intlfin mktsandinstrmts

8/2/2019 IntlFin MktsandInstrmts

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International Financial

Markets and InstrumentsAn Introduction


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Globalization --- New Phenomenon

Alan M. Taylor (2004) noted that the surge ininternational payments we see today occurredearlier, between 1870 to 1914

Laura Brown (1997) , Canada, Globalizationand Free Trade: The Past is New! wrote thatthe globalization phenomenon we areexperiencing was also seen at the turn of thelast century.

Brown focussed on North America

In Mexico it ended with a revolution.


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Globalization 2nd surge

Both periods are similar with greatchanges in transportation andcommunication (telegraph, train era)

Taylor notes that last period, worldeconomy had a gold standard, now mixedflexible exchange rates

earlier period, a lot of the flow was todeveloping regions, now mostly betweendeveloped


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Globalization 2nd surge

What can we learn from this?

Even when a trend seems new andunstoppable

.Trends can end, sometimes abruptly

and be reversed

The forces that cause the end are oftenpresent but ignored during the surge(environmental problems, inequality)


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Back to the present markets andInstruments

This chapter surveys assets

1. International bank lending

2. International bonds

3. Inernational stock markets (and mutual funds)

4. Derivatives

It will examine

size

how they work


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International Bank Lending

The exclusively domestic approach tounderstanding money is no longer valid.

Some first year texts already discussinternational transactions and exchangerate risks (McConnell & Brue, for example)

Why not only domestic approach?

the size and scope of internationaltransactions are huge

even small investors and companies can be

part of the international lending market


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Bank lending

International bank lending can occur formany reasons

domestic banks lend to private firms abroad

who are making real investments

domestic banks purchase foreign financialinstruments, if return is higher than at home

foreign banks may borrow from domesticbanks to have working balances of domesticcurrency


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Bank lending

Table 1 (coming up) shows total banklending from the Bank for InternationalSettlements (BIS) (http://www.bis.org)

BIS acts as a clearinghouse for centralbank settlements, deals with internationalbanking matters, and promotesinternational financial cooperation
http://www.bis.org/http://www.bis.org/


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Gross international bank lending is thesum of total cross-border claims and localclaims in foreign dollars.

Net international bank lending is thisgross number, lessinterbank deposits

Interbank deposits are deposits by

foreign banks in home banks and homebanks in foreign banks. They arent reallyloans, but exist to facilitate internationaltransactions --- they are big


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Table 1. Gross and Net International BankLending, Dec 2003 ($bil)

(1) Total cross-border bank claims $14,944.3

(2) Local claims in foreign currency 2,147.1

(3) Gross international bank lending 17,091.4

(4) Minus: Interbank deposits 10,486.4

(5) Net international bank lending 6,605.0


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$6,605 billion dollars is a lot of money.

To provide a further perspective, the next tableshows bank liabilities(deposits, not loans) as apercentage of GDP for various internationalbanking centres

Looking at the last column, in 2006, the areawith the smallest liabilities to GDP ratio is

developing countries at 16% The highest area is Carribean offshore, where

these liabilities constitute 5,608 % of GDP.


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International bank lending

There are 3 components to bank lending domestic bank loans in domestic currency to

nonresidents (German bank lending Euros to US firm for

purchase of German exports) domestic bank loans in foreign currency to

nonresidents (German bank lends dollars to US firm to buy

Saudi oil) domestic bank loans in foreign currency to

domestic residents (German bank lending dollars to German firm to

buy Saudi oil)


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Component 1 is called traditional banklending this type of lending facilitates trade, it has a

long history Components 2 and 3 are more recent

they are part of activity in the eurocurrencymarket (aka eurodollar market)

The eurocurrency market is the market forcurrencies outside the home country. (ex.British bank lending dollars)


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Eurocurrency Market

Historically, this was the Eurodollar marketbecause it was based on US dollars in Europeanbanks

