EUROCURRENCY MARKET

CHAPTER 1
EUROCURRENCY MARKET
1.1 INTRODUCTION:
It is a market for Borrowing and Lending of currency at the center outside the
country in which the currency is issued. It is different than the Foreign Exchange Market,
wherein the currency is bought and sold. Euro () is a single currency which was
launched on 1st Jan1999. (With 11 of 15 member countries of the European Union
participating in the experiment) .Now Euro () is the official currency of 16 of the 27
member states of the European Union (EU). These 16 states include some of the most
technologically advanced countries of the European continent and are collectively known
as the Euro zone. The Euro is an important international reserve currency. Euros have
surpassed the US dollar with the highest combined value of cash in circulation in the
world. The name euro was officially adopted on 16 December 1995. The euro was
introduced to world financial markets as an accounting currency on 1 January 1999,
replacing the former European Currency Unit (ECU) at a ratio of 1:1.
The currency was introduced initially in non-physical forms, such as travellers checks
and electronic bank in Euro coins and banknotes entered circulation on 1 January
2002.The Euro is administered by the European Central Bank (ECB) based in Frankfurt,
and the Euro system, comprising of the various central banks of the Euro zone nations.
A one-euro coin is shown. The euro is used
throughout Europe as an international currency. The
symbol of the euro is , the letter "E" with one or two cross
lines.
The states, known collectively as the Eurozone: are
Austria, Belgium Cyprus, Finland, France, Germany, Greece, Ireland, Italy,
Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain. The
currency is also used in a further five European countries, with and without formal
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EUROCURRENCY MARKET
agreements. and is consequently used daily by some 327 million Europeans. Over 175
million people worldwide use currencies which are pegged to the euro, including more
than 150 million people in Africa.

The most important implications of having a common currency, the

Euro, are:
Exchange rate certainty while travelling across Europe
No exchange risk and, therefore, no cost of hedging against it
No transaction costs
Increased transparency and fewer transactions for importers and exporters
Increased liquidity in the United Euro financial market

1.2 HISTORY OF EUROCURRENCY MARKET:

After World War II, the amount of US Dollars outside the United States increased
enormously, both as a result of the Marshall Plan and as a result of imports into the USA.
As a result, large sums of US Dollars were in custody of foreign banks outside the United
States. Many foreign countries, including the Soviet Union, had deposits in US dollars in
USA banks.

After the invasion of Hungary in 1956, the

Soviet Union feared that its deposits in
American banks could be frozen as retaliation. A
British bank offered the Soviets the possibility
of receiving its US Dollar reserves as deposits,
outside the USA. This operation was considered
the first to create so-called Eurodollars.

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EUROCURRENCY MARKET
Gradually, as a result of the successive commercial deficits of the United States, the
Eurodollar market expanded until today where it is available in virtually every country.
Today, Eurocurrency refers to deposits in any currency residing in banks that are located
outside the borders of the currencys country. For example a deposit denominated in Yen
residing in an Australian bank is a Eurocurrency deposit, or more specifically a Euro Yen
deposit. Similar external deposits apply to Euro Sterling, Euro Euro, Euro Swiss Franc, etc.
While opening up of the domestic markets began only around the end of
seventies, a truly international financial market had already been born in the mid-fifties
and gradually in size and scope during sixties and seventies.
This refers to the well-known Eurocurrencies Market. It is the largest offshore
market. Prior to 1980, Eurocurrencies market was the only truly international financial
market of any significance. It is mainly an inter-bank market trading in time deposits and
various debt instruments. What matters is the location of the bank neither the ownership
of the bank nor ownership of the deposit.

1.3 HISTORICAL EVENTS:

1. British restrictions on lending 1957:
The Eurocurrency market received a major push in 1957 when the British
government prohibited British banks from lending British pounds to finance nonBritish trade, a business that had been very profitable for British banks. British
banks began financing the same trade by attracting dollar deposits and lending
dollars to companies engaged in international trade and investment. Because of
this historical event, London became, and has remained, the leading center of
Eurocurrency trading.
2. US Restrictions on lending 1960:
The Eurocurrency market received another push in the 1960s when the US
government enacted regulations that discouraged US banks from lending to nonUS residents. Would-be dollar borrowers outside the United States found it
increasingly difficult to borrow dollars in the United States to finance

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EUROCURRENCY MARKET
international trade, so they turned to the Eurodollar market to obtain the necessary
dollar funds.
The US government changed its policies after the 1973 collapse of the
Bretton Woods system, removing an important impetus to the growth of the
Eurocurrency market.
3. Oil Price 1973-1980:
The oil price increases engineered by OPEC in the 1973-74 and 1979-80
periods, gave the market another big shove. As a result of the oil price increases,
the Arab members of OPEC accumulated huge amounts of dollars. They were
afraid to place their money in US banks or their European branches, lest the US
government attempt to confiscate them. (Iranian assets in US banks and their
European branches were frozen by President Carter in 1979 after Americans were
taken hostage at the US embassy in Tehran; their fear was not unfounded.)
Instead, these countries deposited their dollars with banks in London, further
increasing the supply of Eurodollars.
Although these various political events contributed to the growth of the
Eurocurrency market, they alone were not responsible for it.
The market grew because it offered real financial advantagesinitially to
those who wanted to deposit dollars or borrow dollars and later to those who
wanted to deposit and borrow other currencies.

