euro-currency market dnc

EURO-CURRENCY MARKET

Workshop at PDIMTROn

11TH of March 2010

WHAT IS EURO-CURRENCY MARKET?

• It is a market for Borrowing and Lending of currency at the center outside the country in which the currency is issued.

• It is different than the Foreign Exchange Market, wherein the currency is bought and sold.

WHAT IS EURO-CURRENCY MARKET?

• This is a Capital Market:– Dollar deposited in London is called as Euro-Dollar deposit– Sterling deposit in Germany is called as Euro-Sterling deposit– Euro loan extended in Japan is called as Euro-Euro loan

• Centers for Euro-Currencies:– London– Few other in Europe– Singapore (also called as Asian Dollar Market)– Hongkong

Features of Euro-Currency Market

1. Types of transactions2. Control of the country of issue of the currency3. Huge amounts of transactions4. Highly competitive Market5. Floating rates of interest based on LIBOR6. Dominance of Dollar denominated

transactions7. Four different segments


• Types of Transactions:1. Japanese Exporter, earning USD, keeps these

USD in London Bank (say AMEX)as Deposit.2. AMEX bank may use such deposits for lending

to a French Importer.3. Indian exporter, earning Japanese Yen, keeps

these Yen in Korea as Deposit4. Nigerian Importer avails loan in INR from Russia

to import machinery from India.

Features of Euro-Currency Market• No Direct Control of the country which issued the currency:– Utility of the currency that is being bought and sold

is entirely outside the control of the country of its issue.

• But Indirect control is possible:– As the settlement always takes place in the country

in which the currency is issued, indirect control is possible.

• Because of this Euro-Currencies are also referred to as Offshore Currencies.

Euro-Currency Market

• Bankers and the Public form the participants of the Euro-Currency Market and the two types of transactions take place:

1. One bank with the other

2. One bank with Public

Features of Euro-Currency Market• Huge amounts of Transactions:

– Generally they are in only millions of USD

– This has lead to Syndication of loans, where large numbers of banks participate in the lending operations

– It also consists of pool of large number of short term deposits, which provides the biggest single source of funds for commercial banks


• Highly Competitive Market:

– There are no entry barriers. There is free access to the new institutions in the market

– The lending rates are low and deposit rate are high, thus allowing a wafer thin margin for operations

– Consumers, i.e. investors and borrowers derive advantage out of this situation


• Concept of Floating Rate of Interest:

– The rate of interest in the market is linked to the Base Rate usually LIBOR, i.e. London Inter-Bank Offered Rate

– The rate of interest on advances and deposits is reviewed periodically and amended according to changed circumstances, if any in LIBOR


• Dominance of Dollar in the market:

– Dollar is a leading currency traded in the market (about 90% to 95% market share)

– However other currencies are now emerging thus reducing the role of dollar somewhat (about 80% market share)• Euro• Japanese Yen• Pound Sterling


Euro-Currency Market Segments:There are four predominant market segments as follows:1. Euro-credit markets: where international group of banks engage in lending for

medium and long term2. Euro-bond market: where banks raise funds on behalf of international borrowers

by issuing bonds3. Euro-currency (deposit) market: where banks accept deposits, mostly for short term4. Euro-notes market: where Corporates raise funds

The segmentation is not watertight and different segments overlap each other.

Factors favouring the Growth of Euro-Currency Market

• The following five countries are responsible for the growth of the Euro-Currency Market:– China (fear that its Fx in USD would be blocked)– USA (indeed blocked identifiable Fx in USD in1950,

federal Reserve Act, regulation ‘Q’ and ‘M’; control and restrictions on borrowing funds in US in 1965, and introduction of interest equalization tax in 1963)

– Korea (War broke out in 1950)– Russia (erstwhile USSR){because of their banking

presence in Paris and London}– UK (policy of not granting sterling loan outside

sterling area in 1957)

China / Korea / Russia

• Since 1949, China feared that its dollar earnings would be blocked by USA.

• So China shifted its dollar earnings to Paris in the Russian banks

• Korean war broke in 1950• USA indeed blocked Chinese identifiable dollar

deposits in USA• Russian banks in Paris and London started disguising

their balances by placing them in western European banks rather than in N.Y.

• So communist countries had dollar claim on the western European banks and western European banks had similar claim on USA

UK

• British Government in 1957, decided not to grant sterling pound loans outside sterling area.

• During the same period, however, Western European banks were permitted to foreign currency deposits (say bank in London will accept dollar deposit)

• So the banks in London offered dollar loans to their non-sterling area customers.

USA: Federal Reserve Act: Regulation ‘Q’

• This act was about restriction on payment of interest on dollar deposits as well as other currency deposits.

• No interest was payable on deposits having maturity of 30 days or less. There were restrictions and ceilings on interest payments on deposits having maturity above 30 days.

