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) Then started lending – borrowing. 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.M.S.Origin E. flow of funds to London based banks with high interest rates. banks could not compete with banks in London in rates on deposits. .M.Contributory Factors for E. Regulations on Assets / Loans Glass – Steagal Act (1933) restricted banks from entering into investment banking. brokerage and insurance. Development Regulations on Liabilities / Deposits Limitation on maximum interest rates on deposits – Regulation Q Hence U.S. Contributory Factors for E.S. Development Federal Reserve Regulation .M.M. Capital control under voluntary credit restraint programme (1964-74) due to BOP problems in U. . Reserve requirements on deposits – deposit insurance – Absence in Europe banks. controls and restrictions on borrowing funds in the U..S. Development Convenience and cost advantages to hold dollars deposits outside U.Contributory Factors for E. for reinvestment abroad . Foreign Direct Investment Regulations Restriction on $ overseas investment i.S.M.e. the oil boom. interest equalization tax – 1963-74.M. . residents’ earnings on foreign securities.S.Contributory Factors for E.S. that did not apply overseas. Other limitations in the 1960s and 70s on obtaining loan within U. rise in prices etc. U. It was a tax on U.S. Development OPEC surpluses in the 70s.. 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 . growing financial needs innovation in financial services Revolution in communication technology – CHIPS / SWIFT .General Factors Growing BOP deficits of majority of developing countries. General Factors Role of Narrow Spread Depositors’ demand for the highest yield – borrowers to pay the lowest cost. sheer size and a number of informal contacts the banks can charge lower borrowing costs. deposit insurance and other costly regulation Eurobanks can offer higher interest on deposits. . Due to absence of reserve requirements.Due to absence of controls/ regulations. . it has also to a great extent contributed to destabilization of exchange rate system.Consequences Just as the Euro dollar has brought about economic miracles by providing finance to economic development and world trade. . Consequences Freely circulating mass of Euro-market funds is much larger than the reserves in the central banking system. . the central bank’s defensive mechanism. Consequently. intervention is rendered ineffective. in case speculative forces dominate exchange market. .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. Emergence of Off-shore Banking Centres Singapore. Hongkong. . Jersey. London. Bahrain. Manila. Nassau.Expanding Size of the market due to multiplier effect. 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 . Arbitrage .Space long run .Interest rate . Arbitrage operation .Time arbitrage Financing foreign trade operations Improving liquidity through SWAP operations Funding loan assets .Uses Borrowing at lower interest in the short run to lend at higher rate in the long run. Innovations Syndicate loan + bond Swaps . securitization – transforming credits into negotiable instruments. several hybrid varieties – encompassing features of bond. tax and other policy frames. . syndicate loan and swaps have been developed in response to emerging needs circumstances including circumventing regulation. Borrowers in the Euro market issue Short Term Bonds / Promissary Notes – backed by standby facilities.In between these two. Market in long term thin.Mechanics of Euro Dollar Market Call funds: 7 to 15 days. handle Euro currency. Mostly foreign exchange Dept. . System of two-way quotations – bid and offer. 1month to 12 months. Dealing through brokers / Direct. SIBOR.. All transactions are spot.000. BIBOR. . Banks run: graded maturities-i. HIBOR. Variety of interest rates: LIBOR. borrow short and long term.e.Mechanics of Euro Dollar Market Stipulating credit limit on borrowers. JIBOR etc. Usual amount is 1 mn and it might be as low as $ 25. Wholesale market. variety of innovative instruments have been developed for lending and borrowing in the Euro currency markets.Facilities / Instruments / Innovations In response to changing economic. . legal and fiscal circumstances. 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. . a hybrid variety.Facilities / Instruments / Innovations Euro 2000 coupon bonds. 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. FLOATING RATE NOTES (FRN): A large variety of FRN. . E. Earlier they were at fixed rates of interest.Euro bonds Market Euro bonds are unsecured obligations of a borrower issued to investors all over the world.g. A large variation emerged as a result of changing market conditions. 5. Option bonds => with option of receiving interest/principal in different currencies. 6. Convertible bonds => with option to convert equity shares of issuing …. 7. Dual currency 3.Types of Bonds 1. Issued in domestic . 4. Bonds with warrants => warrants provide option – purchase shares or traded separately. Zero coupon bond => No interest during life time but issued at substantial discount to par. Convertible bonds => convertible into shares dominated into different currency. Straight bonds => Fixed coupon 2. Foreign bonds => capital markets. SWAP does not change or affect position in foreign currency.SWAPS Most common forward transaction is SWAPS => SWAP involves buying and selling same amount of foreign currencies for different maturities. . Exchange of fixed to floating rate of interest rate viceversa. In currency swaps both principal and interest amount are swaped. .Interest rate swaps and currency swaps. from one interest base to another. or involving both – used for obtaining low cost financing. obtaining high yielding assets. A/c management or speculation.SWAP is a financial transaction which involves two parties agreeing to exchange streams of payment over time on the basis of certain understanding. one currency to another. change in currency exposure. . Minimising exposure to a single borrower. . Based on principle of ‘Risk Spreading”.Syndication of Loans The process of making a loan jointly as a syndicate by using common loan documentation is known as syndication. the syndicate called off. In the case of poor response. .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. 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. . The Lead Manager invites bids and makes available all details. . Lead Manager => Role => Lending banks. in case of poor response.Techniques of Syndication Firm Commitment Syndication: Lead Manager undertakes the responsibility to provide full amount of loan and then offer to the market.