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					 INBU 4200
INTERNATIONAL
FINANCIAL
MANAGEMENT

Lecture 10
Topic: International Money Markets:
      The Eurocurrency Markets and
       International Banking
Recall From Lecture 2: Defining the
International Monetary System?
   It is the overall financial environment in which global
    businesses operate.
   It is represented by the following two sectors:
       Foreign Exchange Markets
           Currency markets (and foreign exchange regimes)
       International Money and Capital Markets
           Eurocurrency Markets (dominated by global banks)
               Traditional financial centers (London, New York, etc) and
               Offshore Financial Centers and Offshore Financial Markets
                (Cayman Islands, Singapore, etc).
           Bond markets
           Equity markets
Financing Global Operations
   The global firm can finance its overseas
    activities through either:
       Internal sources of funds (i.e., within the corporate
        family).
           Funds from the parent or “sister subsidiaries.”
       External sources of funds (i.e., outside of the
        corporate family).
           Funds raised in the parent country’s financial markets.
           Funds raised in financial markets outside the parent
            country
               Can be either debt or equity funds.
External Financing of the Global Firm
                Financing in
                                    Banks & other financial inst.
             parent country’s
              financial market
                                 Capital markets or money markets
  Funds      (Debt and Equity)

 Sourced
 External     Financing with
                                 Bank Loans: Local Currency Debt

    to            Debt in
                                  Eurocurrency Financing: Banks
            foreign countries’
   The       financial markets
                                        and Direct Markets

  Global                            Long-term Bond Financing:
                                    Foreign and Offshore Bonds
   Firm
              Financing with      Individual foreign shareholders
                 Equity in
            foreign countries’   Joint venture with foreign partners
             financial markets
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) intermediaries
    (commercial banks) or through the direct markets.
   The major international money markets are:
       Eurocurrency Loan (Euro-Lines of Credit) Markets
       Eurocredits (Syndicated) Market
       Euronotes Market
       Euro-Medium-Term Notes Market
       Eurocommercial Paper Market
Sources of Debt in the International
Money and Capital Markets
     Bank Loans              Local Currency Bank Loans
   (Intermediary
       Market)               Euro lines Offered by Banks
     (floating-rate,
 short-to-medium term)       Syndicated Euro Credits


 Euronote/Paper            Euro-Short Term Notes
     Market
 (Direct Market)           Euro-Medium Term Notes
    (floating-rate,
short-to-medium term)      Euro-commercial Paper

