INTERNATIONAL FINANCIAL MARKETS

Note: The prefix Euro is somewhat of a misnomer since it does not mean that the
bank/institutions/market has to be located in Europe. A Eurocurrency is a time
deposit of money in an international bank located in a country different from the
country that issued the currency. E.g. Eurodollars are deposits of US Dollars in
banks outside the US, Euro yen are deposits of Japanese Yen in banks outside
Japan.

CONCEPTS

1. Distinction between Euro Credit and Euro Bond Market

Both Euro bonds and Euro credit (Euro currency) financing have their advantages
and disadvantages. For a given company, under specific circumstances, one method
of financing may be preferred to the other. The major differences are:

1. Cost of borrowing
Euro bonds are issued in both fixed rate and floating rate forms. Fixed rate bonds
are an attractive exposure management tool since the known long-term currency
inflows can be offset by the known long-term outflows in the same currency. In
contrast, Euro currency loans carry variable rates.

2. Maturity
Euro bonds have longer maturities while the period of borrowing in the Euro currency
market has tended to lengthen over time.

3. Size of the issue

Earlier, the funds available for lending at any time have been much more in the inter-
bank market than in the bond market. But of late, this situation does not hold true.
Moreover, although in the past the flotation costs of a Euro currency loan have been
much lower than a Euro bond (about 0.5 % of the total loan amount versus about
2.25 % of the face value of a Euro bond issue), compensation has worked to lower
Euro bond flotation costs.

4. Flexibility
In a Euro bond issue, the funds must be drawn in one sum on a fixed date and
repaid according to a fixed schedule, unless the borrower pays a substantial
prepayment penalty. By contrast, the drawdown in a floating rate loan can be
staggered to suit the borrowers needs and can be repaid in whole or in part at any
time, often without penalty. Moreover, a Euro currency loan with a multi-currency
clause enables the borrower to switch currencies on any roll-over date, whereas
switching the denomination of a Euro bond from currency A to currency B would
require a costly, combined, refunding and reissuing operation.

5. Speed
Funds can be raised by a known borrower very quickly in the Euro currency market.
Often, a period of two to three weeks should suffice. A Euro bond financing generally
takes more time, though the difference is becoming less significant.

2. Euro Credit Market

Euro credit or Euro Loans are the loans extended for one year or longer. The market
that deals in such loans is called Euro Credit Market.

The common maturity for euro credit loans is 5 years. Since Euro banks accept
short-term deposits and provide long-term loans, it is likely that asset liability
mismatch may arise. To avoid this Euro banks often extend floating rate euro credit
loans fixed to some market interest rate. The London Inter Bank Offer Rate (LIBOR)
is the most commonly used interest rate. It is the rate charged for loans between
Euro Banks.

Participants in Euro credit Market

The major lending banks in the Euro credit market are Euro banks, American,
Japanese, British, Swiss, French, German and Asian (specially that of Singapore)
banks, Chemical Bank, JP Morgan, Citicorp, Bankers Trust, Chase Manhattan Bank,
First National Bank of Chicago, Barclay's Bank, National Westminster, BNP, etc.
Among the borrowers, there are banks, multinational groups, public utilities,
government agencies, local authorities, etc.

Dealing in Euro credits

When a borrower approaches a bank for Euro credit, a formal document is prepared
on behalf of potential borrowers. This document contains the principal terms and
conditions of loan, objectives of loan and details of the borrower.

Before launching syndication, the approached bank decides primarily, in consultation

with the borrower, on a strategy to be adopted, i.e. whether to approach a large
market or a restricted number of banks to form the syndicate. Each of the banks in
syndicate lends a part of the loan. The duration of this operation is normally about 6
to 8 weeks.

Several clauses may be introduced in the contract of Euro-debt:

Pari-passu clause that prevents the borrower from contracting new debts that
subordinate the interest of lenders;
Exchange option clause that allows the withdrawal of a part or totality of loan in
another currency;
Negative guarantee clause that commits the borrower not to contract other debts
that subordinate the interest of lenders.

Characteristics of Euro credit

A major part (more than 80 %) of the Euro debts is made in US dollars. The second
(but far behind) is Pound Sterling followed by Deutsch mark, Japanese yen, Swiss
franc and others.
Most of the syndicated debts are of the order of $50 million. As far as the upper limits
are concerned, amounts involved are of as high magnitude as $5 billion and more. In
1990, Euro tunnel borrowed $6.8 billion.

On an average, maturity periods are of about five years (in some cases it is about 20
years). The reimbursement of the loan may take place in one go (bullet) or in several
installments.

The interest rate on Euro debt is calculated with respect to a rate of reference,
increased by a margin (or spread). The rates are available and generally renewable
(roll over credit) every six months, fixed with reference to LIBOR. The LIBOR is the
rate of money market applicable to short-term credits among the banks of London.
The reference rate can equally be PIBOR at Paris and FIBOR at Frankfurt, etc. It is
revised regularly.