1.4 ORIGIN OF EUROCURRENCY MARKETS:

During 1950s, Russians were earning dollars from the sale of gold and other
commodities and wanted to use them to buy grain and other products from the West,
mainly from the US. However, they did not want to keep these dollars on deposits with
the banks in New York, as they were apprehensive that the US government might freeze
the deposits if cold war intensified. They approached banks in Britain and France who
accepted these dollar deposits. Later on till 1980s, such deposits were by and large in
Europe only. So words coined were Euro Yen, Euro Rupee; in general; Eurocurrency
deposits. Since 1990, the markets have expanded geographically and also in volume, but
the prefix Euro has still remained. Eurocurrency markets are in all the countries having
significant international transactions and capital flows. Eurocurrency does not any longer
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EUROCURRENCY MARKET
refer to Europe in any way. It strictly and really means offshore and not necessarily
always refers to Europe.

US
Dollars
British
Pound
sterlings

Depos
ited in

UK

are Euro
dollars

Depos
ited in

Japan

are Euro
sterlings

Japanese Depos
Yens
ited in

Australia are Euroyens

Eurodollar or Eurocurrency refers to bank time deposits in a foreign currency i.e.

currency other than that of the country in which the bank or bank branch is located. Euro
currency market is the market for such bank deposits. This prefix Euro should not be
confused with the European single currency Euro. Even Euros deposited outside
Europe are called as Euro Euros.

1.5 CHARACTERISTICS OF EUROCURRENCY MARKETS:

The various characteristics of Eurocurrency Markets are:
1. Unregulated Market:
It is a cross border market. Hence no government has full control over the
transactions. Hence transacting entities escape from most of the stringent
provisions and regulations. (Absence of) following regulations is specifically
important:
a. No reserve requirements
b. No interest rate regulations or caps
c. No withholding taxes
d. No deposit insurance requirements
e. No credit allocation regulations
f. Less stringent disclosure requirements
Government interference is minimal. Thus it is an unregulated market.
2. Short Term Deposits and Long Term Loans:

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EUROCURRENCY MARKET
Deposits in Eurocurrency markets are primarily for short term.
Eurocurrency loans however are for longer period of time. This leads to assetliability duration mismatch problem for the banks.
3. Largely wholesale market:
Transactions in Eurocurrency markets are very large. They are mostly
within Banks and Governments, Public Sector Organizations and large MNCs.
This makes the market a wholesale rather than a retail market. Also,
approximately 80% of the Eurodollar market is interbank, which means that
the transactions take place between banks. This also underline the nearabsence of default risk in Eurocurrency Markets.
4. Time Deposits:
The Eurocurrency market exists for savings and time deposits (time
deposits in Indian context are popularly called as fixed deposits and
recurring deposits in banks.) There is hardly any space in Euromarket for
demand deposits (what we call as current account in banks).
5. Eurodollar and LIBOR based market:
Eurocurrency interest rates are tied to a variable rate base such as the
London Interbank Offer Rate (LIBOR). This reduces interest rate risk. Market
is largely dominated by US Dollars over other currencies. Following breakup
shows the presence of each currency.

US Dollar $

Swiss Frank SFr

18%
Canadian Dollar C$
8%
43%
7%
Pound 3% Yen
3% 2%
14%
Others

Australian Dollar A$

Euro

1.6 PARTICIPANTS IN EUROCURRENCY MARKET:

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EUROCURRENCY MARKET

Government
International Organizations
Central Banks
Commercial Banks
Corporations
MNC
Traders
Individuals

1.7 PARTICIPANTS HAVE CONTRIBUTED IN THE DEMAND AND

SUPPLY OF THE FUND, IN THE FOLLOWING WAY:
SUPPLY:
Central banks of various countries are the suppliers; they channel the fund
through BIS. Increase in the Oil Revenue of the OPEC has added to the fund. MNCs and
the traders place their surplus funds for the short-term gains.
DEMAND:
Government demand for these funds to meet the deficit arising due to meet the
deficit arising due to the deficit in Balance of Payment and the rise in the oil prices.
Commercial Banks needs extra funds for lending. Some also borrow for the better
window dressing in the year-end

1.8 FUNCTIONS OF EUROCURRENCY MARKETS:

The following are some of the functions of the Eurocurrency markets:
1. Cheap Source of working capital:
Eurocurrency loans attract lesser interest rate than the loans of the
domestic economy. This is because overhead costs are low. Since dealings are
between banks with good credit rating, the costs of credit checking and processing
are less. Lending rates can thus be fixed lower than domestic market.

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EUROCURRENCY MARKET
2. Liquidity:
Financial institutions find it highly profitable to hold their idle resources in
Euromarkets. As there are fewer restrictions in the markets, investors can make
investments in bearer securities. It has an advantage in the form of absence of tax
withholding on interest. Most of the Euro deposits have maturities ranging from
less than a day to few months. On an average 80% of these deposits have maturity
of six months.
3. Facilitates International Trade:
Eurocurrency markets provide easy loans, which facilitate international
trade. Most banks prefer this form of financing to traditional forms (such as letter
of credit). Its mainly for two reasons: (i) Lower interest rate and (ii) easy
procedural formalities.
Eurocurrency markets create effective linkages between national markets and
facilitate international trade as well as capital flow. It is shown in the following schematic
diagram:

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EUROCURRENCY MARKET

Savers
Borrowers Eurozone customers
Euro-zone
Internal credit
market

Eurocurre
ncy
(external
credit)
markets

Euro
doll
ars
Euro
yen

Savers
Borrowers US.
customers
U.S. Internal
credit market
Euro
euro
s
Euro
sterl
ing