US dollars came to be important in Europe in the

1950s, (after WWII, during the Cold Warbetween US and the Soviet Union)

Soviet Union shifted its dollar accounts out of USto Britain in case US decided to seize the money

Britain had currency controls on British poundsUS dollars were not controlled US had controls on interest rates that could be

paid to depositors, these didnt apply to Britishbanks with US dollars


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Eurocurrency Market

Also, in 1960s, US introduced policies thatincreased demand for Eurodollars

Federal Reserve introduced lending

guidelines to discourage loans to foreigners,also taxed these loans

Vietnam war caused US to tighten money

supply at home, and so, US dollars werecheaper to borrow in Europe than in US


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Eurocurrency Market

On the supply side Oil shock! 1973-74.. OPEC quadrupled oil

prices, which were denominated in dollars,

OPEC countries (wisely for the time)deposited dollars in European banks

In sum a lot of dollars have beendeposited and loaned in Europe. And now,a lot of various currencies are depositedand loaned in other countries.


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Eurocurrency Market

Like all bank deposits, Eurocurrencyincreases with the multiple-depositexpansion process

An initial $1 million dollar deposit in aEurobank can become $10 million in depositswith a 10% reserve.

$1 million deposited -> $0.9 mil loaned,deposited again

$0.9 million deposited -> $0.81 mil loaned

Final result $1 mil / 0.1 = $10 million


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Eurocurrency Market

The rate of interest on loans is based on the LondonInterbank Offered Rate (LIBOR)

LIBOR is found by an average of the rate of interest

that major banks are using when lending money toeach other

Other parties can borrow at a rate that is aboveLIBOR

Note: international banks dealing in loans in foreigncurrency are still sometimes called eurobanks eventhough it may be a Carribean bank loaning yen.


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Eurocurrency Market

The effect of eurocurrency markets is thatinternational financial transactions are very easy.

They have also encouraged the relaxation of barriers

to capital flows (since such a barrier will simplyencourage this market)

There are concerns though, because the centralbank of an issuing country has no control over

eurocurrency, and so it can increase home marketinstability.

This is a bigger concern for the US, because itscurrency is a major part of the Eurocurrency market.


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International Bond market

Governments and corporations issuebonds, which are a form of borrowing afixed amount for a fixed period of time.

The maturity period is the time of the loan.

Notes: maturity is less than 10 years

Bonds: maturity is 10 years or longer


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Bonds have a face valueor maturity valuewhich is the value of the bond at thematurity date.

For example, a bond may have a value of$5,000 upon redemption at maturity.

Bonds will also have interest payments, ora coupon rate which are usually paidyearly. For example, a $1,000 bond paying 5%

coupon rate will yield an annual payment of

$50.


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Bond underwriters are banks or financialinstitutions that sell the bonds for theissuing entity.

If a bond has an underwriter, then theunderwriter essentially buys all the bondsand resells them. It receives a fee for this

service, and because it bears the risk thatthe bond issue will not sell out.


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A sometimes blurred distinction of bond markets

Foreign bond market is used when a borrowerin one country issues bonds in a second, host,

country. Sale is mainly to residents of the hostcountry

Eurobond market is used when a borrower inone country issues bonds in many countries,using a multinational loan syndicate. Thesebonds could be in several currencies.


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Size of market:

The stock of bonds and notes at the end of2003 was $11,681.4 billion

Issued in Euro area $4,524.2US $3,105.9

Japan $ 120.9

Offshore centers $ 750.4Other countries $ 564.3

Intl Institutions $ 507.1


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More were issued in Euros than US dollars($5,104.8 Euros, $4,655.6 US$, $859.8British )

$8,546.5 bil issued by commercial banksand other financial institutions.