The margin depends on the supply and demand of the capital as also on the degree
of the risk of these credits and the rating of borrowers. Financial institutions are in
vigorous competition. There is an active secondary market of Euro debts. Numerous
techniques allow banks to sell their titles in this market.

3. Euro Bond Market

Euro Bond issue is one denominated in a particular currency but sold to investors in
national capital markets other than the country that issued the denominating
currency. An example is a Dutch borrower issuing DM-denominated bonds to
investors in the UK, Switzerland and the Netherlands.

The Eurobond market is the largest international bond market, which is said to have
originated in 1963 with an issue of Eurodollar bonds by Autostrade, an Italian
borrower. The market has since grown enormously in size and was worth about $
428 billion in 1994.

Eurobond markets in all currencies except the Japanese Yen are quite free from any
regulation by the respective governments. Straight bonds are priced with reference
to a benchmark, typically treasury issues. Thus a Eurodollar bond will be priced to a
yield a YTM (Yield-to-Maturity) somewhat above the US treasury bonds of similar
maturity, the spread depending upon the borrowers ratings and market conditions.
Floatation costs of the Eurobond are comparatively higher than costs indicated with
syndicated Eurocredits.

4. Euro CPs
Commercial paper is a corporate short-term, unsecured promissory note issued
on a discount to yield basis. Commercial paper maturities generally do not exceed
270 days. Commercial paper represents a cheap and flexible source of funds While
CPs are negotiable, secondary markets tend to be not very active since most
investors hold the paper to maturity.
The emergence of the Euro Commercial Paper (ECP) is much more recent. It
evolved as a natural culmination of the Note Issuance Facility and developed rapidly
in an environment of securitisation and disintermediation of traditional banking. CP
has also developed in the domestic segments of some European countries offering
attractive funding opportunities to resident entities.
5. Euro CDs
A Certificate of Deposit (CD) is a negotiable instrument evidencing a deposit with a
bank. A CD is a marketable instrument so that the investor can dispose it off in the
secondary market whenever cash is needed. The final holder is paid the face value
on maturity along with the interest. It is used by the commercial banks as short- term
funding instruments.
Euro CDs are mainly issued in London by banks. Interest on CDs with maturity more
than a year is paid annually than semi-annually.

6. International Capital Markets

International Capital Markets have come into existence to cater to the need of
international financing by economies in the form of short, medium or long-term
securities or credits. These markets also called Euro markets, are the markets on
which Euro currencies, Euro bonds, Euro shares and Euro bills are
traded/exchanged. Over the years, there has been a phenomenal growth both in
volume and types of financial instruments transacted in these markets. Euro
currency deposits are the deposits made in a bank, situated outside the territory of
the origin of currency. For example, Euro dollar is a deposit made in US dollars in a
bank located outside the USA; likewise, Euro banks are the banks in which Euro
currencies are deposited. They have term deposits in Euro currencies and offer
credits in a currency other than that of the country in which they are located.

A distinctive feature of the financial strategy of multinational companies is the wide

range of external services of funds that they use on an ongoing basis. British
Telecommunication offers stock in London, New York and Tokyo, while Swiss Bank
Corporation-, aided by Italian, Belgian, Canadian and German banks- helps
corporations sell Swiss franc bonds in Europe and then swap the proceeds back into
US dollars.

Firms have three general sources of funds available: (i) internally generated cash, (ii)
short-term external funds, and (iii) long-term external funds. External investment
comes in the form of debt or equity, which are generally negotiable (tradable)
instruments. The pattern of financing varies from country to country. Companies in
the UK get an average of 60-70% of their funds from internal sources. German
companies get about 40-50% of their funds from external suppliers. In 1975,
Japanese companies got more than 70% of their money from outside sources, but
this pattern has since reversed; major chunks of finances come from internal
sources.

Another significant aspect of financing behaviour is that debt accounts for the
overwhelming share of external finance. Industry sources of external finance also
differ widely from country to country. German and Japanese companies have relied
heavily on bank borrowing, while the US and British industry raised much more
money directly from financial markets by the sale of securities. However, in all
countries, bank borrowing is on a decline. There is a growing tendency for corporate
borrowing to take the form of negotiable securities issued in the public capital
markets rather than in the form of commercial bank loans. This process known as
securitisation is most pronounced among the Japanese companies.
7. Petro Dollar

During the oil crises of 1973, the Capital markets have played a very important role.
They accepted the dollar deposits from oil exporters and channeled the funds to the
borrowers in other countries. This is called recycling the petrodollars.