Japanese
Internal credit
market
Japanese
customers
Savers
Borrowers

U.K. Internal
credit market
U.K. customers
Savers
Borrowers

1.9 COMPONENTS (COMPOSITIONS) OF EUROCURRENCY

MARKETS:
Composition is described in 3 areas, viz., (A) Market Participants, (B) Euro
financial-Instruments and (C) Transactional Structure
A. Market Participants:
1. Commercial Banks:
Commercial banks form the institutional core of the market.
Banks enter the euro-currency market both as depositors and as
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EUROCURRENCY MARKET
lenders. Around twenty of the worlds biggest banks play a dominant
role in the Euromarket. They attract a disproportionate volume of
primary deposits which are then re-lent to other Eurobanks. These
banks link the external with the domestic market, taking funds from
one and placing them in other market. The breadth and depth of the
interbank market enable banks to adjust liquidity positions with great
ease.
2. Corporate:
Corporations borrowing Eurocurrencies are mainly those whose
name, size and good standing enable banks to make loans to them with
little more than a superficial analysis of creditworthiness. But more
recently the range of corporate and government borrowers has
widened to embrace less good names. The main reason for this is the
vast amount of funds available for lending.
3. Governments and central banks:
Governments and central banks are also lenders in the
Eurocurrency markets. In addition, international institutions such as
the World Bank and various regional development banks, and
institutions associated with the EU, have been regular borrowers. In
the last decade the market has also seen an expansion in government
and government-related borrowers. This is especially true of the
medium-term EuroCredits market, which has become widely tapped
for infrastructure projects and for financing balance of payments
deficits.
4. Private Individuals:
Private individuals are minor participants in the Eurodollar
markets. High net worth individuals have, however, always been
significant participants as investors in the Eurobond market, where the
fact that payment of interest is gross of tax (without deduction of tax)
and securities are bearer securities gives the market anonymity and an
obvious attractiveness from a tax point of view.
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EUROCURRENCY MARKET

B. Euro financial-Instruments:
1. Eurodeposits:
Most deposits in the Eurocurrency market are time deposits at
fixed interest rates, usually of short maturity. Around three-quarters
of deposits in London Eurobanks have maturities of less than three
months. Many of these deposits are on call; thus they can be
withdrawn without notice. Most of the time deposits are made by other
bank, but many are made by governments and their central banks as
well as Multinational Corporation. A few are made by wealthy
individuals, often through a Swiss bank. Deposits come in many
forms.

Besides

negotiable

Eurodollar

certificates

of

deposit

(sometimes termed London dollar CDs), there are various similar

certificates of deposit.
2. Euroloans:
Many Eurodollar loans are direct, bank-to-customer credits on the
basis of formal lines of credit or customer relationships. However, the
market has developed the technique of loan syndication for very large
currencies. Interest on syndicated loans is usually computed by adding
a spread to LIBOR, although the US prime rate is also used as a basis
for interest pricing. LIBOR interest rates change continuously.
3. Eurobonds:
Eurobonds are international bonds denominated in a currency
different from that of the country in which they were issued.
Eurobonds are transferable securities, and the Eurobond market is a
significant factor in international finance; the size of the international
Eurobond market exceeds that of the U.S. bond market.
4. Other Instruments:
Other Euro financial instruments include Euro commercial papers,
Euro certificates of deposits, etc.

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EUROCURRENCY MARKET

IE E n u u t re r o o r cbc r au e nr d r k ei t n c y M a r k e t s
M M a a (r r Ek k eu e tr t o b a n k i n g )
E E E u u u r r or o o bn s oeC nct o e ud m s r i mt y e r c i a l
M M M P a a a ra r kp kr eke te rt t M s a r k e t
C. Transactional structure of Euro Markets:
The Euro currency market is entirely a wholesale market. Transactions are
rarely for less than $1 million and sometimes they are for $100 million. Like
the foreign exchange markets, the vast bulk is confirmed to inter bank
operations. The largest non banking companies have to deal via banks.
Borrowers are the very highest pedigree corporate names carrying the lowest
credit risks. The market is telephone linked or telecommunication linked and
is focused upon London, which has a share of around one third of the
Eurocurrency market. All Euro currency transaction are unsecured credits,
hence the fact that lenders pay particular attention to borrowers status and
name.

1.10 ADVANTAGES AND DISADVANTAGES OF EUROCURRENCY

MARKET
ADVANTAGES OF EUROCURRENCY MARKET:
1. It helped the economics to solve the liquidity problems:
2. It provided better investment opportunities.
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EUROCURRENCY MARKET
3. Funds are also by the commercial banks of various countries for domestic credit
creation and window dressing.
4. This facilitated the growth and development of various countries like Brazil,
South Korea, Taiwan and Mexico etc.
5. Its international acceptance has helped in the international trade to expand and
accelerated the process of globalization.
6. Act as a Vehicle Currency for carrying world trade.

DISADVANTAGES OF EUROCURRENCY MARKET:

1. For many economies it a new concept.
2. For many economies also considered that the speed of its growth or expansion
is Too fast.
3. For many economies, they feel this market gives a chance to avoid many a
regulations that they try to impose on their national money market.
4. Affects international monetary stability

1.11 RISKS OF EUROCURRENCY MARKETS:

The unregulated environment dictates many risks such as
1.
2.
3.
4.

