporation,
i.e., CAD.

Foreign bonds issued on national markets have a long history. They often
have colorful names:
Yankee Bonds (in the U.S.), samurai bonds (in Japan), Rembrandt bonds (in
the Netherlands) and bulldog bonds (U.K.). Government regulations have
forced many international borrowers to leave foreign bond markets and
borrow instead in the Eurobond market. The Eurobond market has had a
fantastic growth during the past 30 years. At its inception, in the early 1960s,
the Eurobond market was mainly a Eurodollar bond market, that is, a market
for USD bonds issued outside the U.S. Today, the Eurobond market comprises
bonds denominated in all the major currencies and several minor currencies.
Together the foreign bond and Eurobond markets make up the international
bond market. As we will see below, Eurobonds are no different from domestic
or foreign bonds. The distinction between these markets is based on
technical and historical reasons

International Equity Markets

Firms are financed with both debt and equity. Although the debt markets have been the center of
activity in the international financial markets over the past three decades, there are signs that
international equity capital is becoming more popular. Transaction of a foreign borrower in a
domestic market in local currency is the predominant international equity activity. Foreign firms
often issue new shares in foreign markets and list their stock on major stock exchanges, such as
those in New York, Tokyo, or London. The purpose of foreign issues and listings is to expand the

investor base in the hope of gaining access to capital markets in which the demand for shares of
equity ownership is strong.
A foreign firm that wants to list its shares on an exchange in the United States does so through
American Depository Receipts (ADRs). These are the receipts to bank accounts that hold shares
of the foreign firms stock in that firms country. The equities are actually in a foreign currency,
so by holding them in a bank account and listing the receipt on the account on the American
exchanges, the shares can be revalued in dollars and redivided so that the price per share is more
typical of that of the U.S. equity markets ($20 to $60 per share frequently being the desired
range).
There was considerable growth in the 1990s in the euro-equity markets. A euro-equity issue is
the simultaneous sale of a firms shares in several different countries, with or without listing the
shares on an exchange in that country. The sales take place through investment banks. Once
issued, most euro equities are listed at least on the Stock Exchange Automated Quotation System
(SEAQ), the computer-screen quoting system of the International Stock Exchange (ISE)
inLondon.