   International           Eurobonds (“Offshore” Currencies)
   Bond Market                * straight fixed-rate debt
  (Direct Market)             * floating-rate notes (FRN)
 (fixed & floating-rate,      * equity-related issue
 medium-to-long term)      Foreign Bonds (Domestic Currency)
Creation of a Eurocurrency Deposit:
Example
   Assume a German company sells a product to a US
    company and charges $1,000,000 for the sale.
   The US company pays by instructing its bank in New
    York to transfer $1,000,000 into the account of the
    German company (assume the German company has an
    account at the same New York bank).
   The German company then instructs its US bank to
    transfer the dollar deposit to a dollar time deposit at its
    bank in London.
   Note: Dollars do NOT leave the US, but instead the time
    deposit shifts from the US bank to a London bank.
   The London bank can now lend out these dollars to its
    clients.
Brief 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 the potential freeze of their dollar accounts
    in US banks, shifted their deposits to London
   The original bank in the London market accepting these deposits
    was the Banque Commercial pour I'Europe du Nord was best
    known by its cable code, EUROBANK; hence the term
    euromarket.
   By the 1960s, the practice of euro-deposits was extended to
    regular business customers.
   In 1964, the market size was estimated at $20 billion dollars, with
    the majority in the form of US dollar deposits.
   As the economies of Europe and Asia grew, the market was
    extended to additional currencies other than the US dollar.
   By 1995, the market had grown to $7 trillion, but the US dollar
    share was down to 44%.
   Market is growing about 25% per year!
The Meaning of the “Euro” Prefix
   In the Eurocurrency Market, the prefix “euro” is used
    to denote the particular offshore currency in which
    the transaction is occurring, e.g.,
       Euro-dollars, euro-yen, euro-pounds, euro-euros.
       Eurocurrencies are only the major currencies of the world.
   Although historically the market originated in
    Europe, today eurocurrency markets exist all over
    the world.
   Banks accepting euro deposits and making euro
    currency loans are commonly referred to as
    Eurobanks.
   Note: do not confuse this term with the single
    European currency, the “Euro.”
Functions of the Eurocurrency
Markets
   The Eurocurrency market serves two valuable
    functions for global firms:
       (1) Investment Market: Eurocurrency deposits are a
        convenient way for global firms to earn a return on their
        short term excess (“idle”) funds.
         Eurodollar time deposits normally have maturities from
           overnight to six months, but may be as long as five
           years; they are not insured.
         Minimum investment of $100,000; and are not
           marketable.
         For an example see:
          http://www.wachovia.com/corp_inst/page/0,,7_26_252_923,00
          .html
       (2) Borrowing Market: Eurocurrency loans are a major
        source of short-term and intermediate term loans for global
        firms to finance their working capital needs.
Eurocurrency Market Structure
   The Eurocurrency market is two tiered:
       Wholesale (interbank) market where large global
        banks trade euro-currencies among themselves
        ($1,000,000 minimum).
           Represents about 50% of the market. Gross data (next
            slide) includes wholesale market
       Retail market: where global banks accept euro-
        deposits from clients and make euro-currency
        loans to clients.
           Represents about 50% of the market. Net data (next
            slide) includes only retail market.
           Major clients include global firms and
            governments.
Size of Eurocurrency Deposit Market
(Billion of Dollars), 1964-1995
Interest Rates in the Eurocurrency
Market
   Within the interbank Eurocurrency market, there are
    two important interest rates:
       Interbank Offer Rate: The rate charged by banks with
        excess currency deposits to lend to other banks
        (“borrowing rate”).
           Major market is in London, hence LIBOR.
       Interbank Bid Rate: The rate at which a bank will
        accept deposits from another bank (“deposit rate”).
           Again, the major market is London, hence LIBID.
       Offer rates will be higher than bid rates by about 1/8%
   The LIBOR rate is often used to scale loan rates to
    clients in the retail market.
LIBOR, March 29, 2007




   Fixed by the British Bankers Association, 11:00 London time
   Source: http://www.marketprices.ft.com/markets/currencies/money
Importance of LIBOR Rates
   (1) Used by foreign exchange market maker
    banks to calculate forward rates on currencies.
       Recall: Under the interest rate parity the forward
        rate must offset market interest rate differentials.
       In equilibrium, the forward rate offsets the LIBOR
        differential between currencies.
   (2) Used by global banks in “scaling” retail market
    lending rates to corporate and sovereign entity
    borrowers:
       Lending rate = LIBOR + “X” basis points
           Where “X” basis points is the lender’s estimation of the
            unique risk associated with a particular borrower.
LIBOR, LIBID and Domestic Rates
   LIBOR and LIBID rates will generally parallel the
    rates on equivalent borrowing and deposit
    opportunities in each country’s domestic
    financial market.
       However, 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.
Typical Spreads in Domestic and
Eurocurrency Credit Markets
LIBOR and Domestic Borrowing
Interest Rates, March 29, 2007

        12 Month LIBOR   Prime Lending Rate

 US       5.20%          8.25%
 Euro     4.17%          4.58%
 Yen      0.78%          1.63%
Eurodollar Deposit Rates and CD
Rates, April 3, 2007
CDs (secondary market) United States
1-month 5.29
3-month 5.30
6-month 5.29

Eurodollar deposits (London)
1-month 5.32
3-month 5.34
6-month 5.32
Source:
http://www.federalreserve.gov/Releases/H15/update/
Eurocurrency Loans (Euro-Lines)
   Eurocurrency loans (also called euro lines):
    These are short term lines of credit against
    eurocurrencies offered by banks.
       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 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) and then an interest rate applied against
        any borrowed amount.
           Interest rate on borrowing 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
       A number of banks will form a syndicate to share the
        size and risk of the loan (hence, syndicated
        eurocredits).
   Eurocredits feature a “roll over provision.”
       The loan’s maturity can be extended by mutual
        agreement between lender and borrower.
       At roll over, the interest rate is re-scaled to the new
        LIBOR.
Example of a Roll Over 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