Foreign exchange volatility risk

Individual bank risk
System risk
Uncertainty in the interaction of legal system between host country and home

currency
5. Unsecured credit transaction risk

1.12 FINANCIAL ADVANTAGES:

1. Lack of Regulation:
Prime advantage is lack of government regulation. This is mainly related
to Cash Reserve Ratio (CRR) and disclosure requirements.
2. Higher Interest rate on deposits:

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EUROCURRENCY MARKET
Lack of regulations allows banks to offer higher interest rates on
Eurocurrency deposits than on deposits made in the home currency, making
Eurocurrency attractive to those who have cash to deposit.
3. Lower interest rate on loans:
The lack of regulation also allows banks to charge borrowers a lower
interest rate for Eurocurrency borrowings than for borrowing in the home
currency, making Eurocurrency loans attractive for those who want to borrow
money.
In other words, the spread between the Eurocurrency deposit rate and the
Eurocurrency lending rate is less than the spread between the domestic deposit
and lending rates.

1.13 EURO CURRENCY NOTES MARKET:

Euro notes are instruments of borrowing issued by borrowers directly to
investors without using banks as intermediaries, with or without the underwriting support
to the issue.
They have shorter maturities than bonds. Maturities normally range from 15 days
to five years. There are five types used in this market.
1. Bankers Acceptance (BA):
This instrument is used to finance domestic as well as international trade.
On completing the transaction, the exporter hands over the shipping documents
and letter of credit (LC) issued by the importers bank to its own bank. At the
same time, the exporter draws a draft (or bill) on the importers bank and gets
paid the discounted value of the draft. A bankers acceptance (BA) is created
when the exporters bank presents the draft to the importers bank which accepts
it. This BA may be sold (or discounted) as a money market instrument or the
exporter may keep it as an asset with himself. BAs are highly standardized
negotiable instruments and are available in varying amounts. They permit
importers and other users to obtain credit on better terms than simple borrowing.
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EUROCURRENCY MARKET

2. Euro Commercial Paper (ECP):

Euro Commercial Paper is a short-term Euro note issued by corporate on a
discount-to-yield basis. Investors in ECP may be money market funds, insurance
companies, pension funds and other corporate bodies having short-term cash
surpluses. Before ECP came into existence, its domestic version, called simply
commercial paper (CP) had been in existence for quite some time. For investors,
it represents an attractive short-term investment opportunity, unlike a time deposit
with financial institutions. For borrowers, it is a cheap and flexible source of
funds, cheaper than bank loans. As mentioned above, a CP or ECP is a discount
instrument, purchased at a price below its face value and redeemed at face value
on maturity. For example, an ECP issued at $952.4 with a maturity of 180 days
will have a face value of $1000, if the discount rate is 10 per cent p.a.
3. Euro Certificate of Deposit (ECD):
A Certificate of Deposit is an evidence of a deposit with a bank. CD is a
negotiable or marketable instrument. Unlike a bank term-deposit, a CD can be
sold in the secondary market whenever cash is needed. Whoever is holding it at
the time of maturity receives its face value in addition to the interest due. Euro
CDs are issued by London banks. The interest on floating rate CDs is indexed to
LIBOR and Treasury Bill rate, etc. These instruments may be issued in sum like
$100000 or more. For fixed rate CDs, usually there is a single period maturity
when principal and interest rate paid. As regards floating rate CDs, their time-span
is divided into sub-periods of usually six months, when the rates are reset.
4. Repurchase Obligation (REPO):
This is a form of short-term borrowing in which the borrower sells
securities to the lender with an agreement to the lender with an agreement to buy
them back at a later date. That is why it is called REPO. The repurchase price and
selling price are the same. But the original seller has to pay interest while
repurchasing the securities. The amount of interest depends on demand-supply
conditions. Repos may be overnight repos or of longer maturity.

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EUROCURRENCY MARKET

5. Notes issuance facility (NIF):

In situations where borrowing entity requires resources for the medium
term but investors desire to invest on short term basis, the reconciliation is
brought about through this. The borrower issues short term notes supported by
underwriting from banks. The notes are redeemed on maturity by issue of fresh
notes. Shortfalls in subscriptions are covered by the underwriters.

1.14 EURO CURRENCY CENTERS

Country

Currency

India

Rupee

United States

Dollar

Euro Member

Euro

Japan

Yen

Switzerland

Franc

Australia

Dollar

Canada

Dollar

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EUROCURRENCY MARKET
Austria

Austrian Schiling

Belgium

Belgian Franc

Netherlands

Dutch Guilder

France

French Franc

Germany

German Mark

Italy

Italian Lira

Portugal

Portuguese Escudo

Spain

Spanish Peseta

1.15 FIVE COUNTRIES RESPONSIBLE FOR THE GROWTH OF

THE EURO-CURRENCY MARKET:

China (fear that its Fx in USD would be blocked)

USA (indeed blocked identifiable Fx in USD in1950, federal Reserve Act,
regulation Q and M; control and restrictions on borrowing funds in US in

1965, and introduction of interest equalization tax in 1963)

Korea (War broke out in 1950)
Russia (erstwhile USSR){because of their banking presence in Paris and London}
UK (policy of not granting sterling loan outside sterling area in 1957)

1.16 GROWTH OF OTHER EURO INSTRUMENTS:

It is obvious that a bank cannot just accept deposits. It has to lend money in the
market and has to earn interest. The banks which accepted Eurodeposits started lending
in foreign currencies i.e. euro currencies. Thus it was the beginning of EuroCredits or
Euroloans. Corporate and merchants started borrowing from the banks in euro currencies
for short, medium as well as for long terms.
As it was possible for a corporate to borrow from a bank in euro currency, they
also started innovating other euro instruments. They started issuing bonds and
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EUROCURRENCY MARKET
commercial papers in domestic markets but denominated in foreign i.e. euro currencies.
This was called as Eurobonds and Euro Commercial Papers. Very soon, it was possible
to issue any instrument in euro currency and was titled accordingly.
Russia was just a visible starting reason. However, market always needed
Eurocurrency when it started. Mainly 3 factors are listed below.

