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					Lecture 13: International Money
                        Markets


            The Eurocurrency Markets
Where is this Financial Center?
Grand Cayman
 Stingray City   Turtle Burgers
    Grand Cayman Islands as an
    Offshore Financial Center
   Offshore Financial Center:        Grand Cayman Islands (population 52,000):
    Countries or jurisdictions           533 banks, with approximately US$415 billion in
                                          deposits (making it fifth largest financial center in
    with financial centers that           the world). Other financial companies include
    contain financial                     insurance, cash management, asset
    institutions that deal                management (including hedge funds).
    primarily with nonresidents          Foreign companies generally register as an
                                          ―exempted company‖ because they are
    and/or in foreign currency            guaranteed against any future taxes for at least
    on a scale out of                     30 years. In addition, its list of shareholders is
    proportion to the size of             not open to public inspection, they do not have
                                          to file annual returns and no annual audits are
    the host economy (OECD                required.
    definition).                         Total start-up costs to form an exempted
       Characterized by a low (or        company range between $2,300 and $3,000.
        zero) tax environment and         Annual maintenance costs and government fees
        specializing in providing         thereafter run about $2,000
        corporate and commercial         There are no personal income taxes, no
        services (including               corporate income taxes, no capital gains taxes,
        investment services) to non-      no withholding taxes, no estate, gift or
                                          inheritance taxes, no sales taxes in the Cayman
        resident entities on a            Islands. The Caymans have no tax treaties with
        confidential basis.
                          .
                                          any nation.
Examples of Offshore Financial
Centers: IMF Data (1999)
Africa       Asia and       Middle East   Europe          Western
             Pacific                                      Hemisphere
Djibouti     Cook Islands   Bahrain       Gibraltar       Bahamas
Liberia      Guam           Israel        Isle of Man     Barbados
Mauritius    Hong Kong      Lebanon       Liechtenstein   Bermuda
Seychelles   Macao                        Luxembourg      Cayman Islands
Tangier      Philippines                  Malta           Panama
             Singapore                    Monaco          Puerto Rico
             Tahiti                       Switzerland     St. Lucia
The International Financial Market
   It is the overall financial environment in which global
    businesses and global investors operate. It is
    represented by the following three sectors:
       (1) Foreign Exchange Markets
           Currency markets (including foreign exchange regimes)
       (2) International Money Markets (Markets for short term
        funds)
           Traditional Financial Centers servicing both their domestic
            markets and non-residents (e.g., London, New York, Chicago,
            Tokyo)
           Offshore Financial Centers Markets consisting primarily of non-
            resident financial institutions and non-resident clients: (e.g.,
            Cayman Islands, Singapore, Hong Kong).
       (3) International Capital Markets (Markets for long term
        funds)
           Bond markets (Lecture 14)
           Equity markets (Lecture 15)
International Money Markets
   The International Money Market represents the short
    and intermediate term borrowing and investment
    market.
   Global firms have access to the international money
    markets either through (1) financial intermediaries
    (primarily large global banks) or through access to
    (2) direct financial markets.
       Intermediary markets include:
           Eurocurrency Loan Market (i.e., Euro-Lines of Credit)
           Eurocredits Market (i.e., Syndicated Eurocredits)
       Direct markets include:
           Short Term and Medium Term Euro-notes Market
           Eurocommercial Paper Market
The Eurocurrency Market
   The international money market has as its core the
    euro-currency deposit market, also called the
    offshore currency market.
   A Eurocurrency is a freely convertible currency
    deposited in a bank outside its country of origin.
       For example, Eurodollars are U.S. dollar-denominated time
        deposits in banks located outside of the United States.
   This deposit market supports the borrowing and
    lending of ―offshore‖ currencies.
   Banks accepting euro-currency deposits can be
    local banks (i.e., domestic to the financial market),
    or foreign banks operating in the local market
    (including U.S. banks).
       These banks are referred to as Eurobanks. Major
        Eurobanks include Citi, Deutsche, and UBS.
    History of the Eurocurrency Market
   Market originated in the 1950s, when communist
