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EURO MARKET

A Euro market is a market for deposits and loans in currency that exists outside the borders of the home country of that currency. Thus it is beyond the control or jurisdiction of the monetary authorities of that country. A market for banking outside the regulatory control of the country of origin of currency.

Geographic coverage

Developed in Europe, spread to other areas like Asian dollar market, Petro dollar market, Euro Yen market, Euro dollars and Euro + Sterlings, Euro-Marks, EuroSw.Fcs (outside Switzerland)

Origin

E.M. came to light in 1957 late 19th century witnessed exchange of foreign deposits.

In the post World War II era, communists deposited the dollar currency earning in European banks to avoid possible deposits freeze by U.S. Then started lending borrowing.

Contributory Factors for E.M. Development

Regulations on Liabilities / Deposits Limitation on maximum interest rates on deposits Regulation Q Hence U.S. banks could not compete with banks in London in rates on deposits, flow of funds to London based banks with high interest rates.

Regulations on Assets / Loans Glass Steagal Act (1933) restricted banks from entering into investment banking, brokerage and insurance.

Contributory Factors for E.M. Development

Federal Reserve Regulation .M. Reserve requirements on deposits deposit insurance Absence in Europe banks.

Capital control under voluntary credit restraint programme (1964-74) due to BOP problems in U.S.

Contributory Factors for E.M. Development

Convenience and cost advantages to hold dollars deposits outside U.S.

Foreign Direct Investment Regulations Restriction on $ overseas investment i.e., controls and restrictions on borrowing funds in the U.S. for reinvestment abroad

Contributory Factors for E.M. Development

OPEC surpluses in the 70s, the oil boom, rise in prices etc.,

Other limitations in the 1960s and 70s on obtaining loan within U.S. that did not apply overseas. U.S. interest equalization tax 1963-74. It was a tax on U.S. residents earnings on foreign securities.

General Factors

Removal of controls on capital movements by OEDC


leading to quicker integration of international markets closer link between the exchange and market variety of funds flow

General Factors

Growing BOP deficits of majority of developing countries.


growing financial needs innovation in financial services

Revolution in communication technology CHIPS / SWIFT

General Factors

Role of Narrow Spread Depositors demand for the highest yield borrowers to pay the lowest cost. Due to absence of reserve requirements, deposit insurance and other costly regulation Eurobanks can offer higher interest on deposits. - Due to absence of controls/ regulations, sheer size and a number of informal contacts the banks can charge lower borrowing costs.

Consequences

Just as the Euro dollar has brought about economic miracles by providing finance to economic development and world trade, it has also to a great extent contributed to destabilization of exchange rate system.

Consequences

Freely circulating mass of Euro-market funds is much larger than the reserves in the central banking system. Consequently, in case speculative forces dominate exchange market, the central banks defensive mechanism, intervention is rendered ineffective.

Consequences

The central banking system reserves of about $ 1000 bn are no match to freely circulating mass of Eurofunds of about $ 2500 bn to $ 3500 bn.

Expanding Size of the market due to multiplier effect. Emergence of Off-shore Banking Centres Singapore, Bahrain, Manila, Hongkong, Nassau, Jersey, London, New York International Banking facility.

System of Two-way Quotation Parallel markets Euro-markets are Parallel markets

Traditional
Loans fully secured Self-liquidating
Lender of Last Resort

Parallel
Unsecured Not necessarily No L/R Market left to it own devices

Monetary controls Confirmist approach to business

Rates are informal, totally flexible & business expeditious

Uses Borrowing at lower interest in the short run to lend at higher rate in the long run.

Arbitrage operation - Space long run - Arbitrage - Interest rate - Time arbitrage
Financing foreign trade operations

Improving liquidity through SWAP operations


Funding loan assets

Innovations

Syndicate loan + bond

Swaps

In between these two, several hybrid varieties encompassing features of bond, syndicate loan and swaps have been developed in response to emerging needs circumstances including circumventing regulation, tax and other policy frames, securitization transforming credits into negotiable instruments. Borrowers in the Euro market issue Short Term Bonds / Promissary Notes backed by standby facilities.