1.17

FACTORS

RESPONSIBLE

FOR

ORIGINATION

AND

GROWTH OF EUROCURRENCY MARKETS:

Factors related to the USA:
1. Less Willingness of countries to hold dollars in USA-Based Banks:
The centrally planned economies were reluctant to hold bank deposits in
the United States, so they put their dollar earnings on deposit in London.
Gradually other European dollar holders did the same, a tendency that was
particularly marked when the United States ran large balance of payment deficits.
2. Regulation Q in the USA:
The growth of the Eurocurrency market was also stimulated by certain
monetary regulations in the United States. There was a regulation called as
Regulation Q which had put a ceiling (upper limit) on the interest rates that
banks operating in the United States could offer on domestic deposits. So, such
depositors were naturally attracted to Eurobanks that were not bound by
Regulation Q. In addition, banks in the United States were required to hold noninterest-bearing reserves. By diverting dollar deposits to their offshore branches or
subsidiaries, U.S. banks were able to avoid tying up so much of their funds in
reserve requirements at a zero rate.
3. Capital Controls in USA:
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EUROCURRENCY MARKET
General controls on the movement of capital also helped to boost the
Eurocurrency markets. One example was the introduction, in 1965, of the
Voluntary Foreign Credit Restraint Program (VFCR) in the United States. The
specific goal of the VFCR was to limit the growth of foreign lending by U.S.
banks. Instead, their foreign branches-which were not subject to the VFCR- took
deposits and lent them outside the ceiling. Between 1964 and 1973 the number of
U.S. banks with overseas branches increased from 11 to 125. The number of
branches increased from 181 to 699 over the same period.
Factors related to other countries:
4. Restrictions in UK:
Balance of payments pressures made the United Kingdom government
limit British banks external use of sterling, so they had a strong incentive to
develop business in foreign currencies.
5. Full Capital Account Convertibility adopted by developed countries:
By the end of 1958 the main industrial countries had restored full
convertibility of their currencies. The new freedom produced a surge of
international banking business.
6. Growth of offshore banking and tax heaven concept:
At the end of the 1960s and during the early 1970s the Eurocurrency
markets, which had been located in Western Europe (and centered in London),
expanded to a number of other offshore banking centers. These were typically
small territories that had tax, exchange control, and banking laws favorable to
international banks. The business was entrepots in nature, with foreign currency
funds deposited by one foreign source and then lent to another. Offshore centers
have been set up in the Caribbean area, Latin America, the Middle East, and
establishment

of international banking facilities (IBFS) in the United States

designed to bring the locus of American banking business back onshore.

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EUROCURRENCY MARKET

CHAPTER 2
EUROCURRENCY FINANCES AND LOANS
2.1 EURO CURRENCY SHORT TERM FINANCE: EURO LOANS:
The borrowings in the international capital markets are in the form of Euro Loans
which are fundamentally loans from the bank to the companies which require long-term
and medium-term funds. The most significant characteristic of the Eurocurrency market
is that loans are made on a floating-rate basis. Interest rates on loan to governments and
their agencies, Companies, and nonprime banks are set at a fixed margin above London
Inter Bank Offered Rates (LIBOR) for the given period and currency chosen. At the end
of each, the interest for the next period is calculated at the same fixed margin over the
new LIBOR. The margin, or spread between the lending banks cost of funds and the
interest charged to borrowers perceived riskiness. These loans are made to the
corporations in the required currency by banks. These loans are basically short-term
adaptation for periods less than one year. They are mostly provided in euro dollars. The
interest rates on these loans are based on the London Inter Bank Offered Rates (LIBOR)
for their respective currencies. LIBOR-represents a rate of interest used in interbank
transactions in London. The rate for each currency is arrived at as an average of the
lending rates charged by six leading London banks in the interbank market. The
borrowers of euro-loans are charged on the basis of LIBOR + depending upon the six
months floating interest rates is charged. If these loans are for periods beyond six months,
the loan is rolled over and interest is charged on the LIBOR prevailing at the time of
rollover.

2.2 FEATURES OF EUROLOANS:

1. Swap:
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EUROCURRENCY MARKET
Swap in loans means you pay for my debt and I will pay for your debt.
So, borrowing companies separate out two thing in Euroloans viz., getting the
loan (sourcing or borrowing) and second is servicing the loan (paying interest and
principal amount). They borrow in a currency in which it will be easier and less
costly for them to raise money in the prevailing market conditions.
Simultaneously, they arrange a swap to transform a debt denominated in one
currency into a liability denominated in a different currency. Swap can be interest
rate swap or currency swap.
Swaps make the choice of borrowing and servicing of debt very convenient.

