1

Borivali Education Society

Matrushri Pushpaben Vinubhai Valia College of Commerce
M. K. School Complex, Factory Land, Borivali (w), Mumbai 400092.

A PROJECT
ON

Eurocurrency market

IN THE SUBJECT OF ECONOMICS OF GLOBAL TRADE & FINANCE

SUBMITTED TO
UNIVERSITY OF MUMBAI,
FOR SEMSTER II OF
MASTER OF COMMERCE (ACCOUNTANCY)
BY
BHAVYA P. SAVLA
ROLL NO: 112
UNDER THE GUIDANCE OF
PROFESSOR: V. MANIKANDAN

YEAR 2015-16

DECLARETION BY STUDENT

MR. BHAVYA P. SAVLA The student of M.com Part-I (2015-16) Roll No: 112 hereby
declare that the project for the strategic management titled.

Eurocurrency market

Submitted by me for semester-II during the academic year 2015-16 is based on actual
work carried out by me under the guidance and supervision of Professor V. Manikandan
I further stated that this work is original and not submitted anywhere else for the
examination.

Signature of Student.

EVALUATION CERTIFICATE
This is to certify that the undersigned have assessed and evaluated the project

Eurocurrency market

Submitted by Bhavya P. Savla Student of M.Com part I. This project is original and best of
our knowledge and has been accepted for internal assessment.

Prof. V Manikandan
Internal Examiner

Prof. V Manikandan
External Examiner

I/C PRINCIPAL

ACKNOWLEDGEMENT

It given me immense pleasure to present this project while I taking this opportunity to thank
all of them who helped me to prepare this project and timely guidance received which help
me greatly in the competition of the project.

I would acknowledge my deep sense of gratitude to Prof. V. Manikandan. For his kind cooperation in this project at all stages.His constant support, encouragement and guidance
without which the successful completion of this project would have been impossible.

I would like to thanks our respected principle, librarians and other teaching and non- teaching
staff for their corporation in this project.

Last but not least I would also like to thanks all our friends for their suggestions and valuable
help.

Once again I would like to thanks all those people who have helped me to complete this
project on time.

INDEX
SR
No.
1.

Eurocurrency Market

Page
No.
6-15

2.

Detailed Overview of Migration

16-34

3.

Case Study on Euro Currency Market

35-38

4.

Suggestions, Recommendations, And

Conclusion.

39-42

5.

Bibliography & References

43-45

Chapter Name

CHEPTER 1:- EUROCURRENCY MARKET

INTRODUCTION
One of the most controversial issues surrounding the development of Euro-currency
banking concerns the ability of Euro-markets to expand autonomously the stock of
money and credit outside the control of national authorities. The rapid expansion of
international banking aggregates, which have grown by around 25 per cent, per
annum, is said itself to provide evidence of monetary expansion in the Euro-markets.
A short-hand name frequently used to describe this process is the Euro-currency
credit or deposit multiplier.
Two important questions in this issue are: the ability of the Eurocurrency banking
system to expand because a proportion of the funds the banks lend out is redeposited
with them - endogenous money or credit creation and the Euro-currency multiplier
proper; and second, the role of the Euro-markets in increasing the credit-creating or
multiplier potential of the banking system as a whole, i.e. the domestic and
international banking systems combined. When these effects are large they are said
to undermine national monetary policies, in the first case because the monetary
expansion is beyond the direct control of domestic authorities (unlike, for example,
domestic bank deposits in Germany and the United States, Euro-currency deposits
are not subject to legally imposed reserve ratios or direct credit controls); in the
second, because the relationship between the domestic control variable - the supply
of domestic bank reserves - and the stock of money is weakened when deposits are
placed in the Euro-currency market.
This paper reviews the models that have been used to estimate and explain the size
of these "multiplier" effects, and their implications for the rate of expansion of the
Euro-market. Two distinct approaches have been adopted: one characterises the
depositing and redepositing process by fixed coefficients (discussed in Section I),
the other suggests that the size of any multiplier is variable and reflects general
portfolio considerations and interest rate adjustments (Section II). Both depend on
making "plausible" guesses at the likely size of the coefficients and interest rate
adjustments in order to estimate the size of the multiplier. As estimates are, however,

based on ex ante guesses without any ex post verification, the size of the monetary
influence of Euro-banking remains an untested hypothesis. Some new approaches
have therefore evolved to explain the growth and influence of the Euro-market in
terms of empirically observed "institutional" links between the Euro-markets and
national banking systems (Section III). These suggest that it is completely
inappropriate lo treat the Euro-market as a closed or autonomous banking system
and that the role of the Euro-markets in adding to the volume of credit can only he
seen in the context of the world financial system as a whole. The paper concludes
with a short summary of the main analytical conclusions.

Throughout, this paper, as with much of the literature on the subject, focuses on the
role of Euro-banks in intermediating between private non-banks rather than between
banks, although this latter activity is numerically the largest function of the Euromarket. The main issue of importance is the impact of the Euro-markets on the
liquidity of the non-banking sector and whether this is significantly increased by the
activities of Euro-banks outside the control of national authorities. By increasing the
flow of liquidity between national money markets, Euro-markets might enhance the
credit-creating ability of some national banking systems and thus the liquidity of the
non-banking sector. The channelling of funds to domestic commercial or central
banks may also provide balance-of-payments finance which can be used to sustain
the level of world activity. To that extent, Euromarkets will have larger expansionary
effects on the wealth and liquidity of private non-banks. But that is a separate issue
and may be regarded as being caught by national policies. These effects would,
however, be factors explaining any Euro-currency re-depositing multiplier. Another
issue which is briefly considered, because of its policy implications, is the role of
central-bank deposits in explaining the size of any Euro-currency multiplier.
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.

Eurocurrency market
Definition and background
The Eurocurrency market consists of banks (called Euro banks) 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 Euro Swiss franc
and the Euro DM 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.

10

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 co-managers 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.

11

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.
Interest rates in national and Eurocurrency markets are closely linked through
arbitrage.
US $ credit markets
US lending rate

Sterling credit markets

UK lending rate

Eurodollar lending rate

Eurosterling lending rate

Eurodollar deposit rate

Eurosterling deposit rate

US deposit rate

UK deposit rate

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

12

A.

Eurobond markets

Eurobonds are bonds sold outside the country whose currency they are dominated in.
They are similar in many ways to public debt sold in domestic capital markets.
However, the Eurobond market is entirely free of official regulation and is selfregulated by the Association of International Bond Dealers.
Borrowers in the Eurobond market are typically well known and have impeccable
credit ratings (for example, developed countries, international institutions, and large
MNCs). The Eurobond market has grown rapidly in the last two decades, and it
exceeds the Eurocurrency market in size.
i) Currency denomination
About 75 % of Eurobonds are dollar denominated. The most important nondollar
currencies for Eurobond issues are DM and FF (now rapidly replaced by the euro),
the JY and the BP [The Swiss central bank ban has led to the absence of SF
Eurobonds].
ii) Fixed rate Eurobonds
Fixed-rate Eurobonds pay coupons once a year, unlike the semiannual coupon,
domestic bonds in the US market. Borrowers compare the all-in cost, that is, the
effective interest rate, on Eurobonds and domestic bonds.
This interest rate is calculated as the discount rate that equates the present value of
the future interest and principal payments to the net proceeds received by the issuer,
or as the IRR of the bond.
iii) Comparing Eurobond issue with a US domestic issue
To compare a Eurobond issue with a US domestic issue, therefore, the all-in cost of
funds on an annual basis must be converted to a semiannual basis or vice versa.
Thus,
Semiannual yield = [1 + Annual yield]^0.5 1, and

(1)

Annual yield = [1 + Semiannual yield]^2 1.