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International Bond market Bond market grew for the same reasons

Eurocurrency market grew

US tax on on income from new and existingforeign securities held by US citizens (Interest

Equalization Tax or IET) voluntary lending restraints on US banks

lending abroad

Price of European bonds fell in US(interest rate higher) so US people wouldbuy them

lenders issued bonds in Europe


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International Stock Markets

Stock holding allows you to own a tinypiece of a company

If you own a lot, then there is an elementof control in the purchase of a stock

In practice, that is rarely meaningful.

Size of market is difficult to measure asthe information is not collected in manycountries


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We know the market has grown from countries thatdo collect data

Cross-Border transactions in stocks as a percentage

of GDP (gross purchases and sales)

Country 75-79 80-89 1999

Germany 1.6 % 7.3 % 83.4 %Japan

0.6 % 9.7 % 29.1 %

US 1.9 % 6.7 % 53.1 %


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We know the market has grown from countries thatdo collect data

Cross-Border transactions in stocks as a percentage

of GDP (gross purchases and sales)

Country 75-79 80-89 1999

Germany 1.6 % 7.3 % 83.4 %

Japan 0.6 % 9.7 % 29.1 %

US 1.9 % 6.7 % 53.1 %


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International Stocks

Developing countries are becoming moreimportant as issuers of international stocksas their governments open theireconomies.

Most (not all) showed significant gains intheir stock price indices through 2003.

Example (in dollar terms): China - 8.4 % - Chile 50.2 %

Indonesia 117.2 % - India 88.3 %

Mexico 26.2 % - Peru 107.8 %


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International Stocks

The statement that international financialflows are not going to developing countriesduring this surge in internationalization isnot entirely exact.

There is money flowing south, just not a lotcompared to the vast amounts flowingbetween developed countries.


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International Stock markets

The problem with stock market transactions isthat people occasionally act like lemmings

one leads all follow whether it be to wealth or a

crash

This can lead to increased volatility inmarkets if one market has high stock prices,

people should lower demand, but if theexpectation is that prices will rise even higher,

demand increases, driving prices higher


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Similarly, if one market has low stock prices,

people should increase demand, but if theexpectation is that prices will fall even lower,

demand falls, driving prices down, sometimes to acrash

Sooner or later, the underlying value of

companies will cause soaring markets to fall,or help languishing markets recover. (usually)


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When demand behaves as it is expected to,given rational decision-makers

high price lowers demand

low price raises demand

Then, the international purchase of stockswould push yields toward convergence,

where stocks with similar risks in differentcountries have the same return

I t ti l P tf li


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International PortfolioDiversification

Investors can reduce the risk of losing a lotof money in a crash by holding stocks indifferent countries.

This is called guess what?

This way, there is a smaller gain when amarket soars, and a smaller loss when itcrashes, so that investors can earn a good,but steady return.

I t ti l P tf li


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International PortfolioDiversification

One tool that can help with diversification is mutualfunds

With a mutual fund, investors need very little

information on the countries and companies inwhich they are investing

They trust fund managers to purchase equities(stocks) and other financial assets and to managethe mutual fund portfolio for a long-term gain

They mainly need to look at fun performance tomake a decision about which funds to choose

I t ti l P tf li


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International PortfolioDiversification Types of funds

Global funds contain stocks of corporations inmany different countries, including the homecountry

International funds hold stocks of corporationsoutside the country

Emerging market funds hold developingcountries stocks

Regional funds hold stocks in specific regions(Asia, Latin America, China..)

Funds can charge fees load entry, exit, as well asmanagement ratios.


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International Markets

There are costs and opportunities with thegrowth of these international markets

International stock market, bond market and

currency markets can all serve to help fundsmove to where they can be best used.

These markets can lead to convergence of returns across the

world for investments with similar risks can lead to wild swings due to bandwagon effects

can encourage more freedom in international

transactions.


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Review

What can we learn from previous surges ininternational finance?

What is a eurocurrency?

What is the difference between aeurobond and a foreign bond?

Name and explain the four types of mutualfunds.