8. Junk Bonds
A junk bond is issued by a corporation or municipality with a bad credit rating. In
exchange for the risk of lending money to a bond issuer with bad credit, the
issuer pays the investor a higher interest rate. "High-yield bond" is a nicer
name for junk bond The credit rating of a high yield bond is considered
"speculative" grade or below "investment grade". This means that the chance
of default with high yield bonds is higher than for other bonds. Their higher
credit risk means that "junk" bond yields are higher than bonds of better credit
quality. Studies have demonstrated that portfolios of high yield bonds have
higher returns than other bond portfolios, suggesting that the higher yields
more than compensate for their additional default risk.

Junk bonds became a common means for raising business capital in the 1980s,
when they were used to help finance the purchase of companies, especially by
leveraged buyouts, the sale of junk bonds continued to be used in the 1990s to
generate capital

9. Samurai Bonds
They are publicly issued yen denominated bonds. They are issued by non-Japanese
entities.
The Japanese Ministry of Finance lays down the eligibility guidelines for potential
foreign borrowers. These specify the minimum rating, size of issue, maturity and so
forth. Floatation costs tend to be high. Pricing is done with respect to Long-term
Prime Rate.

Shibosai Bonds
They are private placement bonds with distribution limited to banks and institutions.
The eligibility criteria are less stringent but the MOF still maintains control.

Shogun / Geisha Bonds

They are publicly floated bonds in a foreign currency while Geisha are their private
counterparts.

10. Yankee Bonds

These are dollar denominated bonds issued by foreign borrowers. It is the largest
and most active market in the world but potential borrowers must meet very stringent
disclosure, dual rating and other listing requirements, options like call and put can be
incorporated and there are no restrictions on size of the issue, maturity and so forth.
Yankee bonds can be offered under rule 144a of Sec. These issues are exempt from
elaborate registration and disclosure requirements but rating, while not mandatory is
helpful. Finally low rated or unrated borrowers can make private placements. Higher
yields have to be offered and the secondary market is very limited.

DESCRIPTIVE

1. Trace the development of the International Capital Markets

The financial revolution has been characterized by both a tremendous quantitative

expansion and an extraordinary qualitative transformation in the institutions,
instruments and regulatory structures.

Global financial markets are a relatively recent phenomenon. Prior to 1980, national
markets were largely independent of each other and financial intermediaries in each
country operated principally in that country. The foreign exchange market and the
Eurocurrency and Eurobond markets based in London were the only markets that
were truly global in their operations.

Financial markets everywhere serve to facilitate transfer of resources from surplus

units (savers) to deficit units (borrowers), the former attempting to maximize the
return on their savings while the latter looking to minimize their borrowing costs. An
efficient financial market thus achieves an optimal allocation of surplus funds
between alternative uses. Healthy financial markets also offer the savers a range of
instruments enabling them to diversify their portfolios.

Globalization of financial markets during the eighties has been driven by two
underlying forces. Growing (and continually shifting) imbalance between savings and
investment within individual countries, reflected in their current account balances,
has necessitated massive cross-border financial flows. For instance, during the late
seventies, the massive surpluses of the OPEC countries had to be recycled, i.e. fed
back into the economies of oil importing nations. During the eighties, the large
current account deficits of the US had to be financed primarily from the mounting
surpluses in Japan and Germany. During the nineties, developing countries as a
group have experienced huge current account deficits and have also had to resort to
international financial markets to bridge the gap between incomes and expenditures,
as the volume of concessional aid from official bilateral and multilateral sources has
fallen far short of their perceived needs.

The other motive force is the increasing preference on the part of investors for
international diversification of their asset portfolios. This would result in gross cross-
border financial flows. Investigators have established that significant risk reduction is
possible via global diversification of portfolios.

These demand-side forces accompanied by liberalization and geographical

integration of financial markets has led to enormous growth in cross-border financial
transactions. In virtually all major industrial economies, significant deregulation of the
financial markets has already been effected or is under way. Functional and
geographic restrictions on financial institutions, restrictions on the kind of securities
they can issue and hold in their portfolios, interest rate ceilings, barriers to foreign
entities accessing national markets as borrowers and lenders and to foreign financial
intermediaries offering various types of financial services have been already
dismantled or are being gradually eased away. Finally, the markets themselves have
proved to be highly innovative, responding rapidly to changing investor preferences
and increasingly complex needs of the borrowers by designing new instruments and
highly flexible risk management products.

The result of these processes has been the emergence of a vast, seamless global
financial market transcending national boundaries. But control and government
intervention have not entirely disappeared. E.g. South East Asia- Korea, Taiwan, etc-
permit only limited access to foreign investors. However, despite these reservations,
the dominant trend is towards globalization of financial markets.

International financial markets can develop anywhere, provided that local regulations
permit the market and potential users are attracted to it. The most important
international financial centers are London, Tokyo and New York. All the major
industrial countries have important domestic financial markets as well but only some
such as Germany and France are also important international financial centers. On
the other hand, even though some countries have relatively unimportant domestic
financial markets, they are important world financial centers such as Switzerland,
Luxembourg, Singapore and Hong Kong.