(2)

13

Illustration II
P & G plans to issue a 5-year bond with a face value of $ 100 million.

Its

investment banker estimates that a Eurobond issue would have to bear a 7.5 %
coupon and that fees and other expenses will total $ 738,000 providing net proceeds
to P & G of $ 99,262,000.
Exhibit 1 shows the cashflows associated with the Eurobond issue. The all-in cost
(IRR) of this issue, which is an annual rate, is shown as 7.68 %. As a cross check,
the third column shows that the PV of the cashflows, using a discount rate of 7.68 %,
sum to P & G s net proceeds of $ 99,262,000.
Alternatively, P & G can issue a $ 100 million, 5-year bond in the US market with a
coupon of 7.4 %. With estimated issuance costs of $ 974,000, P & G will receive net
proceeds of $ 99,026,000.
Exhibit 2 shows the cashflows associated with this issue and its all-in cost (IRR) of
3.82 %. Note that the cashflows are semiannual, as is the all-in cost. Again, the
third column does a cross-check to confirm the 3.82 % all-in cost.
According to Equation (1) above, the equivalent semiannual all-in cost for the
Eurobond issue is (1.0768)^0.5 1 = 3.77 %. Thus, the all-in cost of the Eurobond
is lower, making it preferable if all other terms and conditions on the two bonds are
the same.
Alternatively, using Equation (2) above, we can convert the US bond yield to its
annual equivalent and compare that figure to the Eurobond yield of 7.68 %. This
computation would have yielded an annualized all-in cost of the US bond issue
equal to (1.0382)^2 1 = 7.78 %. As before, the Eurobnd issue is preferable
because its all-in cost is 10 basis points lower.

Eurocurrency market or Eurobond market

A MARKET based in Europe, comprising a web ofinternational banks and money br
okers, which is engaged in the borrowing and lending of FOREIGN
CURRENCIES such as US dollarsoutside their countries of origin, as a means of fin
ancing trade and investment transactions.

14

The main instrument used in the Eurocurrency market to finance long

term investment is the Eurobond, a form of fixed interest securitywhich is denominat
ed either in a single currency or is syndicated with a lead' bank arranging with other
banks a multi-currency loan package.
Depositors of funds in the Eurocurrency market include commercial banks, compani
es and central banks, while borrowers for the most partare industrial and financial co
mpanies, particularly MULTINATIONAL ENTERPRISES, who use Eurofinance du
ring times of domestic creditrestrictions and/or when domestic interest rates are high
in comparison with Eurocurrency rates. See LIBOR.
Eurocurrency market or Eurobond market
a market based primarily in Europe that is engaged in thelending and borrowing of
USDOLLARS and other major foreign currencies outside their countries of origin to
finance international trade andinvestment.
The main financial instrument used in the Eurocurrency market for long-term invest
ment purposes is the Eurobond (see BOND), a form offixed-interest security denomi
nated in a particular currency or currencies. Depositers in theEurocurrency market in
clude commercial banks,
industrial companies and central banks. Borrowers for the most part are companies t
hat have resorted to Eurofinance during times ofdomestic credit restrictions and/or w
hen domestic interest rates have been high in comparison to those prevailing in the E
urocurrencymarket. See FOREIGN EXCHANGE MARKET.

Objectives

To provide meaning full suggestions regarding Eurocurrency Market.

To understand Eurocurrency Market.
The aim of my project is to know why Eurocurrency Market is necessary.
To know wheather Eurocurrency market is really good or not.
And also it should be useful to others.

METHODOLOGY OF PROJECT.

15

There are two types of data,

Primary Data:- Questionary, Interviews, Etc.

Secondary Data:- Books, Magazines, Journals, Newspapers, Websites, Etc.
Since, I am undertaking these project for university purpose, and I am a college
going student, so collection of my data is secondary i.e through various books ,
magazines , newspapers , and various websites.

Importance of Project
It is important not only to me but also to the society as well as nation.

Limitation of Project.

Since, I am a college going student, and these project is for university purpose, review
of my project is very limited. I have very limited time and insufficient money, and
hence I have gather very limited data. And because of lack of time, financial crunch,
limited resources, etc , I could not survey much at a primary level.

16

CHEPTER 2:- OVERVIEW OF EUROCURRENCY MARKET

CHARACTERISTICS OF EURO-CURRENCY (OFFSHORE) MARKET:

1. Transactions in each currency take place outside the country of origin of that
currency.
2. Even though the transactions are recorded outside the country of issue, it continues
to be held in the country of issue. This is because a currency cannot be used for
settlement of commercial liability outside its domestic area. (The existence of the
foreign exchange market is based on this feature.)
3. Euro-Currency deposits and loans fall outside the regulatory and supervisory control
of the monitoring authority in the country of origin.
4.

Euro-Currency market is distinct from the foreign exchange market. It is a market

for deposits and for loans between banks and between banks and their customers. It
is a market in which foreign currencies are lent and borrowed whereas in the foreign
exchange market, foreign currencies are bought and sold. This market therefore
converts short term deposit resources into short and medium term loans for financing
projects. While the Euro- Currency market operates on interest rates, the foreign
exchange market operates on exchange rates.

5.

Due to absence of regulation, deposits in this market are unsecured. Due to this
deposits are received only on short term basis (max: one year) whereas loans are
demanded on medium to long term basis. This creates an asset-liability mismatch
which results in Euro-banks being exposed to both liquidity and interest rate risks.

6. To eliminate interest rate risk Euro-banks developed the credit roll-over concept
which involves resetting the interest rates on loans at fixed pre-decided intervals. To
achieve this loans/credits are provided on floating rates of interest. To ensure that
the Interest rates are reset on a fair and equitable basis the concept of reference
rates called LIBOR. (LIBOR London Interbank Offered Rate) was developed.
7.

Each Euro-Currency credit (loan) specifies the periodicity of the roll-over and the
LIBOR to which it is referenced. To provide a uniform profit margin for the lender a
MARKUP is specified over and above the LIBOR. The interest cost to the

17

borrower is therefore the applicable LIBOR + Mark-up. The mark-up normally

remains constant through the life-span of the loan.
8.

Financial assets and liabilities in a currency by way of deposits, loans and

instruments can be traded only in the domestic market of that currency. Such
markets are called the Domestic or Onshore markets. However in the case of freely
convertible currencies, it is possible to trade in assets and liabilities in such
currencies outside their home country. Such markets are called Euro-Currency or
Offshore markets. Consequently such markets deal only in freely convertible
currencies such as USD, GBP, EUR, JPY, CHF, CAD, AUD etc. The predominant
currency is USD.

9. It is essentially a wholesale market dealing only is standardised deposit amounts and

large volume Euro-credits involving substantial credit risk. Lending in this market is
therefore done on a Consortium basis, i.e. a syndicate of banks collectively finance
a project on uniform terms and conditions thereby distributing the risk among the
syndicate members.
10.

The Euro-Currency market can be broadly divided into 4 components:

(i)

Euro-Currency

deposit

market

involving

short

term

deposits.

(ii) Euro-Currency loan market (Euro-credits) involving syndicated loans.