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Financial Linkages andEurocurrency Derivatives

Now we will look at how financial marketsare linked through interest rates andexchange rates

Later we will look at more financialinstruments that can be used for hedgingor speculation, called derivatives.


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Financial Linkages

In the last chapter, we looked at financiallinkages between exchange rates andinterest rates in various markets.

We now have (at least) two more marketswhere these links can be observed.

Given our example of US and London

markets, we can add US dollar market in London (eurodollar)

British market in US. (eurosterling market)


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Financial linkages

First, lets recap what we learned aboutthe markets in Chapter 20.

Remember the domestic investor who isconsidering international investmentsmust consider

1. the domestic rate of return

2. the foreign rate of return

3. expected changes in the exchange rate

Fi i l li k


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Financial linkages

The parity condition withoutconsideration of exchange rate risk was:

(1+ ihome)/(1+iforeign) = E(e)/e

We had set

xa= 1 + E(e)/e

then showed that the above could be writtenas

(ihome - iforeign)/(1+iforeign) = xa

which could be approximated by

(ihome - iforeign) = xa

Fi i l li k


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Financial linkages

The parity condition without

(ihome - iforeign) = xa

states that equilibrium occurs in theinternational financial market when the

difference in interest rates is offset by theexpected appreciation of the foreigncurrency

Because xais an estimate, if actors arerisk-averse, we replace this conditionwith:

(ihome - iforeign) = xa -RP

Fi i l li k


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Financial linkages

The parity condition without

(ihome - iforeign) = xa- RP

states that equilibrium occurs in theinternational financial market when the

difference in interest rates is offset by theexpected appreciation of the foreign currencyless a risk premium for this investment

If RP is the risk premium for expectedexchange rate risk, and this risk can becovered in the forward market, we have theequivalence of two conditions.

(ihome - iforeign) = p = xa -RP


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Financial linkages

Now let us consider the financial markets with theinclusion of eurocurrencies

We now have 6 prices to consider:

Interest rates: U.S. interest rate (in US) U.K. interest rate (in UK)

eurodollar interest rate

eurosterling interest rate Exchange rates:

spot rate (dollars/pound)

forward exchange rate (dollars/pound)

R l ti b t h t d


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Relation between home rates andEurorates

As the graphs show, there is a consistentpattern between US interest rates athome, and the eurodollar rate, as

summarized by LIBOR. The LIBOR deposit rate is slightly higher

than the deposit rate in the US

The LIBOR lending rate is slightly lowerthan the lending rate in the US.


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Market adjustment with six markets

In the text, they show adjustment to atightening of monetary policy in the US.

The first graph shows the NY money

(financial) market. tighter monetary policy is reflected as a shiftup of the money supply curve

The second graph is the London money

(financial) market lower supply in the US shifts demand for

investment dollars to London, increasingdemand


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The third graph is the spot exchangemarket (price of s)

the higher US interest rate leads to an

increase in the supply of s as savers buy USsecurities at the higher rate

The sixth graph is the forward market

demand for s increases as those buying 3month securities want to bring the s home atthe end of the period.


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The fourth and fifth graphs are the Londonmoney markets (eurosterling financial andhome financial market)

there is pressure to increase the interestrate there (decrease supply) as saversshift funds to the US market. However, it

is possible for the British central bank tocircumvent that pressure, and the effect tobe played out only in the US andexchange rate markets


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Note, in all financial market the slides, theintersection of the curves is NOT whereequilibrium exists.

The text is careful to show that themovement of the markets maintains aspread between the lending rate and the

borrowing rate. Therefore, the equilibrium amounts are to

the left of the intersection.