International Capital Markets, also called Euro markets, are the markets on which
Euro currencies; Euro bonds, Euro equity and Euro bills are exchanged. International
financing in the form of short-, medium- or long-term securities or credits has
become necessary for the international economy. Financing techniques have
diversified, volumes dealt have increased and the process is continuing to grow.

Notable developments in international capital markets can be traced to the end of

1950s. There are several reasons for their growth. The significant ones are:

Transfer of assets of erstwhile Soviet Union to Europe. In the 1950s and early
1960s, the former Soviet Union and Soviet-bloc countries sold gold and commodities
to raise hard currency. Because of anti-Soviet sentiment, these Communist countries
were afraid of depositing their US dollars in US banks for fear that the deposits could
be frozen or taken. Instead they deposited their dollars in a French Bank whose telex
address was Euro-Bank. Since that time, dollar deposits outside the US have been
called Eurodollars and banks accepting Eurocurrency deposits have been called
Euro banks. International capital markets subsequently came to be known as Euro
markets.

Restrictive measures taken by the administration. Several regulatory measures

(initiated particularly in the USA) also contributed (in an indirect manner) to the
development of International capital markets. The important ones are as follows:

Regulation 'Q'. In 1960, Regulation 'Q' in the USA fixed a ceiling on interest rates
offered by American banks on term deposits and prohibited them to remunerate the
deposits whose term was less than 30 days. Besides, at the end of the 1960s, the
Federal Reserve reduced the growth of total monetary mass. The money market rate
went up. American banks borrowed on the Euro dollar market, which resulted in:
The increase of indebtedness of these banks on the Euro dollar market;
The flight of American Capital, attracted by the interest rate on Euro market.

Tax of interest equalization. In 1963, tax was imposed on the purchase of foreign
securities (portfolio investments) by American residents. The objective was to reduce
the deficit of BOP of the USA and to establish equilibrium in international structure of
interest rates. In fact, in order to avoid tax payment, some companies launched the
issue of dollar bonds outside the USA. This contributed to the growth of Euro dollar
market. Realizing its adverse effects, subsequently, the tax was withdrawn in 1974.

Program of voluntary restrictions on investments. The USA initiated/imposed various

restrictions on its financial system to tackle BOP problems. For instance, banks were
directed not to lend or invest in foreign operations beyond the limits of the previous
year(s). As a result, the business community felt a scarcity of funds. This in turn led
them to take recourse to the Euro dollar market.

Differential of American lending and borrowing rates. The interest rate paid by
American banks was low, vis--vis, the expected rate from borrowers. European
banks availed of this opportunity; they offered higher rates of interest at the cost of
contenting themselves with smaller margins than those offered by American banks,
to attract investors. They could do so by operating on Euro dollar markets, which
were not subject to interest-rate and other regulations. For instance, banks were
neither constrained to respect a certain compulsory reserve ratio on their deposits in
Euro dollars nor constrained to maintain their interest rates below a certain ceiling.

There may be other reasons as well for development of Euro dollars. Globalization of
big multinationals has further boosted this development. The financing system
practiced hitherto also was not able to respond to capital needs of the international
economy.

Indian entities began accessing external capital markets towards the end of the
seventies as gradually the amount of concessional assistance became inadequate to
meet the increasing needs of the economy. The initial forays were low-key. The pace
accelerated around mid-eighties, but even the authorities adopted a selective
approach and permitted only a few select banks, all India financial institutions and
large public and private sector companies to access the market. After liberalization,
during 1993-94 there was a sharp increase in the amount of funds raised by
corporate entities form the global debt and equity markets.

Indias borrowings have mainly been by way of syndicated bank loans, buyers
credits and lines of credits. Other instruments such as foreign and Euro bonds have
been employed less frequently though a number of companies made issues of Euro
convertible bonds after 1993. Prior to that only apex financial institutions and the
public sector giant ONGC had tapped the German, Swiss, Japanese, and Euro dollar
bond markets. Throughout the eighties, there was a steady improvement in the
markets perception of the creditworthiness of Indian borrowers (manifested in the
steady decline in the spreads they had to pay over LIBOR in the case of Euro loans).
The 1990-91 crisis sent Indias sovereign rating below investment grade and the
foreign debt markets virtually dried up to be opened up again after 1993.

2. Describe the mechanism of the Euro Bond Market.

Euro Bond: issue is one denominated in a particular currency but sold to investors in
national capital markets other than the country that issued the denominating
currency. An example is a Dutch borrower issuing DM-denominated bonds to
investors in the UK, Switzerland and the Netherlands.

The Eurobond market is the largest international bond market, which is said to have
originated in 1963 with an issue of Eurodollar bonds by Autostrade, an Italian
borrower. The market has since grown enormously in size and was worth about $
428 billion in 1994.