(iii) Euro-Bond market in which Corporate entities issue debt instruments to raise
resources

from

investors

through

banks

operating

as

underwriters.

(iv) Euro-Notes market in which international borrowers raise resources directly

from the investors without using banks as intermediaries or any underwriting
support.

THE

COMPETITIVE

ADVANTAGES

OF

THE

EURO-CURRENCY

MARKET

As the alternative mechanisms of the domestic markets for credit creation and
capital movement, Euro-currency markets must have some competitive advantages.
The main reason of the continuing success of Euro-banking despite the relaxation of

18

regulation on US banks is that they are able to offer higher deposit rate and lower
loan rates than US banks, i.e. the interest rate spread is lower for Euro-banks than
US banks.
SL
Rate of
Interest

SL
SD

SD
D

DL
O
Volume Ooffofsit
SL: the loan supply of the domestic market;
SL: the loan supply of the Euro-currency market
SD: the deposits supply of the domestic market
SD: the deposits supply of the Euro-currency market
DL: the demand of deposits in the domestic market
AB: interest margin in the domestic market
CD: interest margin in the Euro-currency market

Figure 1

The lower Euro-banks interest margin can be accounted for the following factors:
First, Euro-banks, unlike the US banks have no official regulation. They are not
official imposed reserve requirement on banks foreign currency liabilities. Thus
Euro-banks do not need to hold reserve assets. This means they have a lessconstrained asset structure. For example, up until 1990 the Federal Reserve imposed
a 3 per cent reserve requirement on US banks so that for every $100 taken in only
$97 could be lent out; on an interest rate of 10 per cent this amounted to a need to
charge 10.31 per cent to cover the cost of the reserves.
Second, the economies of scale derived in international business, the more
competitive structure of the Euro-currency market. For the size of the Euro-bank

19

deposits and loans is much greater than that of the domestic banks, the cost involved
with per unit dollar deposit and loan transaction is much lower than that of the
domestic banks.
Third, the Euro-banks have a low entry standard which makes the Euro banking
business very competitive. Compared with the Euro-banks, due to the official
regulation and reserve requirement imposed from the central bank, the domestic
banks have more to do to cover the high operation cost and transaction cost.
Fourth, unlike the domestic banks which need to pay the deposit insurance to make
sure their savings are safe and thus eliminate the bank panics, the Euro-banks have
not to do so.
Finally, in the domestic banking business, the domestic banks may have low quantity
customers just like the ordinary savings and deposits from the residents. But since
Euro-currency market is a wholesale market, the Euro-banks only based on the high
quantity customers which means that they can charge a lower risk premium than the
domestic banks do.

THE ECONOMIC SIGNIFICANCE OF THE EURO-CURRENCY MARKET

Due to the competitive advantages, the Euro-currency market is more efficient than
the domestic banking systems. Thus the significant effects of the Euro-currency
market in the modern banking business can be described in three aspects:
First, the Euro-Currency market has the advantages which guarantee its ability to
add to the total volume of the world credit. This marvelous contribution can be
described from the basic operating mechanics of the market. Assume a company A
has a 10 million dollar deposits at a bank in New York and decides to transfer its
dollar deposits to a Euro bank B in London. Thus the balance sheet changes will be
shown in the following table:

Liabilitie

Assets

s
+10m

+10m

20

Net

+10m

+10m

change

However the Euro bank B will not hold that deposits in London but in that bank in
New York. Therefore at this point there is no direct effect on the U.S. money supply
or volume of the bank deposits since only the ownership of the deposits has been
changed in the transaction. However it has increase the total volume of the world
deposits as the U.S. bank has not lost deposits but the Euro bank has gain a deposit
of 10 million dollars which increase the lending capacity of the Euro bank. Then
Euro bank B has to find the customer to lend the deposit for gaining profit from the
differential between the loan-deposit interest rates. Suppose the Euro bank B lends
the deposits on the inter bank market to the Euro bank C. The balance sheet of bank
C is just the same as depicted in the above table and since the bank C will also hold
its dollar deposit in the U.S. bank. Thus the total dollar deposits in the world have no
changes but the ownership does. Continuing bank C has to seek to lend the deposit
and by chance a company in France will borrow the deposits and sell it spot for
French francs and the Banque de France will buy the dollar in order to prevent
upward appreciation of the Francs. The Banque de France will hold the dollar
deposits in the U.S. banks. If the Banque de France deposits in the euro-currency
market the process will repeated and the multiple creation of the euro market credit
will occur.
The key in this case is that the total volume of the world credit increases as the
transfer of funds from U.S. to the euro-dollar market that improve the lending
capacity of the euro banks without reducing that of the U.S. banking system. It also
implies increased velocity of the money. Another essential point is that the dollar has
never leave the United States. Moreover in this case, there is a rise in the foreign
exchange reserves of the Banque de France which results the rise in the highpowered money and the money supply in France.
Thus, the euro currency market must have some competitive advantages that enable
the euro market to provide the credit that would not be given by the domestic
institutions. Considering this issue, it is suitable to use the analytic framework when
discussing the non-bank financial intermediation in two aspects. One is that the

21

Euro-currency market in the domestic bank deposits in that Euro-market transactions

involve changes only in the ownership but not the total volume of bank deposits.
When the transactions happen, though the ownership of the deposits has changed but
the dollar deposits have never leave the U.S. banking system. This is similar to
NBFIs within a country who are lending and borrowing bank deposits. They have
borrowed money from the banks but they also hold the deposits in their banking
account, That is to say the money has never leave the banking system. The other
aspect is to say that Euro banks have increased their lending capacity of the credit
thus the total volume of the world credit has increased. This is quite the same as the
NBFIs.
Thus the methodology in analyzing the Euro-currency market is that of non-bank
financial intermediation. Basically the same as the NBFIs, if any of the following
conditions is fulfilled, the credit generated within the Euro-currency market adds to
the total volume of credit:
(1) The internal efficiency enables Euro currency market to serve a small margin. As
analyzed in Figure 1, the competitive advantages give the Euro banks ability to serve
a lower lending interest rate than domestic banks can. Since the demand of the credit
is sensitive to the lower lending interest rates charged by the euro banks compared
with lending rate in national banking systems, the lending capacity of the euro banks
is more powerful than that of the domestic banks.
(2) The competitive advantages of the euro banks forces domestic banks lending interest
rates to be lower. Thus again the case in that the demand of credit will be sensitive to
the lower lending interest rates which undoubtedly will increase the total volume of
the world credit.
(3) Resulting from the case discussed before, in general, borrowing from the eurocurrency market, with the funds switch to some other currency, leads a rise the
external component of high-powered money through central bank foreign exchanged
market

intervention.

Thus

because

of

the

interventionbuying

dollar

deposits/selling the domestic currency, the money supply of the central bank will
increase and also the high-powered money. Therefore banks will receive more
deposits which will raise the lending capacity of the domestic banks. And the total
volume of the credit in that country will increase.