H d i E d ll I t t R t


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Hedging Eurodollar Interest RateRisk

We already discussed how the forwardand futures markets can be used to hedgeexchange rate risk

Now we will look at instruments that areused to hedge against interest rate risk

These instruments are called derivatives

in the financial markets (because they areoffshoots of standard contracts) (Note: any instrument that is used for hedging

can also be used for speculation)


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Hedging Eurodollar Interest Rate Risk

We describe 8 instruments:1. maturity mismatching

2. future rate agreements

3. eurodollar interest rate swaps4. eurodollar cross-currency interest rateswaps

5. eurodollar interest rate futures

6. eurodollar interest rates options

7. options on swaps

8. equity financial derivatives

1 M i i hi


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1. Maturity mismatching

To hedge against a change in interest rate,a financial institution can acquire two ormore financial contracts whose maturities

overlap. Borrow short term and deposit long term to

lock in current interest rate for later deposit

Deposit short term and borrow long term tolock in current interest rate for later loan.

1 Maturity mismatching


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Example 1:

Firm is getting $100,000 in three months and needsto pay $100,000 in six months. Manager is worriedinterest rate will fall by 3 months and wants to lockin current interest rate for last 3 months.

Firm can borrow $100,000 for 3 months and deposit itnow for six months.

This way firm gets current interest rate on savings.

Cost is difference between deposit and loan rate forfirst 3 months.


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Example 2: Firm is loaning money in 4 months for an 8

month period. Manager is worried interest

rate will rise by 4 months and wants toacquire funds for loan at current interest.

Firm can borrow $100,000 for 12 months anddeposit it now for 4 months.

This way firm gets current interest rate onfunds, and can loan it at expected higherfuture interest rate.


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2. Future Rate Agreements (FRA)

This is an agreement on a future interestrate. It locks in an interest rate for a loanor deposit to be made at a future date for a

specific time Also called forward-forwardor forward-ratecontract

The purchaser is paid/charged thedifference between the posted interest rateand the agreed upon rate


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Example: Oly-west wants to borrow $1 mil in 6

months for a one-year period.

They purchase a forward rate agreementat 5.5 %. (the contract is for the rate, andthere is a fee)

If the market rate in 6 months is above

5.5 % the seller pays Oly-west thedifference between the two rates. (If rate is5.7 % seller pays 0.002X $1 mil. = $2000)

2 Future Rate Agreements (FRA)


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Example continued: If the rate in 6 months is below 5.5 %, the

seller receives the difference. (If rate is 5.35% seller receives 0.0015 X $1 mil = $1500)

Note: 0.20 % is called 20 basis points;

0.15 % would be 15 basis points.

By purchasing a forward rate agreement, thepurchaser gets a fixed interest rate instead ofa floating rate for the period waiting for theloan

3 Eurodollar interest rate swaps


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3. Eurodollar interest rate swaps

This is similar to forward rate agreements,except

there are two different kinds of interest rates for anumber of time periods in the future

it can involve two floating rates, one relative toLIBOR, another relative to a specific basket ofcurrencies (floating-floating swap)

3 Eurodollar interest rate swaps


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3. Eurodollar interest rate swaps Text example:

Ms. Smith has an 8 percent, three-year euro-dollarbased loan she wants a variable rate loan

Mr. Brown has a eurodollar loan. He is paying six-

month LIBOR+30 basis points. They swap interest rates.

If interest rates fall, Smith gets the lower floatingrate.

If they rise, Brown now has a fixed rate loan.

If they fall and look like they will rise, Smith canswap again for a new, lower, fixed rate.

4. Eurodollar cross-currency


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yinterest rate swaps

This is similar to interest rate swap, but alsoincludes currency swap.

A holder of a fixed rate loan in one currency

can change it for a floating rate in anothercurrency.

Or it can exchange a floating rate in one

currency for a floating rate in a differentcurrency.

This one hedges the currency as well as the

interest rate.

5 Eurodollar interest rate futures


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5. Eurodollar interest rate futures

These are similar to interest forward rateagreements, but with the same types ofdistinctions we see in future exchange rateagreements.

they are transacted on organized exchanges(CME)

they are for fixed periods (3rd Wed. of month)

they are for fixed amounts

gains and losses are paid daily in a marginaccount



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Eurodollar interest rate futures allow actors tolock into fixed interest rates in specificeurocurrencies.

