"Advantages of Eurocurrency Market - DOC"
C. M. Korth INTERNATIONAL FINANCIAL MARKETS Major topics I. World money & capital markets II. Off-shore markets III. Syndicated loans and syndicated security underwriting I. World Money & Capital Markets A. Most important B. Domestic [= on-shore markets] 1. Domestic markets are tightly regulated by the national (& sometimes regional or local) government of that country. 2. Two locations a. Home domestic b. Foreign domestic c. Foreign bonds: floated in a domestic bond market by a foreign issuer d. Depositary receipts FINMKT-OL.10-05 1 C. M. Korth FINMKT-OL.10-05 2 C. M. Korth II. Off-shore markets [= euromarkets] A. International money & capital markets that are free of most government regulations B. Not physically off-shore 1. But off-shore from on-shore (i.e., domestic) regulatory constraints C. Characteristics of the major off-shore markets 1. Favorable legislation 2. Usually requiring the use of contracts denominated in foreign currencies 3. Economic & political stability 4. Good infrastructure (especially communication) 5. Skilled work-force D. Advantages of the off-shore markets for participants 1. Minimum of regulation 2. Avoiding government regulations in countries with which one may be in conflict 3. Ability to avoid exchanging currencies in the FX markets 4. Tax advantages 5. Economies of scale FINMKT-OL.10-05 3 C. M. Korth E. Advantages of offshore markets to local governments 1. Strengthened financial markets 2. Improved employment opportunities 3. Increased fee and tax revenue F. 3 sectors of the off-shore markets: 1. Eurocurrency market 2. Eurobond market 3. Euronote & euro-commercial-paper market 4. Note: there is no true euro-equity market -- despite common use of the term 5. The “euro-markets” are not: a. Limited to Europe b. Generally in euros!!! FINMKT-OL.10-05 4 C. M. Korth G. Eurocurrency market 1. Deposits in a bank [eurobank] of foreign funds 2. CDs or time deposits – not demand deposits a. Most common: 3 & 6 months 3. Can be in almost any currency -- except the local currency 4. The eurocurrency is created when the deposit is made & destroyed only when it is withdrawn. a. The size of the eurocurrency market equals the total of all deposits. 5. Depositors 6. Banks accepting e-deposits can be: a. Local banks (e.g., British banks accepting $ deposits in London) b. Banks of the country whose currency is deposited (e.g., American banks accepting $ deposits in London) c. Banks of a 3d country (e.g., Japanese banks accepting $ deposits in London) FINMKT-OL.10-05 5 C. M. Korth 7. London interbank bid rate (LIBID) a. Interest rate that banks in London quote on deposits from another bank b. Depends upon the deposit, not the nature of the depositor c. Banks of lower quality pay a higher LIBID for deposits. 8. Investments by banks of eurocurrency deposits a. Some money-market investments b. However, mostly loans c. Lenders d. Size FINMKT-OL.10-05 6 C. M. Korth e. Type of eurocredit (1) Direct loan (2) "Stand-by" facility (a) Line of credit (b) "Revolving" commitment i) "Revolver" f. London interbank offer rate (LIBOR) (3) The interest rate at which one eurobank will offer to lend to another eurobank (a) Note: LIBOR is not bank’s cost of capital (4) LIBOR is the almost - universal lending rate in international banking. (a) Even used frequently with domestic loans (5) LIBOR depends upon the nature of the loan: (a) Currency (b) Maturity i) Yield curve (c) Size of loan FINMKT-OL.10-05 7 C. M. Korth (6) Offshore-market rates are more attractive than domestic rates. (7) Most borrowers pay LIBOR+ (a) The spread will increase: i) The lower the quality of the borrower ii) The greater the risk of the project (b) Collateral or other security reduces the spread. (8) Most e-loans have floating rates with 3 or 6-month rollovers. (a) On the rollover date, the interest rate will change to the LIBOR in effect on that day. (b) The new LIBOR will remain until the next rollover (3 or 6 months later). (9) For any loan, fixed or floating, the interest rate is determined at the beginning of the loan period. (10) However, the payment is always made at the end of the period. FINMKT-OL.10-05 8 C. M. Korth H. Eurobond market 1. Long-term negotiable instruments in the euromarkets 2. Mostly bearer bonds 3. Both large corporations and governments are major issuers in the eurobond market. 4. Because of the absence of regulations to protect investors in the eurobond market, only issuers with good credit ratings are welcome in the market. 5. Underwritten in the primary market a. The underwriter guarantees that the notes will be sold at the agreed- upon price. (1) If not, the underwriter must bear the loss b. Underwriting fees 6. Active secondary market 7. Both secured (i.e., mortgage) and unsecured eurobonds exist. FINMKT-OL.10-05 9 C. M. Korth 8. Varieties a. "Straight" fixed rate ("plain vanilla") are most common. b. Floating-rate notes (FRNs) c. Equity-related (1) Convertible eurobonds (2) Eurobonds with equity warrants d. Zero coupon 9. Advantages of eurobonds for issuers: a. Wider range of investors b. Diversification of funding c. Greater borrowing flexibility d. Reduced cost e. Increased international recognition for the company FINMKT-OL.10-05 10 C. M. Korth I. Euro-notes & Euro-commercial-paper 1. Short-term negotiable instruments in the euromarkets 2. Promissory notes (i.e., unsecured) 3. Sold at a discount, with full face value paid at maturity 4. Generally sold in bearer form 5. Active secondary market 6. Underwritten: euronotes 7. Not underwritten: euro-commercial paper (ECP) FINMKT-OL.10-05 11 C. M. Korth III. Syndicated loans or syndicated security underwriting A. Syndicate 1. A group of commercial banks that offer a joint loan (or) 2. A group of investment bankers (also called merchant bankers) that jointly underwrite a stock or debt issue 3. Members of a syndicate a. Lead manager(s) (1) Mandate (2) Co-managers b. Underwriters c. Participants = providers FINMKT-OL.10-05 12 C. M. Korth B. Fees 1. "Front-end" = "up-front" 2. Fees paid "in arrears" C. Interest charges 1. Also paid in arrears 2. Fixed rate 3. Floating rate a. Index (e.g., LIBOR or prime) D. Other borrowing costs 1. Compensating balances 2. Currency risk (if borrowing cross-currency) FINMKT.10-05 13 . Fixed rate 3. Floating rate a. Index (e.g., LIBOR or prime) D. Other borrowing costs 1. Compensating balances 2. Currency risk (if borrowing cross-currency) FINMKT.10-05 15