    governments (mainly the Soviet Union) needing dollars for
    international trade and concerned about a potential freeze of
    their dollar accounts in US banks, shifted their deposits to
    London.
       The first bank in the London market accepting these dollar deposits
        was the Banque Commercial pour I'Europe du Nord was also known by
        its cable code, EUROBANK.
   In the 1970s the market received a further boost when OPEC
    countries ―re-cycled‖ their dollar earnings into the London
    markets.
       London’s advantage was two fold: (1) deposits were not subject to
        reserve requirements and (2) unlike the U.S. at that time there were no
        limitations on interest which could be paid on such deposits.
       London banks recycled these deposits in the form of loans to
        governments and corporates.
Eurocurrency Market Structure
   The Eurocurrency market is essentially a wholesale
    market (as opposed to a retail market).
       Participants include large global banks and other large
        financial institutions, large multinational corporations, and
        governments.
       Estimated size of market (2011): $6 trillion.
       Transactions tend to be large (multiples of $1,000,000).
       Approximately 80% of the market is interbank.
       The market is confined to time deposits.
       The market is essentially unregulated and deposits
        are not insured.
       The Eurocurrency market is primarily a Eurodollar
        market (approximately 2/3rds).
   Eurocurrency markets exist all over the world, but
    the major and largest market is in London (with an
    estimated 20% of the total market).
Interest Rates in the Interbank
Eurocurrency Market
   In the London interbank Eurocurrency market
    there are two important interest rates:
       (1) London Interbank Bid Rate: The interest
        rate which a Eurobank will offer on (―deposit
        rate‖); referred to at LIBID.
       (2) London Interbank Offer (Ask) Rate: The
        rate which a Eurobank will charge to lend a
        eurocurrency (―lending or ―borrowing rate‖);
        referred to as LIBOR.
           LIBOR rates will always be higher than LIBID rates
            (by about 1/8%).
LIBOR and the BBA
   Each morning a panel of banks submit their LIBOR
    data for 15 different maturities (overnight out to 1
    year) in 10 currencies (including the US dollar) to the
    British Bankers’ Association (BBA). BBA LIBOR is an
    average of this data. LIBOR is announced around
    11:00am in London.
       For up to date data see: http://www.global-
        rates.com/interest-rates/libor/libor.aspx
       For a list of panel banks and historical data see:
        http://www.bbalibor.com/rates/historical\
   LIBOR is important because it is used by banks to
    scale loan rates (i.e., as a benchmark rate) to clients
    in the retail market.
USD LIBOR, November 9, 2011
USD LIBOR Panel, As of May 2011
EURIBOR Market
   Euribor stands for Euro interbank offered rate.
   These interest rates for the Euro deposits are
    compiled by the European Banking Federation
    (FBE—Fédération Bancaire de l'Union Européenne)
       Rates are released at 11:00 AM Brussels time, each
        business day.
       Rates are quoted for one week and monthly maturities out
        to a year.
           Overnight rates are referred to as EONIA (Euro Overnight Index
            Average) rates
       Euribor is more widely used than Euro Libor.
       For up to date EURIBOR data see: http://www.global-
        rates.com/interest-rates/libor/libor.aspx
EURIBOR, November 9, 2011
Eonia (Euro Overnight Index
Average) Rates
The Eurocurrency Markets and
Global Firms
   The Eurocurrency market serves two valuable
    functions for global firms:
       (1) Investment Market: The market allows global firms
        to earn a return on their excess (i.e., ―idle‖) funds.
           Can be tailored to the needs of clients as Eurocurrency
            time deposits have maturities from overnight to 12
            months.
         They generally offer higher rates than domestic deposits.
       (2) Borrowing Market: Eurocurrency loans are an important
        source of short-term and intermediate term loans for global
        firms (generally to finance working capital needs).
         These Eurocurrency loans generally carry lower interest
            rates than domestic loans.
Interest Rate Comparisons:
Investing Market
November 3,
2011
Maturity         Eurodollar      Certificate of   Commercial      U.S. Treasury
                 deposit rates   Deposits U.S.    Paper U.S.      Bills
                 (London)        (Secondary       Non-financial   (Secondary
                                 Market)          Firms           Market)
1-month          0.35%           0.20%            0.13%           0.01%
3-months         0.49%           0.37%            0.17%           0.01%
6-months         0.68%           0.51%            n.a.            0.04%
Source:
http://www.fed
eralreserve.go
v/Releases/H
15/update/
Interest Rate Comparisons:
Borrowing Market
November 3,   12-Month LIBOR   Prime Lending   Prime - LIBOR
2011                           Rate
U.S.          0.95%             3.25%          2.30%
Japan         0.55%             1.48%          0.93%