Eurobond markets in all currencies except the Japanese Yen are quite free from any
regulation by the respective governments.

Straight bonds are priced with reference to a benchmark, typically treasury issues.
Thus a Eurodollar bond will be priced to a yield a YTM (Yield-to-Maturity) somewhat
above the US treasury bonds of similar maturity, the spread depending upon the
borrowers ratings and market conditions.

Floatation costs of the Eurobond are comparatively higher than costs indicated with
syndicated Eurocredits.

Primary market: A borrower desiring to raise funds by issuing Euro bonds to the
investing public will contact an investment banker and ask it to serve as
lead manager of an underwriting syndicate that will bring the bonds to
market. The underwriting syndicate is a group of investment banks,
merchant banks, and the merchant banking arms of commercial banks
that specialize in some phase of public issuance. The lead manager will
usually invite co managers to form a managing group to help negotiate
terms with the borrower, ascertain market conditions and manage the
issuance.

The managing group along with other banks, will serve as underwriters for the issue,
that is, they will commit their own capital to buy the issue from the borrower at a
discount from the issue price, if they are unable to place the bonds with investors.
The discount or the underwriting spread is typically in the 2 or 2.5% range. Most of
the underwriters along with other banks will be a part of the placement or selling
group that sells the bonds to the investing public.

The total elapsed time from the decision date of the borrower to issue Eurobonds
until net proceeds from the sale are received is typically 5 to 6 weeks.
The lead manager prepares a preliminary prospectus focusing on economic and
financial characteristics of the project and financial standing of the borrower.

After having consulted a certain number of banks, the lead manager decides on the
interest rate. Subsequently, the issue price is fixed. Clauses of reimbursement before
maturity are provided for. After, the issue advertising is done in International Press in
the form of tombstone. This tombstone indicates the lead manager, co-lead
managers and members of the guarantee syndicate.

Secondary Market: Eurobonds purchased in the primary market can be resold before
their maturities in the secondary market. The secondary market is an over the
counter market with principal trading in London. However, important trading is also
done in other major European cities. The bonds are quoted in percentage of their
value, without taking into account the coupon already running.

The secondary market comprises of market makers and brokers. Market makers
stand ready to buy or sell for their own account by quoting a two way bid and ask
prices. Market traders trade directly with one another, through a broker, or with retail
customers. The bid-ask is their only profit. Brokers accept buy or sell orders from
market makers and then attempt to find a matching party for the other side of the
trade; they may also trade for their own account. Brokers charge a small commission
to the market makers that engaged them. They do not deal directly with retail clients.

Extra Information
What is a bond?
A bond is a loan and you are the lender. The borrower is usually the government, a
state, a local municipality or a big company like General Motors. All of these entities
need money to operate -- to fund the federal deficit, for instance, or to build roads
and finance factories -- so they borrow capital from the public by issuing bonds.

When a bond is issued, the price you pay is known as its "face value." Once you buy
it, the issuer promises to pay you back on a particular day -- the "maturity date" -- at
a predetermined rate of interest -- the "coupon." Say, for instance, you buy a bond
with a $1,000 face value, a 5% coupon and a 10-year maturity. You would collect
interest payments totaling $50 in each of those 10 years. When the decade was up,
you'd get back your $1,000 and walk away.

A key difference between stocks and bonds is that stocks make no promises about
dividends or returns. General Electric's dividend may be as regular as a heartbeat,
but the company is under no obligation to pay it. And while GE stock spends most of
its time moving upward, it has been known to spend months -- even years -- going
the other way.

When GE issues a bond, however, the company guarantees to pay back your
principal (the face value) plus interest. If you buy the bond and hold it to maturity, you
know exactly how much you're going to get back (in most cases, anyway). That's
why bonds are also known as "fixed-income" investments -- they assure you a
steady payout or yearly income. And although they can carry plenty of risk, this
regular income is what makes them inherently less volatile than stocks.
Global Bond: They have a minimum value of $1 billion and are effected
simultaneously in Europe, America and Asia. The salient features of these bonds are
that they permit to raise very high amounts. They offer very high liquidity since they
are quoted on several exchanges while secondary market functions round the clock,
with uniform price all over the world. They are especially used by governments,
public enterprises, international organisations and private financial institutions.

External Bond Market: The external bond market refers to bond trading activity
wherein the bonds are underwritten by an international syndicate, are offered in
several countries simultaneously, are issued outside any country's jurisdiction, and
are not registered. The Eurobond market is a major external bond market. The
external bond market combined with the internal bond market comprises the global
bond market. Examples of an external bond are the "global bond," issued by the
World Bank, and Eurodollar bonds.