22

(4) Identically, if the U.S. residents are facing an excess demand of credit which will
drive up the lending interest rates, they will excess into the euro currency market to
borrow the money for the lower lending interest rates compared with the domestic
banks. Also, if the U.S. residents face another situation of the higher credit
worthyness criteria which means they encounter a high requirement for the
borrowing, they will borrow in the euro currency market.
(5) Actually due to the competitive pressure, Euro banks create a demand of credit that
otherwise will not occur. This is the case in early 1970s, the euro banks were
inducing developing countries to borrow in the euro currency markets on a larger
scale than they had initially planed.
(6) The volume of the world credit will increase to the extent that capital flows through
the euro markets from countries where the banking system has an excess demand of
funds to those having excess supply of the money. This is to say that without the role
euro currency market as the intermediation, the credit effect of increasing the total
volume of the world credit will not exist.
Moreover, Euro-currency market increases the arbitrage opportunity. Normally,
arbitrage involves in two different currencies, for instance, one investor may
arbitrage between sterling and dollar. However, the existence of Euro-currency
market changes this situation. The arbitrage between two different currencies is only
one possibility. The reason for that is after the emergence of the Euro-currency
market; there may be two dollar markets in which one is the dollar deposits in
Untied States and the market of Euro dollars in London. Thus the arbitrage can
happen between the US dollars and the London dollars. This is to say arbitrage may
not always involve in different currencies, but it may involve in the same currency
between two different locations. Also for example, there are Euro-dollar market,
Euro-sterling market, Euro-frank market and Euro-yen market in London. This add
an another arbitrage possibilityarbitrage between different currencies in the
same location.
Thirdly, the Euro-currency market is an important mechanism that banks protect
themselves by acting as a market maker in forward exchange market. As a market
maker in forwards, banks involve themselves in the forward exchange risk. However
the reason for that is they can protect themselves through the Euro-currency market

23

operations. For instance, suppose a corporation A wants to sell a Japanese Yen

forward to the bank, in another word, a bank had to purchase a forward of Japanese
Yen of three months and promise to give dollars at a fixed price agreed today, the
banks thus immediately face an exchange rate risk in case Japanese Yen are going to
be appreciated in three months. To avoid such risk, the bank then does the following
transactions: firstly, it borrows Japanese Yen in the Euro-yen market at an interest
rate of 5%, Then it sell Japanese Yen spot for dollars. Finally, it invests these dollars
to euro-dollar market at, say at a rate of 7%. By making the above transactions, the
bank has a totally balanced and riskless position in forward exchange markets.
Finally, due to their worldwide locations and national origin, the Euro-banks always
engaged in a more wide range of banking business with the counterparties such as
the government, financial institutions and private investors. Without the constraints
in the regulation and credit wothyness criteria, the Euro-banks can allocate their
funds more productively and more efficient compared with the domestic banks. This
may create a fruitful profit for the Euro-banks in doing the modern banking business
and may involve in some special loans for the special purpose.

WHAT IS THE EURO-CURRENCY MARKET AND THE GROWTH OF

THE EURO-CURRENCY MARKET
The Bank for International Settlements (hereafter BIS) 20 years ago defined a Eurodollar as: a dollar that has been acquired by a bank outside the United States and
used directly or after conversion into another currency for lending to a non-bank
customer, perhaps after one or more redeposits from one bank to another. 1
Basically, Euro-currency market is a market in interest-bearing bank deposits
dominated in currencies other than the domestic currency of the bank involved 2. It is
a banking market which involves borrowing and lending conducted outside the legal
jurisdiction of the authorities of the currency that is used. It has two sides to it: the
receipt of the deposits and the loaning out of these deposits. For instance, the Eurodollar deposits are dollar deposits held in London and Paris; Euro-yen loans are yen
loans lent to Germany or Switzerland from British banks. By far the most important
Euro-currency is the Euro-dollar, which currently accounts for approximately 65-70
per cent of all Euro-currency activities, followed by the Euro-mark, Euro-franks

24

(swiss), Euro-sterling and Euro-yen. The use of the prefix Euro is somewhat
misleading because dollar deposits held by banks in Hong Kong or Tokyo are
equally outside the legal jurisdiction of the US authorities and also constitute Eurodollar deposits. This more widespread geographical base means that Euro currency
markets are often referred to offshore markets.
The initial boost of the Euro-currency market trace back to the summer of 1957 with
the sterling crisis: the Bank of England reimposed restriction of sterling financing of
the non UK trade. Because UK banks can not use sterling for external purpose, they
resorted to using dollars for their external operations. And the deficit on the US
balance of payments emerged in the late 1950s resulted in increased foreign holdings
of dollars. By mid-1958, a European market in dollar deposits and loans had
become established.3 There are other causal factors that induce the development of
the Euro-currency market, such as monetary policy and capital control in the US; the
breakdown of the Bretton Woods and the floating of the Exchange rates; recycling
and the international debt crisis and the interbank market and the financial
innovation.

EUROCURRENCIES
The Eurocurrency market is an important source of debt available to the MNE. A
Eurocurrency is any currency that is banked outside of its country of origin.
Eurodollars, which constitute a fairly consistent 65-80 percent of the market, are
dollars banked outside of the United States. Dollars held by foreigners on deposit in
the United States are not Eurodollars, but dollars held at branches of U.S. or other
banks outside of the United States are Eurodollars. Similar markets exist for EuroJapanese yen (Euro-Yen), Euro-German marks (Euro-Deutsche marks), and other
currencies,

such

as

British

pounds,

Swiss

francs,

and

French

francs.

The Eurocurrency market is worldwide. Large transactions take place in Asia (Hong
Kong and Singapore), the Caribbean (the Bahamas and the Cayman Islands), and
Canada, as well as in London and other European centers. However, London is the
key center for the Eurocurrency market, given that nearly 20 percent of all
Eurocurrency transactions in 1989 took place in London. Luxembourg is the center
for Euro-Deutsche mark deposits, with Brussels and Paris the centers for Euro-

25

Sterling

deposits.

The major sources of Eurodollars are:

(1) Foreign governments or individuals who want to hold dollars outside of the
United States.
(2) Multinational corporations with cash in excess of current needs.
(3) European banks with foreign currency in excess of current needs; and
(4) The reserves of countries such as Japan, Taiwan, and Germany that have large
balance-of-trade Surpluses.
The

demand

for

Eurocurrencies

comes

from

individuals,

firms,

and

governments that require funds for operating capital, investment, and the
payment of principal and interest on debt. Eurocurrencies exist partly for the
convenience and security of the user and partly because of the cheaper lending rates for the borrower and better yield for the lender. The security issue
arose because some governments feared currency controls in the United
States and decided that they wanted to, hold their U.S. dollars offshore.
Eurocurrency Expansion
The key to Eurocurrency expansion is the fractional reserve concept. The
total size of the Eurocurrency market is much greater than the actual cash
deposited. Once a Eurocurrency (assume dollar) deposit is made in a London bank,
the bank may use that asset as a basis for making a dollar-denominated loan to
someone else. The fraction of the original deposit not loaned out is called the
fractional reserve. Since there are no reserve requirements on Eurocurrency deposits,
it is up to the individual bank to determine how much protection it requires in the
form of reserves. The expansion occurs when the initial loan is spent, deposited in
another bank, or used as a basis for another loan.