                                                                       23
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.
Eurocommercial Paper
   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.
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.
Who Uses the Eurocurrency Markets?
Rise of the Offshore Financial Center
   Offshore financial centers are best defined as
    those money centers that attract a high level
    of non-resident financial activity.
   Offshore financial centers are not new.
       In the 1920, wealthy American, UK and Canadian
        citizens established offshore trusts in the
        Bahamas and the Cayman Islands (to minimize
        their taxes).
       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.
Offshore Financial Centers (1999)
Africa       Asia and Pacific   Europe             Middle East   Western Hemisphere

Djibouti     Cook Islands       Andorra              Bahrain     Anguilla
Liberia      Guam               Campione (Italy)     Israel      Antigua
Mauritius    Hong Kong          Cyprus               Lebanon     Aruba
Seychelles   Japan              Dublin, Ireland                  Bahamas
Tangier      Malaysia           Gibraltar                        Barbados
             Macao              Guernsey                         Belize
             Marianas           Isle of Man                      Bermuda
             Marshall Islands   Jersey                           British Virgin Islands
             Micronesia         Liechtenstein                    Cayman Islands
             Nauru              London, U.K.                     Costa Rica
             Niue               Luxembourg                       Dominica
             Philippines        Madeira                          Grenada
             Singapore          Malta                            Montserrat
             Tahiti             Monaco                           Netherlands Antilles
             Thailand           Netherlands                      Panama
             Vanuatu            Switzerland                      Puerto Rico
             Western Samoa                                       St. Kitts and Nevis
                                                                 St. Lucia
                                                                 St. Vincent and
                                                                 Grenadines
                                                                 Turks and Caicos
                                                                 United States
                                                                 Uruguay
                                                                 West Indies
Web Sites: Offshore Financial Centers

   For a good discussion of Offshore Financial
    Centers visit the following IMF web site:
       http://www.imf.org/external/np/mae/oshore/2000/eng/back.htm


   To view one offshore financial center, the
    Cayman Islands, visit the following web site:
    http://www.ecayonline.com/cayman-offshore-financial.html
       Link to Offshore Banking and Investments
International (Global) Banks
   Critical to the functioning of the eurcurrency markets
    are global commercial banks.
       Why? Global banks accept euro-deposits and make euro-
        loans.
           And they do so within both in the interbank and retail markets.
   International (i.e., global) banks can be
    distinguished from domestic banks by the:
       The types of services they offer
       The deposits they are willing to accept
       The loans they are willing to make
   For a discussion of why banks establish a global
    presence, please see Appendix 2
International Banks: Services
   Managing Euro-Programs for borrowers.
   Financing of cross border trade (exports)
       Letters of credit; bankers’ acceptances
   Offering foreign exchange services
       Market maker banks.
       Buying and selling foreign exchange for clients
       Offering hedging contracts (forwards and options).
   Offering interest rate and currency swap financing.
   Consulting services to global firms
       Hedging strategies; international cash management.
   Underwriting eurobonds, foreign bonds, and equity
    issues for global firms.
International Banking: Deposits

   International banks may or may not be
    involved in accepting domestic (i.e., local
    currency) deposits in the various foreign
    markets in which they operate.
   All global banks, however, participate in
    eurocurrency deposit market.
       Accepting a wide range of foreign currency
        deposits.
International Banking: Loans
   International banks are lenders of eurocurrency
    deposits
       To one another (in the interbank markets)
       And to retail customers.
   Also, participation in syndicated eurocurrency
    loans to large multinational firms and sovereign
    entities.
       Many banks involved in these loan agreements.
           Some syndicates have involved up to 200 banks.
       Allows for the pooling of resources and the sharing
        of risk!
International Banks Ranked by Asset
Size, 2006
 1 UBS (Switzerland)
 2 Citigroup (United States)
 3 Mizuho Holdings* (Japan)
 4 HSBC (U.K.)
 5 Credit Agricole Groupe (France)
 6 PNB Paribus (France)
 7 JP Morgan Chase (United States)
 8 Deutsche Bank (Germany)
 9 Royal Bank of Scotland (U.K.)
 10 Bank of America (United States)
*Formed by the 2002 merger of Dai-Ichi Kangyo, Fuji Bank
  and The Industrial Bank of Japan.
Appendix 1: Example of a
Corporate Borrower in the
Eurocurrency Market
    CWB, is a Canadian company, that sells western
    Canadian wheat and barley throughout the world.
    The company raises money in Canada, the United
    States and in various eurocurrency markets through a
    Eurocommercial Paper Program and a Euro Medium
    Term Notes Program.
CWB’s Web Site