• Therefore the dollar deposits of Non Resident US citizens got shifted to Europe as the banks in Europe offered higher rates of interest on dollar deposits (as well as other currency deposits)

• Foreign (for US) investors also shifted their dollar deposits from US to centers outside US, mostly to banks in London

• Banks London used these deposits for lending to its customers in non-sterling areas

• Thus London got the prominence in borrowing and lending Euro-dollar.

USA: Federal Reserve Act: Regulation ‘M’

• This act was about reserve requirement of the banks on their deposits

• The act required US banks to block more money in reserves, than European banks

• US banking regulation was not very tight then (and it is not so even now)

• American banks found it beneficial to move the deposits of Non Resident US citizens as well as those of resident citizens to banks in Europe.

USA: Controls and Restrictions

• In 1965 the controls and Restrictions were placed on borrowing in USD for investments abroad. They were voluntary.

• In 1968 these controls and Restrictions were made mandatory

• So the borrowers from US sought loans from outside US or in other words they were driven to Euro Markets

USA: Interest Equalization Tax

• To discourage flow of dollar outside US, US introduced interest equalization tax in1963 payable by residents of US on their earnings on foreign securities

• To avoid this tax lenders lent through Euro-Currency Markets

Interest Rates in Euro-Currency Maket

• LIBOR: – The banks (called as reference banks)in London charge different rates of interest

on their lending– These rate at 11.00 AM London times, are averaged and rounded off at nearest

0.1250– These are calculated for 1 month, 3 month or 6 month period

• LIBID:– This is the interest rate paid by the banks in London on the deposits kept with

them.– They are generally 0.25% or 0.125% lower than LIBOR

• LIMEAN: It is average of LIBOR and LIBID

• Prime Rate: of USA• SIBOR: Singapore LUXIBOR: Luxembourg• MIBOR: Mumbai BIBOR: Bahrain

Segment 1: Euro-Credit Markets

1. Tenure: Medium and Long Term Loans [up to 10--15 years 10% of loans, 5—8 years 85% of loans, 1– 5 years 5% of loans] provided by group of banks.

2. Amount: It is a wholesale sector of the international capital market.

3. Security: Loans are provided without any primary or collateral security. Credit rating is the essence of lending

4. Type of loan: a) Revolving [like cash credit] b)Term Credit

5. Interest Rate: Generally 1% above the reference rate, rolled over every six moths

6. Currency: Generally USD, but can be any other currency, as required by the borrower and ability of the lender.

Segment 1: Euro-Credit Markets

Syndication of Loan:– Managing banks, as desired by the borrower– Lead bank, generally who takes the largest share of

lending– Agent bank, as required to take interest of the banks

in syndication and comply with the procedure – Common assessment of the borrower and his

country– Common documentation– In very few cases co-financing with IMF or IBRD is

possible

Segment 2: Euro-Bonds

• Euro-Bonds are unsecured securities • They are therefore issued by borrowers of high

financial standing• When they are issued by government

corporation or local bodies, they are guaranteed by the government of the country concerned

• Euro-Bond is outside the regulation of a single country. The investors are spread worldwide

• However foreign bonds are issued in only one country and are subject to the regulation of the country of issue.


• Selling of EB is through syndicates of the banks

• Lead manager advises about size, terms and timing of the issue

• Entire issue is underwritten• Lead manager’s fees, underwriting

commission and selling commission is somewhere between 2% and 2.5% of the value of the issue


• Lead manager allocates the bonds to all members of the selling group at face value less their commission

• Thereafter every member is on his own• They can sell to investors at whatever price

they can obtain• Thus no two investors in the Euro-Bond

market need pay the same price for the newly issued bonds


• Features of Euro-Bonds:– Most Euro-Bonds are bearer securities– Most bonds are denominated in USD 10,000– Average maturity of the Euro-Bond is 5 to 6 years– In some cases maturity extends to 15 years

• Types of Euro-Bonds:– Straight or Fixed Rate Bonds– Convertible Bonds– Currency Option Bonds– Floating Rate Notes

Straight or Fixed Rate Bonds

1. These are fixed interest bearing securities2. Interest is normally payable yearly3. Year is considered of 360 days4. Maturities range from 3 years to 25 years5. Right of redemption before maturity may be

there or may not be there6. If the right of redemption is there then

redemption is done by offering an agio(premium)

Convertible Bonds

1. These are fixed interest bearing securities2. Investor has an option to convert bonds into

equity shares of the borrowing company3. The conversion is done at the stipulated price and

during the stipulated period4. Conversion price is normally kept higher than the

market price

Convertible Bonds

5. The rate of interest is lower than the rate of interest on comparable straight bond.

6. Sometimes the bonds are issued in a currency other than the currency of the share. This provides an opportunity to diversify the currency risk as these bonds are issued with fixed exchange rate of conversion

7. Bonds with warrants: warrant is part of the bond but is detachable and traded separately, when the conversion takes place. The investor can keep the bond and trade the warrant for shares.

Currency Option Bonds

• They are similar to straight bonds• Generally issued in one currency and option

to take interest and principal in another currency.