Even though there are no specific Eurocurrency controls, banks are subject to
solvency rules, and Eurocurrency assets and liabilities are a part of the overall assets
and liabilities of the bank that are subject to capital ratios and capital provisions. In

26

some cases, such as in Britain with the Bank of England, liquidity is monitored very
closely; a Central Bank can issue more of its own currency to ease a liquidity crisis,
but it would be hampered by a liquidity crisis caused by another currency.
Market Size
The size of the market is difficult to determine and depends on whether the gross or
net size is being discussed (the net size eliminates transfers between banks). Gross
liabilities usually are just over twice the net size of the market. In 1971 the total
gross Eurocurrency market size was about $150 billion. As Fig Q , shows, the
market grew to $4,561 trillion by March 1988. It was
Estimated that the market reached $6.1 trillion by September 1989.6 Figure 9.2
illustrates that the dollar portion of the Eurocurrency market has remained over 70
percent for most of the past decade, although the importance of the dollar has
diminished in recent years, especially as the dollar has fallen in value. By 1988 the
dollar portion had slipped to less than 70 percent. As the dollar rises in value,
however, the dollar portion of Eurocurrencies will also rise.

THE EURO-CURRENCY MARKET IN EUROPE AND ITS ROLE

Today, the ECU also serves as a reserve asset. Each EMS member transferred twenty
percent of its gold and dollar reserves to the European Monetary Cooperation Fund
and has received ecus in exchange. The ecus are used for settling debts that arise as
the result of intervention (Solomon, 1981, p. 296).
While EMS has served the European economic community with some satisfaction,
conflicting interests are struggling for currency power as Europe marches towards a
Common Market (Miller, 1988, p. 59). Britain's reluctance to actively participate in
the EMS reflects its desire to remain the center of European currency trading. Cities
such as Paris, Luxembourg and Brussels are all vying for this position while West
Germany continues to dominate the EMS with its strong deutschemark.
The creation of the EMS, however, has meant that over the past ten years there has
been a monetary zone with relatively fixed and stable exchange rates (Seipp, 1989,
p. 302). As a result, it has attracted countries outside of its present members. De

27

facto, Austria and Switzerland have joined the system and it is believed that the
Scandinavian countries will follow. Experts believe that eventually Britain will
succumb to the pressure to participate in the exchange rate: "Otherwise, it would
find itself left out in the cold, even though it is Europe's leading financial center"
(Seipp, 1989, p. 302).
The trend now is for the EMS to be extended, with the ultimate goal one of setting
up a European central bank system comparable to the Federal Reserve in the United
States. Europe appears headed in this direction though there is nothing in the C
market enabling legislation that actually specifies a common currency to replace the
peso, mark, pound sterling, franc and lira (Brimelow, 1990, p. 88). However, plans
for one are being considered.
Such a move would happen in stages. Excluding the pound, most European
Community currencies already are held fairl the euro-currency market in Europe and
its role
Y steady to each other thanks to the EMS. "Over time, this relationship is to become
tighter, central banks will coordinate policy more, and eventually both currencies
and central banks will merge-one currency, one central bank" (Brimelow, 1990,
p.88).
Under EMS, most European currencies are tied to the deutschemark. And,
traditionally West Germany's Bundesbank is the most sensitive to inflation of any
central bank in Europe. Therefore, leaders in other countries have always been able
to blame Germany for imposing monetary discipline on then (Brimelow, 1990, p.
88). However, they have also found this discipline hampering to their freedom of
action in manipulating their domestic economies. For instance, in France, inflation
remains high because the franc is generally thought to be fixed too high relative to
the deutschemark (Brimelow, 1990, p. 88).
Under the new plan of merging central banks, the French and others will got to use
some influence in establishing monetary rates. This possibility has the Germans
somewhat nervous. Though publicly supportive, there are signs they would be
reluctant to entrust their monetary fate to those less committed to sound fiscal

28

practices. Indeed, it is for this reason that Switzerland has said it will not join its
franc in a common European currency even if invited.
Bowing to pressure, Prime Minister Margaret Thatcher finally has said Britain
would join this "exchange rate mechanism" on three conditions: When Britain's
inflation rate fell.

Eurocurrency Spreads
A number of fundamental factors explain the smaller spread in the Eurocurrency
markets.
1. Operations: It is a wholesale market; It typically operates in units of $1 million; It
services large and well-known clients; All these lead to low overhead cost.
2. Regulations: No deposit insurance; Market interest on voluntary reserves; tax
incentives.
3. Asset-liability management: Clients are known with high-quality credits smaller
default risk; Floating rate interest + maturity matching reduced interest rate risk; No
prepayment risk.

ASSET RETURN DYNAMICS BEFORE AND AFTER THE EURO: THE

IMPACT ON STOCK AND BOND MARKETS
In this section we propose a set of measures to assess the effects of the euro on bond
and stock markets. Following Cappiello, Grard, Kadareja and Manganelli
(henceforth CGKM) (2005), we first show how measures of co-movement can be
linked to the degree of financial integration. We then propose two measures of
comovement: (i) a time-varying GARCH-type correlation and (ii) a regression
quantile based codependence measure. The two approaches are robust to the wellknow heteroskedasticity problem that plagues nave correlation measures (see, for
instance, Forbes and Rigobon, 2002). The two methodologies are complementary in
the sense that GARCH-based measures provide a high-frequency picture of the

29

correlation evolution, while with the measures based on regression quantiles we can
analyse changes in correlations over the long run. Finally, through a simple visual
inspection, we also check whether the euro had any major effect on equity and bond
markets volatilities.
IMPACT OF THE EURO ON TERM PREMIA
Applying an LR test to check whether the estimated market-price-of-risk parameters
have changed after the introduction of the euro reveals that not only the macro
parameters are statistically different in the two sub-samples, but also the parameters
that determine how risk factors are priced in the term structure are significantly
different before and after the euro.13 Hence, it would seem that the behaviour of
term premia is different now compared to before the introduction of the euro, and
that this is due partly to changes in the dynamics of the macro state variables, and
partly to changes in the way the market requires compensation for bearing risk
associated with these macro factors.
However, it turns out that, despite these significant changes to the estimates, average
premia are virtually identical before and after the euro introduction. shows the term
structure of average yield premia during the pre-euro period (1975-1998) and during
the euro period (1999-2004). The yield premium can be viewed as the component of
zero-coupon bond yields that are not due to expectations of future interest rates - i.e.
the difference between observed yields and the yields that would prevail if the
expectations hypothesis of the term structure of interest rates were to hold; provides
a definition based on the HTV model. The third curve in, labelled "reprojected",
shows the impact of changes to the price of risk parameters by displaying the
counterfactual average yield premia that would be obtained during the euro period if
macro dynamics were allowed to differ from the pre-euro period, but if, at the same
time, the market price of risk parameters (0 and 1) were held constant at the
estimated pre-euro values. It is clear from the figure that the price of risk parameters
have adjusted in such a way that they offset the (average) effect of the changed
macro dynamics.
The Eurocurrency Market

30

A eurocurrency is

any

currency

banked

outside

of

its

country

of

origin. Eurodollars, which account for about two-thirds of all eurocurrencies, are
dollars banked outside of the United States. Other important eurocurrencies include
the euro-yen, the euro-deutsche mark, the euro-franc, and the euro-pound. The
term eurocurrency is actually a misnomer because a eurocurrency can be created
anywhere in the world; the persistent euro- prefix reflects the European origin of the
market. As we shall see, the eurocurrency market is an important, relatively low-cost
source of funds for international businesses.
Genesis and Growth of the Market
The eurocurrency market was born in the mid-1950s when Eastern European holders
of dollars, including the former Soviet Union, were afraid to deposit their holdings
of dollars in the United States lest they be seized by the US government to settle US
residents' claims against business losses resulting from the Communist takeover of
Eastern Europe. These countries deposited many of their dollar holdings in Europe,
particularly in London. Additional dollar deposits came from various Western
European central banks and from companies that earned dollars by exporting to the
United States. These two groups deposited their dollars in London banks, rather than
US banks, because they were able to earn a higher rate of interest (which will be
explained).
The eurocurrency market received a major push in 1957 when the British
government prohibited British banks from lending British pounds to finance nonBritish trade, a business that had been very profitable for British banks. British
banks began financing the same trade by attracting dollar deposits and lending
dollars to companies engaged in international trade and investment. Because of this
historical event, London became, and has remained, the leading center of
eurocurrency trading.
The eurocurrency market received another push in the 1960s when the US
government enacted regulations that discouraged US banks from lending to non-US
residents. Would-be dollar borrowers outside the United States found it increasingly
difficult to borrow dollars in the United States to finance international trade, so they
turned to the eurodollar market to obtain the necessary dollar funds.