2. Syndicated loans:
Many times, Euroloan amount is too large for a single bank to lend. This is
specifically so when the loan is to ca corporate for the purpose of acquiring
another company. Such loans are given by a group of bank which is called as a
syndicate. These Euroloans are called as syndicated loans. One bank undertakes
responsibility of forming the syndicate and coordinating them. Such bank is called
Lead Manager or Lead arranger. Then there is an underwriting bank which
agrees to lend the balance portion of loan after other banks agree to specific
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EUROCURRENCY MARKET
amounts. Other banks which lend specific amount or portion are called as
participating banks. The lead manager negotiates with the borrower and other
banks about terms and conditions of the loan; there might be more than one lead
manager in a syndicate. There is also an agent bank that acts on behalf of the
syndicate in the administration of the loan: it collects and disburses payments.
Depending on the size of its share, a participating bank might have the title of
senior manager or manager in the syndicate.
The fees involved in syndicated loan are an establishment fee, legal fees
and Administration fee payable to the agent bank. The borrower and the lenders
can negotiate a particular principal repayment schedule.
3. Transferable Loan Certificates:
Euroloans are given by the banks in the form of Transferable Loan Certificates
(TLCs). This certificate enables the lending bank to remain as lender till desires to
remain so. Anytime during the tenure of loan, participating bank can sell the TLC to
another new bank. Thus the earlier bank gets the loan amount back and the buying
(new) bank becomes the new lender. Such sell does not require consent of the
borrower. This sell-down provision in the loan agreement allows the lender to take the
loan asset off its balance before maturity. The agent bank then registers the buyer as a
new lender: a process referred to as secondary syndication. Trading in syndicated
banks turns these illiquid assets on bank balance sheets into liquid ones and,
therefore, lowers borrowing rates. At present, it is mostly a banking market, but there
is a potential of growing supply of capital form a broader base of financial intuitions,
including pension funds and insurance firms. To aid the development of a structured
and liquid secondary market for syndicated loans, specialized trading organizations
have been established the loan Market Association (LMA) in London, the loan
syndication and trading Association (LSTA) in New York and &e Asia Pacific Loan
Market Association (APLMA) in Hong Kong (APLMA) has branches in Singapore
and Sydney.
4. Lending Rate:

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EUROCURRENCY MARKET
Euroloan is a floating-rate loan with an interest rate as Reference Rate
(usually LIBOR) plus Lending Margin.
For example, if the interest period of a loan is six months, the references
rate is LIBOR and the lending margin is 100bps (100 basis points means 1%),
then at the beginning of every six-month period, the lending rate will be
recalculated as the current six-month LIBOR for the appropriate Eurocurrency
plus 100bps. In some cases, the lending margin is fixed for a particular period of
time: say, 75bps for the first year and 60bps for the following years. The precise
margin depends on the lenders credit assessment of the borrower as well as on
the condition of the market (demand versus supply of loan able fund). The most
common reference rate is LIBOR for the issues currency.

Rate of
Interes
Rate
of t

Domes Interest
tic
Lendin
Domes
g
tic
Rates
Deposi
0
t
Rates

Eurocurr
ency
Lending
Eurocurre
Rate
ncy
Deposit
Rate

It is seen that Eurodeposits get better (higher) interest from banks and Euroloans have a
lower interest rate as compared to domestic markets.

2.3 BENEFITS OF EUROLOANS (EUROCREDITS):

Benefits (or motives) of borrowers from Euroloans are shown in the following
diagram:

Page 23

ADVANT
AGES

EUROCURRENCY MARKET

BANK
S
(Lend
ers)
Offsho
re
Banks
Corporate
Giant
Refinancing
Banks
Working
Eurob
Capitalanks
Acquisitions

Flexible
Can be
arranged
quickly
Cost of
fund is
attractive
To all
Gap
borrowers
funding
Government
s&
Banks &
Government
Financial
Entities BOP
Institutions
Adjustments
To diversify
Budegtory
source of
Deficits
funds
Developmen
t Projects
Types of
Borrowers

2.4EURO

CURRENCY

SHORT

TERM

FINANCE:

EURO

COMMERCIAL PAPER (ECP)

Commercial paper refers to short-term securities from seven days to a few
years, issued by private companies. Just as euro-bonds are the disintermediated
version of long term euro-bank loans, euro commercial paper (ECP) forms the
disintermediated counterpart of short-term bank loans. Euro commercial paper is
a floating Eurocommercial promissory note. These notes are issued at discount on
their face value and such discount represents the profit to the investor. These
ESPs are also issued for less than one year between 7 to 365 days. They offer a
high degree of flexibility to the borrower with wide ranging alternative of
amounts and maturities. They are thus tailor made to take into account the specific
needs of the borrower. It is quite common for an ECP issuer to follow it up with
Euro Bond/Equity Issues. ICICI was the first Indian institution to obtain finance
through ECP in 1987. ECP markets have existed in an emergent form ever since
banks drew promissory notes on their borrowers as a way to confirmed loan
agreements. But the market became significant only in the eighties, when, as part
of the universal disintermediation movement, large corporations with excellent
credit standing started issuing short-or medium-term paper, which is positioned
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EUROCURRENCY MARKET
with institutional investors. The volume of the market remains low comparative to
the bond and bank-loan market.

2.5 FEATURES OF EUROCOMMERCIAL PAPER:

1. The market consists of notes, promissory notes, and CDs Notes are medium-term
paper with maturities from 1 to 7 years, usually paying out coupons. Promissory
notes have shorter lives, sometimes as short as 7 days, and are issued on a
discount basis, that is, without interim interest payments and with par value.
2. Although an ECP issue can be a one-time affair, many issuers have an ECPprogram contact with a syndicate.
3. A bare-bones ECP program just eliminates the botheration of getting a syndicate
together each time commercial paper needs to be placed;
4. But many program contracts also offer some form of underwriting commitment.
Such a commitment can stipulate the following terms:
a. A fixed spread (for example 0.5% above LIBOR; this is called a Note
Issuing Facility (NIF).
b. A capped spread; this is called a Revolving Underwritten Facility (RUF).