• Exchange Rate is either fixed (generally not) or is spot rate prevailing in the market three business days before the due date of payment of interest and principal

Floating Rate Notes• FRN is similar to straight bonds with respect to

maturity and denomination• Rate of interest however varies and is based on LIBOR

+ 1/8%, ¼%,1.5%........• Rate of interest is adjusted every six months• Minimum interest rate clause may be included• ‘drop lock’ clause may also be included, which means

if minimum interest rate happens to be paid then it is locked for the remaining period of the bond.

• Generally it is found that banks issue and invest in FRNs

Segment 3: Euro-Currency Deposits

1. Euro-bonds represent the funds amassed by the bank on behalf of international borrower; Euro-currency deposits represent the funds accepted by the bank themselves.

2. The Euro-currency market consists of all deposits of currencies placed with the banks outside their home currency.

3. The deposits are accepted in Euro-currencies, as well as currency cocktails (SDR, ECU etc.)

Segment 3: Euro-Currency Deposits

4. The deposits are placed at call (overnight, two days or seven days notice) for USD, Sterling pounds, Canadian dollars and Japanese Yen; and of two days in any other currencies

5. Time deposits are accepted for periods of 1,3,6 and 12 months for all currencies

6. USD and Sterling pound can be placed for a period of five years

7. Minimum size of deposit is USD50,000 or its equivalent

Segment 3: Euro-Currency DepositsCertificate of Deposit

1. It is negotiable instrument2. They are bearer instrument and can be traded

in the secondary market3. Period: 1 year (1 month through 12 months)4. Minimum amount: USD50,0005. Currencies: USD, Sterling Pound, Yen6. Interest Rate: 1/8 % below LIBOR7. Tranche CD: carries different rates of interest

for each tranche8. Discount CD: they are issued at discount

Segment 4: Euro-Notes Market1. This market constitutes the instruments of

borrowing issued by the corporates in the Euro-currency market

2. The instruments issue may be underwritten or may not be underwritten

3. The borrowers directly approach the lenders without the intermediation of the banks or financial institution.

4. Instruments are of the following categories:1. Commercial Paper2. Note issuance Facilities3. Medium Term Notes

Commercial Paper

1. It is a promissory note with maturity less than a year, generally the period varies between 90 days to 180 days

2. Generally issue is not underwritten3. Amount: USD 100,000 or equivalent4. Issued on ‘Discount to Yield ‘ basis, but interest

rate works out lesser than that is paid on bank borrowing and higher than that is paid by the bank on deposits

5. They are unsecured instrument

Note Issuance Facilities (NIF)

1. Borrowers place short term notes of 3 months to 6 months maturity directly with the investors

2. The notes are rolled over on maturity3. The banks underwrite at the time of issue as

well as when the notes are rolled over4. With slight variation they are also known as:

1. Revolving underwriting facility (RUF)2. Standby Note Issuance Facility (SNIF)3. Note Purchase Facility (NPF)

Medium Term Notes

1. MTN represents Long Term, Non Underwritten and fixed interest rate source of raising finance.

2. It can be comparable with Euro-bonds with a difference that Eurobonds issue is underwritten, where as MYN issue is not underwritten.

3. Their maturity is somewhere between short term CPs(less than one year) and long term Euro bonds(more than five years)

4. They are privately placed and have great flexibility

Euro-Issues

• Access to Euro Equity Market is through the following two ways:1. Foreign Currency Convertible Bonds2. Depository Receipts

(FCCB has already been explained)

• Depository Receipts:1. Global Depository receipts2. American depository Receipts

Global Depository Receipt (GDR)

• Shares of the issuing company are issued in the name of an international bank, located in foreign country and is called as ‘Depository’

• The physical possession of the shares issued is with the ‘Custodian’, in the issuing country

• Based on the shares issued to depository, depository issues GDR in USD

• GDR is a negotiable instrument• GDR is a bearer instrument and traded in

international market, either through ‘stock exchange’ mechanism or on ‘Over The Counter’ basis

Global Depository Receipt (GDR)• The settlements are done through international clearing

systems like ‘Euro-clear’ (Brussels) or CEDEL (London)• GDR is denominated in US dollars, that represents shares

issued in local currency• Issuing company pays the dividend to the depository in

local currency• Depository converts this local currency into USD at the

ruling exchange rate and distribute it among the GDR holders pro rata

• Exchange risk is borne by the investor• Voting rights are only with the depository and are

regulated by the agreement between issuing company and the depository

American Depository Receipts

• They are similar to GDR, but issued in USA.

Issues in Foreign Domestic Market

• When bonds (or equities) are issued in only one foreign domestic capital market, they are known as:– Yankee Bonds, if issued in US domestic market– Bulldog bonds, if issued in UK domestic market– Samurai Bonds, if issued in Japanese domestic

market• Reliance industry, ICICI, Infosys Technologies

etc. tap the foreign markets

Thank you

euro-currency market dnc

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