Internal Bond Market: The internal bond market refers to all bond trading activity in a
given country and is comprised of both a domestic bond market and a foreign bond
market. Also referred to as the "national bond market." The internal and external
bond markets comprise the global bond market

Bulldog Bonds: A sterling denominated foreign bond, priced with reference to the UK
gilts.

Rembrandt Bond: Denominated in the Dutch guilder.

(For more information, please refer to page 504-505 in P G Apte)

3. What are the different international financial markets?

The international financial markets consist of the credit market, money market, bond
market and equity market.

The international credit market, also called Euro credit market, is the market that
deals in medium term Euro credit or Euro loans.

International banks and their clients comprise the Eurocurrency market and form the
core of the international money market. There are several other money market
instruments such as the Euro Commercial Paper (ECP) and the Euro Certificate of
Deposit (ECD).

Foreign bonds and Eurobonds comprise the international bond market. There are
several types of bonds such as floating rate bonds, zero coupon bonds, deep
discount bonds, etc.

The international equity market tells us how ownership in publicly owned

corporations is traded throughout the world. This comprises both, the primary sale of
new common stock by corporations to initial investors and how previously issued
common stock is traded between investors in the secondary markets.
International Financial Market- (general- can be used in any)

The last two decades have witnessed the emergence of a vast financial market
across national boundaries enabling massive cross-border capital flows from those
who have surplus funds and a search of high returns to those seeking low-cost
funding. The degree of mobility of capital, the global dispersal of the finance industry
and the enormous diversity of markets and instruments, which a firm seeking funds
can tap, is something new.

Major OECD (Organization for Economic Co-operation and Development) countries

had began deregulating and liberalizing their financial markets towards the end of
seventies. While the process was far from smooth, the overall trend was in the
direction of relaxation of controls, which till then had compartmentalized the global
financial markets. Exchange and capital controls were gradually removed, non-
residents were allowed freer access to national capital markets and foreign banks
and financial institutions were permitted to establish their presence in the various
national markets.

While opening up of the domestic markets began only around the end of seventies, a
truly international financial market had already been born in the mid-fifties and
gradually grown in size and scope during sixties and seventies. This refers to the
Euro currencies Market where borrower (investor) from country A could raise (place)
funds from (with) financial institutions located in country B, denominated in the
currency of country C. During the eighties and nineties, this market grew further in
size, geographical scope and diversity of funding instruments. It is no more a "euro"
market but a part of the general category called offshore markets.

Alongside liberalization, other qualitative changes have been taking place in the
global financial markets. Removal of restrictions has resulted into geographical
integration of the major financial markets in the OECD countries. Gradually this trend
is spreading to developing countries many of which have opened up their markets-at
least partially-to non-resident investors, borrowers and financial institutions.

Another noticeable trend is functional integration. The traditional distinctions between

different financial institutions-commercial banks, investment banks, finance
companies, etc.- are giving way to diversified entities that offer the full range of
financial services. The early part of eighties saw the process of disintermediation get
underway. Highly rated issuers began approaching investors directly rather than
going through the bank loan route.

On the other side, debt crisis in the developing countries, adoption of capital
adequacy norms and intense competition, forced commercial banks to realize that
their traditional business of accepting deposits and making loans was not enough to
guarantee their long-term survival and growth. They began looking for new products
and markets. Concurrently, the international financial environment was becoming
more volatile- there were fluctuations in interest and exchange rates. These forces
gave rise to innovative forms of funding instruments and tremendous advances in
risk management. The decade saw increasing activity in and sophistication of the
derivatives market, which had begun emerging in the seventies.
Taken together, these developments have given rise to a globally integrated financial
marketplace in which entities in need of short- or long-term funding have a much
wider choice than before in terms of market segment, maturity, currency of
denomination, interest rate basis, incorporating special features and so forth. The
same flexibility is available to investors to structure their portfolios in line with their
risk-return tradeoffs and expectations regarding interest rates, exchange rates, stock
markets and commodity prices.

4. List out the growth and functions of Eurocurrency markets

While opening up of the domestic markets began only around the end of seventies, a
truly international financial market had already been born in the mid-fifties and
gradually grown in size and scope during sixties and seventies. This refers to the
well-known Eurocurrencies Market. It is the largest offshore market.

Prior to 1980, Eurocurrencies market was the only truly international financial market
of any significance. It is mainly an inter-bank market trading in time deposits and
various debt instruments. What matters is the location of the bank neither the
ownership of the bank nor ownership of the deposit. The prefix "Euro" is now
outdated since such deposits and loans are regularly traded outside Europe.

Over the years, these markets have evolved a variety of instruments other than time
deposits and short-term loans, e.g. certificates of deposit (CDs), euro commercial
paper (ECP), medium- to long- term floating rate loans, eurobonds, floating rate
notes and euro medium-term notes (EMTNs).

The difference between Euro markets and their domestic counterparts is one of
regulation. Eurobonds are free from rating and a disclosure requirement applicable
to many domestic issues as well as registration with securities exchange authorities.