Mechanics of Euro Dollar Market

Call funds: 7 to 15 days, 1month to 12 months. Market in long term thin. Dealing through brokers / Direct. Mostly foreign exchange Dept. handle Euro currency. System of two-way quotations bid and offer.

Mechanics of Euro Dollar Market

Stipulating credit limit on borrowers. All transactions are spot. Usual amount is 1 mn and it might be as low as $ 25,000. Wholesale market. Banks run: graded maturities-i.e., borrow short and long term. Variety of interest rates: LIBOR, SIBOR, BIBOR, HIBOR, JIBOR etc.

Facilities / Instruments / Innovations

In response to changing economic, legal and fiscal circumstances, variety of innovative instruments have been developed for lending and borrowing in the Euro currency markets.

Facilities / Instruments / Innovations

Traditionally through issue of bonds or borrowing directly from the banks or through a method of syndicated loans borrowing was carried out. But in response to a changing environment, products like Euro issuance facilities have been developed.

Facilities / Instruments / Innovations

Euro 2000 coupon bonds, a hybrid variety, combination of bond market and syndicated loan market. Since 1980s, two area of innovations Hybrid variety => syndicated loan market Swaps => Bond market produce hybrid The cause of hybrid shift towards securitization transformation of credit into negotiable instruments.

Euro-Note Facilities: bonds of short-term maturities

NIFs RUFs

= Note Issuance Facilities = Revolving underwriting facilities TRUF = Transferable RUFs MOFF = Multioption Financing Facilities BONUS = Borrowers Option Financing Facilities ECPs = Euro Commercial Papers

Bonds of shorter maturity; bearer promissory notes issued by borrowers issues backed up by standby facility substituted in case notes are not sold.

Euro bonds Market Euro bonds are unsecured obligations of a borrower issued to investors all over the world. Earlier they were at fixed rates of interest. A large variation emerged as a result of changing market conditions. E.g. FLOATING RATE NOTES (FRN): A large variety of FRN.

Types of Bonds

1.

Straight bonds =>

Fixed coupon

2. Convertible bonds => with option to convert equity shares of issuing . Dual currency 3. Convertible bonds => convertible into shares dominated into different currency. 4. Bonds with warrants => warrants provide option purchase shares or traded separately. 5. Option bonds => with option of receiving interest/principal in different currencies. 6. Zero coupon bond => No interest during life time but issued at substantial discount to par. 7. Foreign bonds => capital markets. Issued in domestic

SWAPS

Most common forward transaction is SWAPS => SWAP involves buying and selling same amount of foreign currencies for different maturities.

SWAP does not change or affect position in foreign currency.

Interest rate swaps and currency swaps.

Exchange of fixed to floating rate of interest rate viceversa.


In currency swaps both principal and interest amount are swaped.

SWAP is a financial transaction which involves two parties agreeing to exchange streams of payment over time on the basis of certain understanding, from one interest base to another, one currency to another, or involving both used for obtaining low cost financing, obtaining high yielding assets, change in currency exposure, A/c management or speculation.

Syndication of Loans
The process of making a loan jointly as a syndicate by using common loan documentation is known as syndication. Based on principle of Risk Spreading. Minimising exposure to a single borrower.

Techniques of Syndication

Best Effort Syndicate: Lead Manager or (Lead Bank) will not underwrite but undertake to offer loan to the banks with certain terms and conditions.

In the case of poor response, the syndicate called off; borrower resorts to alternate method.

Techniques of Syndication

Club Syndicate: Limited Group of banks undertake to provide the funds syndication functions shared by the banks known as private placement.

Techniques of Syndication

Firm Commitment Syndication: Lead Manager undertakes the responsibility to provide full amount of loan and then offer to the market, in case of poor response. The Lead Manager invites bids and makes available all details.

Lead Manager => Role => Lending banks.

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