Canada        1.71%             3.00%          1.29%
U.K.          1.77%             3.96%          2.19%
Germany       2.01%             3.77%          1.76%
Australia     4.96%             7.28%          2.32%
Switzerland   0.31%             2.73%          2.42%
Sweden        2.85%             3.39%          0.54%
Denmark       1.66%             4.30%          2.64%
LIBOR and Domestic Interest Rates
   Summary: LIBOR rates will generally parallel the
    rates on equivalent borrowing and deposit
    opportunities in each country’s domestic
    financial market.
       As noted: lending rates will generally be lower than
        equivalent domestic market rates, and deposit rates
        will generally be higher than equivalent domestic
        market rates.
   This interest rate structure reflects:
       Smaller spreads (between deposit rates and lending
        rates) in the offshore markets than in the domestic
        markets due to cost advantages in the market (arising
        from less regulations and domestic lending
        requirements – e.g., compensating balances).
External Financing of the Global Firm
             Financing in the        Intermediary Markets:
                                   Banks & other financial inst.
             Parent Country’s
 Sources      Financial Market
             (Debt and Equity)            Direct Markets:
    of                           Capital markets & money markets

 External
                                         Bank Loans:
  Funds       Financing with          Local Currency Debt
    for          Debt in
            Foreign Countries’      Eurocurrency Financing:
   the       Financial Markets
                                    Banks and Direct Markets

  Global                           Long-term Bond Financing:
                                   Foreign and Offshore Bonds
 Business
   Firm       Financing with
                                       Issuing Shares to
                                      Foreign Shareholders
                 Equity in
                                       Joint Venture with
            Foreign Countries’          Foreign Partners
             Financial Markets
Eurocurrency Loans (Euro-Lines)
   Eurocurrency loans (also called euro lines)
    are short term lines of credit against
    eurocurrencies offered by Eurobanks.
       Specifically these are arrangements between a
        Eurobank and a customer allowing the customer
        to borrow up to a pre-specified amount of a
        designated euro-currency.
       There are two cost elements in a Euroline:
           (1) There is a fee for the line of credit itself (about 1/4 to
            1/2 of 1% per annum on the unused portion of the line).
           (2) Plus an interest rate applied against any borrowed
            amount.
               Interest rate on borrowed amount is scaled to LIBOR
Eurocredits
   Eurocredits are short- to medium-term euro-
    currency loans made by Eurobanks.
   Often these loans are too large for one bank to
    underwrite, thus many banks will form a
    syndicate to share the size and risk of the loan
    (hence, they are called syndicated eurocredits).
   Eurocredits generally feature a ―roll over
    provision.‖
       At maturity, the loan can be extended by mutual
        agreement between lender and borrower.
       At roll over, the interest rate is re-scaled to the new
        LIBOR.
Rolling Over a Eurocredit

    Example: Roll Over of a 6 Month Euro-Credit
                                                               years
Today    1          2           3            4           5         6
                 etc. etc. etc.

         Loan is re-scaled at new LIBOR every six months,
        with interest payments made on those roll-over dates
Euronotes
   Euronotes are short term promissory notes issued
    by a corporation and sold to institutional or private
    investors.
       Maturity is typically three to six months.
   Euro-notes are underwritten by international
    investment banks or international commercial banks
    through ―Euronote Programs.‖
       The program identifies the dealer(s) who will act on
        behalf of the borrower in placing issues with investors.
   Euro-notes are originally sold at a discount from
    their face value and pay back the full face value at
    maturity and can trade in secondary markets.
Euro-Medium-Term Notes (MTNs)
   MTNs are fixed or floating rate notes issued by a
    corporation or government to investors.
           Maturities of 9 months to 10 years (but most under 5 years)
   MTNs are offered on an on-going basis rather than
    all at once like a bond.
       Issued through a ―Euro-MTN Program.‖
       With this type of program, the issuer can vary the amount
        of notes to be issued at any one time depending upon its
        needs and ―windows‖ of opportunity.
           Thus, a Euro- MTN-program offers issuers flexibility in the
            raising of medium and longer-term funds.
   MTNs are placed by dealers and they can trade in
    secondary markets (many do on the London Stock
    Exchange).
   These instruments generally bridge the maturity gap
    between Eurocommercial paper and Eurobonds.
Eurocommercial Paper
   Eurocommercial paper are unsecured short-term
    notes issued by corporations and banks in the
    Eurocurrency markets.
       Maturities typically range from one month to 6 months.
       Historically, U.S. dollar denominated (about 75%); but
        euro is becoming more important.
   Placed directly with investors through a dealer.
       Through a ―Eurocommercial Program‖ with a dealer
        who places the issues with potential investors.
Appendix 1


   Offshore Financial Centers
History: Offshore Financial Center
   Origins of offshore financial centers:
       In the 1920, wealthy American, UK and Canadian
        citizens established offshore trusts in the
        Bahamas and the Cayman Islands (to minimize
        their taxes).
           See: http://www.offshore-
            manual.com/taxhavens/CaymanIslands.html
       In the 1960s and 1970s, US banks established
        offshore branches to escape US regulations and
        to book euro-currency loans.
Characteristics of Offshore Financial
Centers
   Many (but not all) offshore financial centers
    are sparsely populated small island states
    (Switzerland is an exception).
       These locations provide some or all of the
        following advantages: low or zero taxation;
        moderate or light financial regulation; banking
        secrecy and anonymity.
   Since the 1980s, the number of offshore
    financial centers (as identified by the IMF)
    has risen from about 30 to just under 70.
       See following slides for IMF data.
Examples of Offshore Financial
Centers: IMF Data (1999)
Africa       Asia and       Middle East   Europe          Western
             Pacific                                      Hemisphere
Djibouti     Cook Islands   Bahrain       Gibraltar       Bahamas
Liberia      Guam           Israel        Isle of Man     Barbados
Mauritius    Hong Kong      Lebanon       Liechtenstein   Bermuda
Seychelles   Macao                        Luxembourg      Cayman Islands
Tangier      Philippines                  Malta           Panama
             Singapore                    Monaco          Puerto Rico
             Tahiti                       Switzerland     St. Lucia
Source:

				
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