2.6 EURO MEDIUM TERM FINANCE:

1. Syndicate Loans:
As the size of the individual loans increased, individual banks found it difficult to
take the risk single handed. Regulatory authorities in most countries also limit the size of
the individual exposures. Hence the risk was required to be shared by a group of banks
termed syndicate.
A loan syndicate refers to the negotiation where borrowers and lenders sit across
the table to discuss about the terms and conditions of lending. Syndication works on the
principle of risk spreading and benefits the lenders as borrowers.
These are loans given by syndicates of banks to the borrowers. They bear a
variable rate of interest LIBOR. They are attached to specific project in case of
corporations. Government can also borrow syndicate loans. But such loans are not
attached to definite projects. They can be even used to meet balance of payment
difficulties.

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EUROCURRENCY MARKET

PROCESS OF LOAN SYNDICATION:

2. Revolving Underwriting Facility (RUF):

A RUF is a provision in which a borrower issues on a revolving basis
bearer notes, which are sold to investors either by placing with an agent or
through tenders. The investors in RUF undertake to make available a certain
amount of funds to the borrowers up to a certain date. The borrower is free to
draw down repay and redraw the funds after giving due notice. The London
branch of the State Bank of India provided the first RUF in 1984 to an Indian
borrower.
3. Euro-Medium Term Notes (MTNs):
The medium term notes have maturity from 9 months to 20 years. There
is no secondary trading for MTNs. Liquidity is provided by the commitments
from dealers to buy back before maturity at prices, which assure them of their
spreads. These are issued just like Euro-commercial paper. The issuer enjoys the
possibility of issuing them for different maturity periods. Companies use these
notes. The sums involved vary between $2 &$5 million.

2.7 EURO LONG TERM FINANCE:

Two kinds of bonds are floated in international bond market.

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EUROCURRENCY MARKET
1. Euro-bonds underwritten by an international syndicate and placed on the
market of countries other than that of the currency in which the issue is
made.
2. Foreign bonds issued on the market of a country and bought by nonresident in the currency of that country.
A Eurobond is distinguished from a foreign bond as it is denominated in a
currency other than the currency of the country in which it is issued. Eurobonds
are sold to international borrowers in several markets simultaneously by
international group of banks. The same causes, which led to the growth of
Eurocurrency market, have also contributed to the development of Eurobond
market. But the size and growth rate of this market are modest compared to
Euromarkets. In spite of that, it has established itself as a major source of
financing for multinational corporations. In addition MNCs, private enterprises,
financial institutions, government and central banks and international financial
institutions like the World Bank are the principal borrowers. They issue these
bonds. Institutional investors such as insurance companies, mutual funds, pension
funds etc are the principal buyers/investors. Leading multinational banks and
brokerage house also act as lenders. Since it is free from regulations that
characterize the US market, MNCs exploits the control-free environment. An
international syndicate representing major European banks and European does
underwriting of bond issue and foreign branches of US banks with participation
from banks in other financial centers in Asia, the Middle East, and the
Caribbeans as well as large international securities firms.

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EUROCURRENCY MARKET

2.8 DISTINCTION BETWEEN EUROBOND AND EUROCREDIT:

Eurobonds
1.Cost of Borrowing:

Eurocredit (Eurocurrency loans)

Eurobonds are issued in both fixed and

Interest rate on Eurocredit is variable. It is

floating rate forms. Fixed rate bonds are better hedge for non-contractual currency
attractive exposure management tool since exposures.
known long term currency inflows can be
offset with known long-term outflows in the
same currency.
2.Maturity:
Longer maturities
3.Size of Issue:

Relatively shorter maturities

Till 1983, Eurocredit market was far bigger

Now, its a size competition between the

than Eurobonds. As corporate started realizing two markets.

saving of cost in issue process of bonds, the
size expanded dramatically.

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EUROCURRENCY MARKET
4.Flexibility:
Funds must be drawn down in one sum on a
fixed date

Draw down for Eurocredit can be staggered

to suit borrowers needs

Funds can be repaid according to a fixed

Can be prepaid in full or in part often without

schedule. Prepayment can be with substantial penalty

penalty.
5.Speed:
Eurobonds take more time to issue because

Internationally known borrowers can raise

of procedures. This difference is vanishing funds in Eurocurrency market very quickly,

very fast.

often within

This difference is vanishing very fast.

two or three weeks of the first request.

CHAPTER 3
INTERNATIONAL BOND MARKETS
3.1 INTRODUCTION:
Before discussing Eurobonds, it would be appropriate to understand what is bond,
in general.
Term loans are borrowed by corporate from banks. Banks are intermediaries.
General public deposits their money to the bank. Bank pays some interest to them. Banks
lend the same money to corporate at a higher rate on interest. In this process depositors
earn less interest and corporate pay higher interest to banks. This is because the bank
makes the differential profit.