If funds are coming in at a future date (say $3

mil) you can lock in an interest rate now.

At the completion date, the earnings on themargin account represent the difference

between the current contract rate and LIBOR.



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Therefore, investing margin funds and the $3 mil is

the same as investing $3 mil at the current interestrate.

This would be done if you want to hedge against afall in interest rates between now and the time you

have funds to invest. this is called a long hedge

A borrower can guard against a rise in interest rateby selling a futures contract expiring at the point

where they will be borrowing funds. The marginaccount earnings would in essence hedge againstthe interest rate rising. this is called a short hedge.



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The text provides a table of Interest Rate FuturesMarket Quotations, for Monday Mar 29, 2004 (whichgives you an idea of when this book went to press)

The contract is for $1 million

The change in contract price is measured in basispoints per quarter, and represents $25.

(1,000,000 X0.0001/4)= 25

The price is relative to 100, that is, 100 price is theyield on the contract.

price is 100 spot LIBOR



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For contracts expiring in June, the Open priceis 98.83, and the settle price happens to bethe same.

Adjustments to margin accounts are based onthe settle price.

98.83 means the yield is 1.17.

The previous days price was 98.84 On expiry, the futures yield converges to

LIBOR.



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For long period hedges (up to 7 years), actorscan by a stripof three month futurescontracts. (ex. expiry April, June, Sept.,Dec)

Or they could buy a strip, and then roll it overfor a new one again and again.. this is calleda stack.

Banks (and others) can combine hedgingcontracts on interest rates and on currenciesfor specific future needs.

6 Eurodollar interest rate options


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6. Eurodollar interest rate options

Like exchange rate contracts, there is also anoptions market for interest rates

Up until now, all contracts require anexchange to be made, whether the interest

rate moves in a favourable direction or not. Again, as in exchange rate contracts, actors

can participate in this option market by:

buying a call option selling a call option

buying a put option

selling a put option



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buying a call option gives the purchaser the

right to purchase a eurodollar time depositbearing a certain interest rate at a specificdate. there is an up-front price, called the option

premium.

the buyer can choose to exercise the option (if themarket rate is below the option rate)

or not exercise the option, if the market rate isabove the option interest rate.

If interest rates are expected to fall, thepremium will be higher than if they are

expected to rise.



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buying a put option gives the purchaser the

right to sell a eurodollar time deposit (acquireeurodollars) bearing a certain interest rate at aspecific date. there is an up-front price, called the option

premium.

the buyer can choose to exercise the option (if themarket rate is above the option rate)

or not exercise the option, if the market rate isbelow the option interest rate.

If interest rates are expected to rise, thepremium will be higher than if they are

expected to fall.



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On the other side of the market, an actor cansell a call option or a put option.

The seller earns at most, the premium.

The buyer pays, at most, the premium. Options contracts are like futures contracts,

traded for fixed amounts ($1 mil) in 3 month

periods ( Apr, Jun, Sept, Dec) Options for longer periods can be

constructed using a series of agreements.



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Caps, floors and collars: Cap: agreement to pay purchaser if the

interest rate rises above a certain level.

Floor: agreement to pay purchaser if theinterest rate falls below a certain level.

Collar: agreement to pay purchaser if the

interest rate moves outside a specific range. Often a floating rate loan agreement will

have a provision with a cap. (Ex. 7 5 above

LIBOR)



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Caps, floors and collars: Cap: agreement to pay purchaser if the

interest rate rises above a certain level.

Floor: agreement to pay purchaser if theinterest rate falls below a certain level.