Emergence of Euro markets:

1. During the 1950s, the erstwhile USSR was earning dollars from the sale of gold
and other commodities and wanted to use them to buy grain and other products
from the West, mainly from the US. However, they did not want to keep these
dollars on deposit with banks in New York, as they were apprehensive that the
US government might freeze the deposits if the cold war intensified. They
approached banks in Britain and France who accepted these dollar deposits and
invested them partly in US.
2. Domestic banks in US (as in many other countries) were subjected to reserve
requirements, which meant that a part of their deposits were locked up in
relatively low yielding assets.
3. The importance of the dollar as a vehicle currency in international trade and
finance increased, so many European corporations had cash flows in dollars and
hence temporary dollar surpluses. Due to distance and time zone problems as
well as their greater familiarity with European banks, these companies preferred
to keep their surplus dollars in European banks, a choice made more attractive
by the higher rates offered by Euro banks.
The main factors behind the emergence and strong growth of the Eurodollar markets
were the regulations on borrowers and lenders imposed by the US authorities which
motivated both banks and borrowers to evolve Eurodollar deposits and loans. Added
to this are the considerations mentioned above, viz. the ability of Euro banks to offer
better rates both to the depositors and the borrowers and convenience of dealing
with a bank that is closer to home, who is familiar with business culture and practices
in Europe.

SHORT NOTES

1. Participants in International Project Financing a) Sponsors b) Lenders

Sponsors
These are partners in the project who bring in the equity capital or risk capital. Being
so, they are keenly interested in the successful completion of the project and
shoulder major responsibilities as regards its execution. The fact that they bring in
the equity capital is an indication of their interest. Also the amount of equity that they
bring has a marked bearing on the extent of debt that can be raised for the project.

Sometimes people who bring in the equity capital are just the initiators of the project.
Included in this category are multinational firms, future buyers of products or services
of the project, the public or private investors, international organisations,
development banks etc.

Lenders
They bring in the debt capital. Financing of a big project necessitates intervention of
a banking pool consortium composed of banks, national or international financial
institutions, export financing institutions etc.

Guarantors
Guarantees maybe provided by banks, public financing organisations, international
financial institutions, private insurance companies etc.

Project Operators
An operating company intervenes in the erection of the project. It brings its
organisational know-how to manage the project.

2. Risks associated with international projects- financial, political, others

1. Financial risk
In general, international projects are prone to greater financial risk as a bulk of
finance is in the form of debt. The major factors affecting financial risk are degree of
indebtedness, the terms and conditions of repayment of debt and currency used.

Some projects will have expenses and revenues that involve several currencies. As
a result the exchange rate risk is very high.
Projects maybe financed with floating rates. In view of the volatility observed on the
rates like LIBOR, the interest rate risk is also significant. Therefore it is
necessary to plan the coverage of all these risks.

2. Foreign Exchange Risk

As corporations expand their international activities, they begin to acquire foreign
assets and foreign liabilities. As exchange rates change, the values of these foreign
assets and liabilities change accordingly. For a corporation, exchange rate risk is the
sensitivity of the value of the corporation when the exchange rates change.
Obviously, the change in the corporation value is related to the net change in the
values of the foreign assets and foreign liabilities. (E.g. foreign direct investment,
foreign exchange loss, sales and income from foreign sources.)

3. Economic Risk
Economic risk is risk created by changes in the economy. Typically, it is related to
technological changes, the actions of competitors, shifts in consumer preferences,
etc. Ideally, a pure domestic firm is affected only by domestic economic conditions -
the domestic economic risk. However, in today's integrated world economy, the
concept of a pure domestic firm has less practical relevance. Many firms that appear
strictly pure domestic confront foreign economic risk indirectly. (E.g.: local
restaurant/dept store, real estate agent)

4. Political Risk
Political risk is risk created by political changes or instability in a country. These
factors include, but are not limited to, nationalization, confiscation, price controls,
foreign exchange and capital controls, administrative hurdles, uncertain property
rights, discriminative or arbitrary regulations on business practices (hiring, contract
negotiation), civil wars, riots, terrorism, etc. Each country in the world presents a
different political profile and represents a unique source of political risk that firms
must assess and manage when they make foreign investments.

In order to minimize this risk, local investors or the local government may be
associated with the project. Insurance against political risk is another useful
technique recommended for the purpose.

What constitutes political risk and how to measure it?

The political risk management typically involves:
- Identifying political risk and its likely consequences
- Developing policies in advance to cope with the possibility of political risk
- Strengthening a firm's bargaining position
- Devising measures to maximize compensation in the event of expropriation

Country Risk: It refers to elements of risk inherent in doing business in the economic,
social, and political environment of another country.