31

The US government changed its policies after the 1973 collapse of the Bretton
Woods system (see Chapter 10), removing an important impetus to the growth of the
eurocurrency market. However, another political event, the oil price increases
engineered by OPEC in the 1973 - 74 and 1979 - 80 periods, gave the market
another big shove. As a result of the oil price increases, the Arab members of OPEC
accumulated huge amounts of dollars. They were afraid to place their money in US
banks or their European branches, lest the US government attempt to confiscate
them. (Iranian assets in US banks and their European branches were frozen by
President Carter in 1979 after Americans were taken hostage at the US embassy in
Tehran; their fear was not unfounded.) Instead, these countries deposited their
dollars with banks in London, further increasing the supply of eurodollars.
Although these various political events contributed to the growth of the
eurocurrency market, they alone were not responsible for it. The market grew
because it offered real financial advantages--initially to those who wanted to deposit
dollars or borrow dollars and later to those who wanted to deposit and borrow other
currencies. We now look at the source of these financial advantages.

Attractions of the Eurocurrency Market

The main factor that makes the eurocurrency market so attractive to both depositors
and borrowers is its lack of government regulation. This allows banks to offer higher
interest rates on eurocurrency deposits than on deposits made in the home currency,
making eurocurrency deposits attractive to those who have cash to deposit. The lack
of regulation also allows banks to charge borrowers a lower interest rate for
eurocurrency borrowings than for borrowings in the home currency, making
eurocurrency loans attractive for those who want to borrow money. In other words,
the spread between the eurocurrency deposit rate and the eurocurrency lending rate
is less than the spread between the domestic deposit and lending rates. To understand
why this is so, we must examine how government regulations raise the costs of
domestic banking.

32

Domestic currency deposits are regulated in all industrialized

Interest Rate Spreads in Domestic and Eurocurrency Markets

branches of US banks subject to US reserve requirement regulations, provided those

deposits are payable only outside the United States. This gives eurobanks a
competitive advantage.
For example, suppose a bank based in New York faces a 10 percent reserve
requirement. According to this requirement, if the bank receives a $100 deposit, it
can lend out no more than $90 of that and it must place the remaining $10 in a noninterest-bearing account at a Federal Reserve bank. Suppose the bank has annual
operating costs of $1 per $100 of deposits and that it charges 10 percent interest on
loans. The highest interest the New York bank can offer its depositors and still cover
its costs is 8 percent per year. Thus, the bank pays the owner of the $100 deposit
(0.08 * $100 =) $8, earns (0.10 * $90 =) $9 on the fraction of the deposit it is
allowed to lend, and just covers its operating costs.
In contrast, a eurobank can offer a higher interest rate on dollar deposits and still
cover its costs. The eurobank, with no reserve requirements regarding dollar
deposits, can lend out all of a $100 deposit. Therefore, it can earn 0.10 * $100 = $10
at a loan rate of 10 percent. If the eurobank has the same operating costs as the New
York bank ($1 per $100 deposit), it can pay its depositors an interest rate of 9
percent, a full percentage point higher than that paid by the New York bank, and still
cover its costs. That is, it can pay out 0.09 * $100 = $9 to its depositor, receive $10
from the borrower, and be left with $1 to cover operating costs. Alternatively, the

33

eurobank might pay the depositor 8.5 percent (which is still above the rate paid by
the New York bank), charge borrowers 9.5 percent (still less than the New York bank
charges), and cover its operating costs even better. Thus, the eurobank has a
competitive advantage vis--vis the New York bank in both its deposit rate and its
loan rate.
Clearly, there are very strong financial motivations for companies to use the
eurocurrency market. By doing so, they receive a higher interest rate on deposits and
pay less for loans. Given this, the surprising thing is not that the euromarket has
grown rapidly but that it hasn't grown even faster. Why do any depositors hold
deposits in their home currency when they could get better yields in the
eurocurrency market?
Drawbacks of the Eurocurrency Market
The eurocurrency market has two drawbacks. First, when depositors use a regulated
banking system, they know that the probability of a bank failure that would cause
them to lose their deposits is very low. Regulation maintains the liquidity of the
banking system. In an unregulated system such as the eurocurrency market, the
probability of a bank failure that would cause depositors to lose their money is
greater (although in absolute terms, still low). Thus, the lower interest rate received
on home-country deposits reflects the costs of insuring against bank failure. Some
depositors are more comfortable with the security of such a system and are willing to
pay the price.
Second, borrowing funds internationally can expose a company to foreign exchange
risk. For example, consider a US company that uses the eurocurrency market to
borrow euro-pounds--perhaps because it can pay a lower interest rate on euro-pound
loans than on dollar loans. Imagine, however, that the British pound subsequently
appreciates against the dollar. This would increase the dollar cost of repaying the
euro-pound loan and thus the company's cost of capital. This possibility can be
insured against by using the forward exchange market (as we saw in Chapter 9) but
the forward exchange market does not offer perfect insurance. Consequently, many
companies borrow funds in their domestic currency to avoid foreign exchange risk,
even though the eurocurrency markets may offer more attractive interest rates.

34

CHEPTER 3:- CASE STUDY OF EUROCURRENCY MARKET

Case study

A Day in the Life

by Professor Ian H. Giddy
New York University

Life goes on in the international bond market, according to the attached example of
the daily report on the primary market as reported in the London Financial Times.
But how many of the bonds that were brought to market on this day September 2001

35

were ordinary, "plain vanilla" deals? Examine each of the issues, taking into account
any associated commentary and footnotes, and try to identify in each case (1) what
the investor is getting, (2) the effective cost to the issuer, and (3) what the
underwriting banks are getting. Pay particular attention to reasons for the differences
in coupons between different issues. Which of these deals would you describe as
"structured financing," and why?

Eurobond Market Buoyed by Asset-Backed and Targeted Deals

LONDON. THE PRIMARY MARKET was busy yesterday as several specially
structured issues were placed and a quarter-billion deal backed by cellular phone
receivables met a warm reception in a cold climate.
The latter was a $250 million issue brought by JP Morgan Chase SSB for Los
Angeles-based Celworks Trust 2001-1, a special purpose vehicle for the
securitization of receivables for cellular telephones serviced by Cellular Network
Inc. The issue had been extensively marketed by a large syndicate of banks in
Europe and in Asia.
Demand was heavy, with traders reporting strong speculative interest from investors
who believed the deal would see even stronger interest in Japan. As a result the
spread tightened to Treasuries. JP Morgan set the offer price at 99.80, giving a
spread over US Treasuries of 68 basis points. (At launch time the benchmark 7-year
Treasury note was yielding 4.625%.)
Having been fully placed, the issue was quickly freed to trade and rose to 99.85 bid.
The issuer was said to have swapped half the proceeds into floating rate US dollars
to achieve an attractive sub-Libor funding rate.
The Eurobond market also managed to absorb a $200m Japanese warrant deal, one
of the largest of its kind since the plunge of the Tokyo stock market. Nomura, the
lead manager, reportedly placed the bulk of the deal back in Japan.