Collar: agreement to pay purchaser if the

interest rate moves outside a specific range. Often a floating rate loan agreement will

have a provision with a cap. (Ex. 7 5 above

LIBOR)



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Caps, floors and collars:

A floating rate deposit can be protected by

purchasing a floor agreement, for apremium.. has the same effect as a strip ofcall options (Ex. 7 5 above LIBOR)

7 Options on swaps


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7. Options on swaps

As financial instruments, capswere verysuccessful.

The market next introduced options onswaps

It is, as the name implies, an option to swapinterest rates

purchaser of a call option to swap

(swaption) has the right to receive a fixedrate in a swap and pay a floating rate. purchaser will exercise option if fixed rate is

above floating rate

7 Options on swaps


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7. Options on swaps

purchaser of a put option to swap(swaption) has the right to pay a fixed ratein a swap and receive a floating rate.

purchaser will exercise option if fixed rate isabove floating rate

7 Options on swaps


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7. Options on swaps

You can also buy the option to cancel aswap

call option (callable swap) side paying the fixed rate and receiving the

floating rate can cancel swap

put option (putable swap) option buyer paying the flexible rate and

receiving the fixed rate has the right to cancel

8 Equity financial derivative


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8. Equity financial derivative

So far, we have talked about derivatives ofthe exchange and interest rate markets

In an equity swap, an investor can swap

the returns on a currently owned equity toanother investor for a price

With international markets, investors inone country can buy and hold equities andagree to pay investors in another countrythe gains and losses for an agents fee.

8 Equity financial derivative


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8. Equity financial derivative

This practice keeps the foreign investorsidentity secret

allows investor to get advantage of

ownership of foreign equity withoutworrying about local rules of ownership,fees for foreign purchasers of equities, etc.

Growth in derivative markets


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Participants in international financial marketscan alter their exposure to foreign exchangerate and interest rate risk to meet their personal comfort level for risk

their changing expectations about the directions ofrisk

their capacity for bearing risk

their knowledge about the markets and ability to

assess risk They can also participate in market to make

profits from other investors wishes to alter risk

exposure



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The growth in derivatives has been phenomenal

From 1987 to 2003 the growth in exchange-ratetrade instruments (interest rate futures, interest

rate options, currency futures, currency options(falling), stock market index options) was from

$730 bil. to $36,750 bil

Exchange rate traded instruments are traded onorganized exchanges, like the CME


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O l t h


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One last phenomenon

We cant talk about international financewithout mentioning loan syndicates

This is when a group of banks agree to

provide a loan to a corporation or country,and sells shares of the credit to a widerrange of smaller banks.

The syndicate will usually appoint amanager for the loan agreement

L di t


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Loan syndicates

In a direct loan syndicate the syndicate banksare making the loan themselves. They are co-lenders

In a loan participation syndicate thelead

bankexecutes the loan with the borrower andsyndicates the loan by entering into agreementswith other banks

By syndicating a loan, a bank reduces its riskexposure banks share risk and return.

R


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Recap

This chapter has taken us from theestablishment of the Eurodollar market tothe range of international financial

derivatives With Eurodollars, market adjustments can

help coordinate prices in 6 markets (2

exchange rate markets, 4 interest ratemarkets)

Recap


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Recap

We introduced 8 international financialderivatives

1. maturity mismatching borrow and loan fordifferent periods

2. future rate agreements forward purchase offixed rate loan

3. eurodollar interest rate swaps swapping fixedor flexible loan, or floating based on LIBORwith different based interest rate

4. eurodollar cross-currency interest rate swaps -#3 with different currencies involved

Recap


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Recap

We introduced 8 international financialderivatives

5. eurodollar interest rate futures Setfuture purchases on margins in

recognized exchanges ($1 mil basispoint margins)

6. eurodollar interest rates options (options

on forward interest rates)7. options on swaps (just what it says)

8. equity financial derivatives

Next Chapter


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Next Chapter

In the next chapter, we start on theeconomic theory of the financial markets

It is, necessarily, simple compared to the

myriad of instruments that can be traded It starts to try to explain the why of

exchange rate and BoP movements.

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