5. Counter party Risk - The risk that a counter party will default on a financial
obligation.
6. Liquidity Risk -The risk that a financial position cannot be sold quickly at
prevailing prices.

7. Delivery Risk - The risk that a buyer will not deliver payment of funds after a
seller has delivered securities or foreign exchange that were purchased.

8. Rollover Risk - The risk of being closed out from a financial market and unable to
renew (or roll over) a short-term contract.

9. Other risks - Other risks relate to the risk of cost overruns and bad management.

3. Financing of MNCs in local or international market

Project financing may be defined as financing of an economic unit, legally

independent, created with a view to setting up of a big project, which is commercially
profitable and financially viable.
Project is considered as a distinct legal entity and is financed, to a marked extent, by
debt (65 to 75 percent). Therefore the risk to be borne is substantial.

There are two major methods of financing international projects:

1. Financing with total risk borne by lenders where only the future cashflows ensure
the reimbursement of the loan. This method of financing was used in petroleum
and gas industry in the USA and Canada. Due to increased level of risks, this
method of project financing is generally not preferred.

2. In another type of financing, both the lender and the promoter share the risk. The
problem sometimes encountered in this method is to decide the proportion in
which the risk is to be shared between two parties.

Domestic v/s Offshore markets

Financial assets and liabilities denominated in a particular currency - say the Swiss
Franc - are traded are primarily in the national financial markets of that country.
These financial markets are known as Domestic Markets.

In case of many convertible currencies they are traded in the financial markets
outside the country of that currency. These financial markets are known as Offshore
Markets.

While it is true that neither both markets will offer both the financing options nor any
entity can access all segments of a particular market, it is true generally that a given
entity has an access to both the segments of the markets for placing as well as
raising funds.

There are theories by experts that suggest that there are no two types of financial
markets (viz. Domestic and offshore markets) but everything is a part of single
Global Financial Market.
Similarity
Experts suggest that arbitrage will ensure that both these markets will be closely
linked together in terms of costs of funding and returns on assets.

Differences
Both of these markets significantly differ on the Regulatory dimension. Major
segments of the domestic markets are subject to strict supervision by the relevant
authorities such as SEC in US, Ministry of Finance in Japan and the Swiss National
Bank in Switzerland. These authorities regulate foreign (non-resident) entities
access to the public capital markets in their countries by laying down eligibility
criteria, disclosure & accounting norms and registration & rating requirements
(similarly for domestic banks, reserve requirements and deposit insurance).

The offshore markets on the other hand have minimal regulation and often no
registration.
Finally it must be noted that though the nature of regulation continues to distinguish
Domestic from the offshore markets, there are segments like Private Placements,
Unlisted Bonds, Bank loans etc. in domestic markets where regulation tends to be
the least.

4. Eurocurrency Markets

While opening up of the domestic markets began only around the end of seventies, a
truly international financial market had already been born in the mid-fifties and
gradually grown in size and scope during sixties and seventies. This refers to the
well-known Eurocurrencies Market. It is the largest offshore market.

Prior to 1980, Eurocurrencies market was the only truly international financial market
of any significance. It is mainly an inter-bank market trading in time deposits and
various debt instruments. What matters is the location of the bank neither the
ownership of the bank nor ownership of the deposit. The prefix "Euro" is now
outdated since such deposits and loans are regularly traded outside Europe.

Over the years, these markets have evolved a variety of instruments other than time
deposits and short-term loans, e.g. certificates of deposit (CDs), euro commercial
paper (ECP), medium- to long- term floating rate loans, eurobonds, floating rate
notes and euro medium-term notes (EMTNs).

The main factors behind the emergence and strong growth of the Eurodollar markets
were the regulations on borrowers and lenders imposed by the US authorities which
motivated both banks and borrowers to evolve Eurodollar deposits and loans. Added
to this are the considerations mentioned above, viz. the ability of euro banks to offer
better rates both to the depositors and the borrowers and convenience of dealing
with a bank that is closer to home, who is familiar with business culture and practices
in Europe.

5. External Bond Market

The external bond market refers to bond trading activity wherein the bonds are
underwritten by an international syndicate, are offered in several countries
simultaneously, are issued outside any country's jurisdiction, and are not registered.
The Eurobond market is a major external bond market. The external bond market
combined with the internal bond market comprises the global bond market.
Examples of an external bond are the "global bond," issued by the World Bank, and
Eurodollar bonds.
The External Bond Market comprises of the :
Foreign Bond Market and
Euro Bond Market
Foreign Bond: issue is one offered by a foreign borrower to the investors in a
national capital market and denominated in that nations currency. An example is
German MNC issuing dollar denominated bonds to the U.S. investors.

Euro Bond: issue is one denominated in a particular currency but sold to investors in
national capital markets other than the country that issued the denominating
currency. An example is a Dutch borrower issuing DM-denominated bonds to
investors in the UK, Switzerland and the Netherlands.