36

Merrill Lynch brought a $100 million convertible deal for Battle Mountaingold to a
lukewarm reception given today's weakness in the price of gold. The borrower is a
US gold producer with interests in Australia and Papua New Guinea.
The par-priced bond were trading at 99 1/8 bid among fair demand from Swiss
institutions and gold funds based in France. A Merrill official said that the paper was
one of the few gold instruments that carried a good yield in addition to upside
potential.
Credit Suisse First Boston was the lead manager of a 150m three-year bond
for Holderbank Inc., the Swiss cement concern. The bonds offered a 6 1/8 per cent
coupon, and were snapped up by eager Swiss investors.
CSFB was quoting the paper at 100 1/8 bid before the European governments
market backed off, when the price moved to 99 7/8 bid, still very comfortably inside
the 0.22 per cent full underwriting fees. Traders opined that the terms were very
generous, and speculated that Holderbank might even have been able to borrow the
funds more cheaply by going direct to the banks for a loan. "It's a gift," said one
official.
Also in the Euro sector, Credit Commercial de France was the lead manager of a
fungible 750m deal for SNCF, the state railway authority. Combined with the
already outstanding 2bn of bonds, the deal produced the largest recent Eurodenominated issue on the Eurobond market.
The new paper gave little away to investors, with pricing at 37 basis points over
French Governments putting it in line with the trading level of the outstanding
bonds. CCF said that the issue was trading slightly outside fees, at less 1/8 bid.
Cofiroute, a French road management company that builds and maintains
motorways, issued a 300m 15-year bond priced at 38 basis points over swaps. The
company is rated AA- and draws its revenues from motorway tolls. With such
issuers "you always know what your cash-flow is going to be," said a spokesman for
BNP Paribas, a lead manager in the deal. "It is a safe but unusual name in the market
and it attracted a lot of French pension funds and insurance companies." Only 20%

37

was sold outside France. BNP Paribas is also marketing a dual currency deal from
Schlumberger, an oil drilling equipment company. The deal would comprise 1.4bn
and GBP500m and could come to the market as early as next week.
An unusual 100mn kroon deal for Tallinn-based Hansabank traded around full fees,
and was in demand from German as well as French funds. Proceeds were swapped
into floating-rate US dollars. The Estonian kroon is linked to the Euro.
In a new product aimed at high net worth Asian investors and institutions, Credit
Agricole Indosuez and Momentum, the US-based fund house, have teamed up to
launch a capital-guaranteed note tied to hedge fund performance. This structured
note assures investors 100 percent of the initial investment at maturity, plus an
option on a selection of Momentum's fund of hedge funds.
Fuqua Industries, a US consumer products group, announced in Switzerland a partial
buy-back offer on its Sfr100m 6 per cent deal issued by UBS Warburg in 1999. The
borrower said it is willing to buy up to Sfr30m of the deal at 82 per cent plus accrued
interest. Before the offer, which is open until tomorrow, the paper was trading at
around 76 points.

NEW INTERNATIONAL BOND ISSUES

September 2001

Borrower

Amou
nt m.

Coupo
Price
n%

Moodys/S&
Maturit
P
Fees
y
Ratings

Bookrunn
er

Celworks
Trust
2001-1 (a)

US$25
0

4 3/8

99.80

Mar
2008

Aaa/AAA

0.30

Salomon

Marui
Corp*

US$20
0

3/8

100

Sep
2005

A3/A-

1.75

Nomura

5 1/2

100

Sep

Ba2/BB-

2.12

Merrill

Battle
US$10
Mountaingol

38

2016

Lynch

ING
BaringsBBL

Aa3/AA-

0.22

CSFB

ING Groep
600
NV (S)

6 1/2

100

Holderban
k

150

6.125

100.12 Dec
5
2004

SNCF (b,c) 750

4 1/2

98.55

Nov
2007

Aa1/AAA

0.07

CCF

Cofiroute

300

5.875

99.11R

Oct
2016

-/AA-

0.40

BNP
Paribas

Hansabank

EEK10
7.625
0

101
3/8

Sep
2004

Aa2/AA

0.35

Deutsche

100
3/4

Mar
2003

-/-

0.75

CAI,
HSBC

C. Agricole
Indosuez
A$15
(d)

Undated A1/A

Final terms. *With equity warrants. **Convertible. ***Private

placement. (a) Callable at par after 5 years. If call not exercised, bond
pays 50bp over Libor in last year. (b) Fungible with 2bn. (c) Long
first coupon. (d) Redemption linked to hedge fund performance.
Unlisted. (S) Subordinated.

CHEPTER 4:- CONCLUSION

CONCLUSION
The currency markets are the largest and most actively traded financial markets in the
world with daily trading volume of more than $3 trillion (Triennial Central Bank
Survey 2007).
Each transaction in the currency market involves two different trades: the sale of one
currency and the purchase of another.

39

As the world's reserve currency, the U.S. dollar is the most actively traded currency;
pairs involving the dollar make up the majority of transactions.
Most

currency

trading

strategies

fall

into

two

broad

categories: hedging and speculating.

To avoid possible loss from fluctuating currencies, companies can hedge, or protect
themselves, by trading currency pairs.
In arbitrage trades, an investor simultaneously buys and sells the same security (or
currency) at slightly different prices, hoping to make a small risk-free profit.
Another popular category of currency trade is the carry trade, which involves selling
the currency of a country with very low interest rates and investing the proceeds in
the currency of a country with high interest rates.
There are several markets available to currency traders, including the forex
market, derivatives markets and exchange-traded funds.
The majority of currency trading takes place in the forex spot market. In the forex
spot market, large banks and other financial institutions trade currencies among
themselves either for immediate delivery (spot market) or for settlement at a later
date (forward market.)
Derivatives include futures, options and exotic, customizable derivative contracts.
While the more exotic derivatives are generally designed for institutional investors,
individual investors often use futures and options.
Individual investors can buy or sell the futures or the options to speculate on the
direction of the currency pair.
ETFs have been popular vehicles for tracking stock or bond indexes for many years,
but ETFs that track currency movements are relatively new. A currency ETF can be
bought and sold just like any other stock.

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Investors with no intention of directly trading foreign currencies, however, can benefit
from a better understanding of the links between international currencies because
these currency movements can ultimately affect the value of other financial assets.
Four major currency pairs are the most popular: EUR/USD, the euro and the U.S.
dollar; USD/JPY, the U.S. dollar and the Japanese yen; GBP/USD, the British pound
sterling and the U.S. dollar; and USD/CHF, the U.S. dollar and the Swiss franc.
Because they are the two most popular currencies in the world, the euro and the U.S.
dollar are the most actively traded currency pair.
Most foreign currencies trade against the U.S. dollar more often than in a pair with
any other currency. For this reason, it is important for investors interested in the
currency markets to have a firm grasp of the fundamentals of the United
States economy and a solid understanding of the direction in which the U.S. dollar is
going.
While the U.S. dollar is the currency of a single country, the euro is the single
currency of 16 European countries within the European Union, collectively known
as the "eurozone" or the European and Economic Monetary Union (EMU).
The primary factor that influences the direction of the euro/U.S. dollar pair is the
relative strength of the two economies.
Because of Japan's large amount of trade with the United States, Asia, Europe, and
other countries, multinational corporations have a regular need to convert local
currency into yen and vice versa.
The Japanese central bank has been kept its interest rates very low to spur economic
growth following a long period of economic decline. These low interest rates have
made the Japanese yen extremely popular in the carry trade.
The U.S. dollar/Japanese yen pair features low bid-ask spreads and excellent liquidity.
As such, it is an excellent starting place for newcomers to the currency market as
well as a popular pair for more experienced traders.