   Visit CWB’s web site (as noted below) to see
    their recent eurocurrency borrowing activities.
       From this site, link to “funding programs,” then go
        to eurocommercial paper program and euro
        medium term note program.
   http://www.cwb.ca/public/en/about/investor/#f
    unding
Appendix 2: Why Do Banks
Establish a Global Presence
and What Organizational
Structures do they Use?
Why do Banks Establish International
Operations?
   Possible Low Marginal Costs in going global.
       Apply home knowledge to foreign market.
   Knowledge Advantage in global market
       Overseas operations can utilize the parent’s
        knowledge to compete successfully in foreign market
   Home (Headquartered) Information Source
       Providing local firms (in foreign countries) with
        information about parent’s home market
   Growth
       Home market may be saturated or experiencing slow
        growth.
Why do Banks Establish International
Operations?
   Regulation Advantage
       Global banks may not face the same regulations as do
        their domestic banks (e.g., reserve requirements on
        eurocurrency deposits).
   Defensive Strategy
       Following corporate clients overseas
       Providing retail customer overseas services
   Risk Reduction
       Greater stability of consolidated earnings.
   Prestige
Example of Global Bank: Citigroup

   Financial services firm combining
    banking, insurance, and investments under
    one global organization.
       “Universal or full service bank”
   Currently located in over 100 countries
       Began international operations in 1912!
   Go to home page and view countries and
    product lines
       http://www.citigroup.com/citigroup/homepage/
Services Offered by International
Banks
   The particular services offered by a global
    bank is a function of:
   The regulatory environment.
       What will foreign (host) governments allow?
           Developing countries still somewhat restrictive regarding
            foreign banks.
   The type of banking office established.
       Organizational structure will determine type of
        servies to be offered.
           See next 4 slides on global banking structures.
Correspondent Banking Structure
   Correspondent Banking Structure is
    characterized by:
       Having no physical presence overseas
       Headquarters maintains “correspondent
        relationships” with other banks in foreign markets
           Results in “correspondent” balances held at
            overseas correspondent banks.
       Allows a bank to service core clients overseas
        through correspondent banks with little cost.
           Facilities foreign exchange conversion for clients
           Facilities trade financing (clearing bankers
            acceptances) for clients.
Representative Office Structure

   Representative Office is characterized by:
       A small overseas service facility staffed by parent bank
        personnel.
       The office cannot make loans or accept deposits, but:
       Office is there to assist core clients in that country with:
           Country and economic information
           Introductions to government/business contacts
           Credit evaluations of local firms
       This is a potentially useful (and relatively low cost) strategy
        if a global bank has many important clients in foreign
        country and they wish to maintain contact with these firms.
Foreign Branch Office Structure
   Foreign Branch Office is characterized by:
       Since, legally the branch office is part of the parent bank:
           The branch office is subject to regulations both at home and in
            foreign country.
       Branch lending limits are based upon parent capital (not
        branch office “capital’).
           Thus, a branch can provide larger loans to overseas clients.
       This structure allows for fast global clearing of checks
        within the bank’s organization:
           Branch to branch and to parent clearing.
       This has been the most popular form of U.S. bank
        expansion abroad.
Subsidiary Bank Structure
   Subsidiary Bank is characterized by:
     A bank locally incorporated (in foreign country).

           Bank is either wholly owned by parent, or joint
            venture with local partner.
               An affiliate bank is a non-controlled subsidiary
                (i.e., arising out of a joint venture).
       These banks operate under the banking laws of
        the country in which it is incorporated.
       Arrangement was particularly desirable before
        the abolition of U.S. Glass Steagell Act.
           U.S. banks incorporated overseas so as to engage in
            investment banking activities.

				
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