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Although the U.K. is a member of the European Union, the country remains outside
the Eurozone (the European Monetary Union, or EMU) and maintains its own
currency, the British pound sterling (known as the pound).
The British pound/U.S. dollar pair is one of the most liquid in the currency market.
As with the euro/U.S. dollar, the most important factor in determining the relationship
between the U.S. dollar and the British pound is the relative strength of the countries'
respective economies.
One unique aspect of trading the British pound is that there is often conjecture that the
U.K. may choose to join the eurozone (or European Monetary Union, known as the
EMU). If this were to happen, the U.K. would have to give up the pound and use
only the euro.
Although the country remains outside the European Union to maintain its
neutrality, Switzerland does enjoy extensive trade with its European neighbors, the
United States and other countries around the world.
Because of Switzerland's historic political neutrality and reputation for stable and
discreet banking, the Swiss franc is commonly viewed as a safe haven in
international capital markets.
Although it is somewhat less liquid than the euro and the pound, the Swiss franc is
still an easy currency to trade.
The factor most likely to cause large movements in the value of the Swiss franc is
international political and economic instability.
The commodity currencies are currencies from countries that possess large quantities
of commodities or other natural resources.
Commodity currency trading typically focuses on three countries that are rich in
natural

resources

and

also

have

currencies: Canada, Australia and New Zealand.

liquid,

freely

floating

42

The Canadian economy is also closely linked to the state of the U.S. economy,
because weaker growth in the U.S. can result in decreased exports for Canada.
Australia finds it necessary to import large quantities of goods not produced
domestically. These imports can result in large trade deficits that pressure the
Australian dollar.
New Zealand is a small island nation blessed with many natural resources and a large
agricultural sector. These resources result in the New Zealand economy's heavy
exposure to international commodity prices.
The primary determinant of the movement of the commodity currencies is the price of
commodities.
The currencies of Canada, Australia, and New Zealand are all actively traded but are
less liquid than those of the United Kingdom, Japan or the eurozone.
A currency trading pair that does not involve the U.S. dollar is known as a currency
cross rate.
Because currency cross rates, by definition, do not include the U.S. dollar, the most
heavily traded cross pairs do involve the second most commonly used currency, the
euro.
An investor interested in cross rates does not need to be as concerned with the
fundamentals of the U.S. economy as an investor trading more traditional pairs.
A second unique characteristic of cross rates is that they are usually somewhat less
liquid (and less actively traded) than traditional pairs, bringing both benefits and
drawbacks for investors.
Perhaps the most important factor in cross-rate movements is not what affects them,
but what does not. Cross rates are not directly influenced by the direction of the U.S.
dollar.

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The opportunity to generate above-average returns by studying and researching cross

currency pairs makes this corner of the currency market a potentially attractive one
for investors.
In emerging market countries, the financial and banking systems are usually still
forming (compared to those in more developed economies), and the middle-class
population may be small or even non-existent. These characteristics result in greater
financial volatility and larger swings between economic prosperity and economic
decline.
Emerging markets often have political systems that are less stable than those of
developed nations, resulting in a greater possibility of governmental actions that
adversely affect investors.
Many emerging market countries do not allow their currencies to float freely.
Emerging markets often suffer from illiquidity and large bid-ask spreads conditions
that are exacerbated during times of market volatility.
Individual investors who are unable or unwilling to trade emerging market currencies
directly can still be exposed to the risk.
International investors with no intention of directly trading foreign currencies should
understand the influence currency movements can have on foreign stock and bond
holdings.

BIBLIOGRAPHY & REFERENCES

BIBLIOGRAPHY:
1. Llewellyn, David T., 1980, International financial integration: the limits of
sovereignty, Macmillan, 115-133.
2. Llewellyn, David T., 1988, Financial innovation: a basic analysis in financial
innovation by Cavana,H., Loughborough University Banking Centre.

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3. Gibson, Heather D., 1989, The Eurocurrency markets, domestic financial policy
and international instability, Macmillan, 2-27.
4. Llewellyn, D.T., Euro currency markets: their credit effects and the dynamics of
monetary policy in International lending in a fragile world economy, 88-116.
5. Mayer, Helmut W., Credit and liquidity creation in the euro currency market,
Bank for International Settlements Monetary and Economics.
6. Johnston, R. B., 1983, The economics of the Euro-market: history, theory and
policy, Macmillan, 2-50,220-250.
7. Valdez, S., An introduction to Western financial markets. 133-147.
8. Aliber, Robert Z., "The Interest Rate Parity Theorem: A Reinterpretation," Journal
of Political Economy, 81 (November/December 1973), pp. 1451-1459.
9. Clarke, William, The City in the World Economy, London, Institute of Economic
Affairs, 1965.
10. Einzig, Paul, The Euro-Dollar System: Practice and Theory of International
Interest Rates, 5th ed., London, Macmillan, 1973.
11. Emery, Robert F., "The Asian Dollar Market," International Finance Discussion
Papers, Federal Reserve Board, November 1975; processed.
12. Friedman, Milton, "The Euro-Dollar Market: Some First Principles," Morgan
Guaranty, Survey (October 1969), pp. 4-14.
13. Gurley, J. G., and E. S. Shaw, Money in a Theory of Finance, Washington,
The Brookings Institution, 1960.
14. Herring, Richard J., and Richard C. Marston, National Monetary Policies and
International Financial Markets, Amsterdam, North-Holland, 1976.
15. Machlup, Fritz, "Euro-Dollar Creation: A Mystery Story," Banca Nazionale del

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Lavoro Quarterly Review, 94 (September 1970), pp. 219-260.

16. McKinnon, Ronald I., Private and Official International Money: The Case for
the Dollar, Essays in International Finance No. 74, Princeton, N.J., April
1969.
17. Mayer, Helmut W., "The BIS Concept of the Eurocurrency Market," Euromoney
(May 1976), pp. 60-66.
18. Niehans, Jiirg, and John Hewson, "The Eurodollar Market and Monetary
Theory," Journal of Money, Credit and Banking, 7 (February 1976), pp. 127.
19. Swoboda, Alexander K., The Euro-Dollar Market: An Interpretation, Essays
in International Finance No. 64, Princeton, N.J., February 1968.
20. Tobin, James, "Commercial Banks as Creators of Money," Chap. 16 in Essays
in Economics, Vol. 1, Macroeconomics, Chicago, Markham, 1971.
21. Yeager, Leland, International Monetary Relations: Theory, History and Policy,
2d ed., New York, Harper & Row, 1976.

The weblography from which we have collected information are:1.

2.
3.
4.
5.
6.

www.google.com
www.askme.com
www.wikipedia.com
www.wikiaskme.com
www.shareslied.com
www.scribd.com

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