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EUROCURRENCY MARKET

Corporate
Loan from
Banks
Corpor
ate

Issue of
Bonds by
Corporate
Corpor
ate

Lo
a Ban
n k

General
De
Public
pos
its

B
o
n
d
(I
o
w
e
y
o
u)

Ch
Ban
eqWith
k
draw
ueby
General
Cheq
Public
ue

The alternative way to corporate is to borrow directly from public. Public would
withdraw its money from bank and lend it to corporate directly. Companies (corporate)
offer higher interest to depositors as compared to banks. However, the interest paid is less
than what corporate pays to bank to loans. This is a win-win situation for both: banks and
depositors. As a receipt of loan given by public, corporate issue a certificate to each
individual investor which is called as Bond Certificate or just Bond. Bond is a
confirmation that the corporate has borrowed money from you and will pay specified
interest to you. It will also return the principal amount after defined period of some years.
These bonds are listed on the stock exchanges. In case any person does not want to keep

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EUROCURRENCY MARKET
his investment for so many years, he can sell it to someone else on the stock exchange.
The corporate would pay interest to the next (buyer) person.
As a comparison, bonds carry better rate of interest than bank-loan. Bonds are
issued to public and loans are borrowed from bank. Bonds are traded on exchange
whereas loans are traded within banks network.
Indian market does not have matured market corporate bonds. Indian investors are
more familiar with Debentures. Debentures are similar to bonds, issued to public. Tenure
of bonds is much longer than debentures. More often bonds are secured as compared to
debentures.
Bonds are issued domestically and also abroad. Bonds can be issued in home
currency or even in foreign currency. Based on this, bonds are classified as follows:
Name of Bond

Currency

Issuer

Domestic Bond

Home

Home Resident Corporate

or government body

Foreign Bond
Euro Bond

Home
Foreign

Foreign Entity
Home Resident or Foreign,
Either (If issued by a
domestic entity, they are
also called as External
Bonds)

1. Domestic Bonds:
They are issued locally by a domestic borrower and are usually
denominated in the local currency.
For e.g. Amoco Canada issues a bond in Canada for placement in the Canadian
domestic market, i.e. with investor resident in Canada.
The issue is underwritten by a syndicate of Canadian securities houses.
The issue is denominated in the currency of the intended investors, i.e. CAD.
2. Foreign Bonds:

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EUROCURRENCY MARKET
They are issued on a local market by a foreign borrower and are usually
denominated in the local currency. Foreign bond issues and trading are under the
supervision of local market authorities.
For e.g. Amoco Canada, a foreign corporation, issues bonds in the U.S. for
placement in the U.S. market alone. The issue is underwritten by a syndicate of
U.S. securities houses.
The issue is denominated in the currency of the intended investors, i.e.
USD.
3. Eurobonds:
They are underwritten by a multinational syndicate of banks and placed
mainly in countries other than the one in whose currency the bond is
denominated. These bonds are not traded on a specific national bond market.
For e.g. Amoco Canada, a foreign corporation, issues bonds, in a major
international financial center, to be placed internationally. The issue is
underwritten by an international syndicate of securities houses.
The issue is denominated in any currency, including even the currency of the
borrowers country of incorporation, i.e. CAD.
Foreign Bonds have some exotic names depending on the country in
which it is issued.

3.2 EUROBOND:
Definition: A bond underwritten by an international syndicate of banks and
marketed internationally in countries other than the country of the currency in which it is
denominated. The issue is thus not subject to national restrictions.
Euro bonds are similar in many respects to the normal domestic bonds. Eurobond
market is almost free of official regulation. It is however, self-regulated by the
Association of International Bond dealers.
For each currency, the bond markets can be divided into two parts: the markets
within the country of the currency, namely the domestic and foreign bond markets, and
the markets outside of direct jurisdiction of the country, that is the Eurobond market.
As we have seen, Eurobonds can be denominated in any of the several different
currencies. These different markets are linked to one another through the currency swap
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EUROCURRENCY MARKET
market. Swap market provides contracts for future exchange of interest and principal in
two different currencies, or alternatively through the long dated forward-exchange
market.

3.3 FEATURES OF EUROBONDS:

Eurobonds have several distinguishing features:
1. Face Value/Par Value:
The face value (also known as the par value or principal) is the amount of
money a holder (investor, who is generally a common citizen) will get back once
a bond matures. Bond in most cases, is issued at par. A newly issued bond usually
sells at the par value. Par value is not the price of the bond. A bonds price (on
stock exchange) fluctuates throughout its life in response to a number of
variables. When a bond trades at a price above the face value, it is said to be
selling at a premium. When a bond sells below face value, it is said to be selling at
a discount.
2. Coupon (The Interest Rate):
The coupon is the amount the bondholder will receive as interest
payments. Its called a coupon because in early days there were physical
coupons attached to the bond certificate (which was paper printed in those days,
and now are in demat form). The investor had to tear off the yearly coupon and
give it to company-office to get interest.
Most Eurobonds pay interest annually, whereas domestic and foreign
bonds pay interest every 6 months. The coupon is expressed as a percentage of
the par value. Another possibility is an adjustable interest payment, known as a
floating-rate bond. In this case the interest rate is tied to market rates through an
index, such as the rat e on Treasury bills. More often bonds are with fixed rate of
interest.
3. Maturity:
The maturity date is the date in the future on which the investors
principal will be repaid. Maturities can range generally from 10 years to as long
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EUROCURRENCY MARKET
as 30 years (in some cases bonds of 100 years have been issued). 15 years
maturity is more used in case of Eurobonds.
4. Issuer:
Eurobonds are mostly issued by corporate (large MNCs). Other borrowers
are governments, international organizations such as World Bank.
5. Denominations (Currency):
Various currencies are commonly used. The U.S. dollar is used the most,
denominating 70 to 75% of Eurobonds. Many other Eurobonds are denominated
in Euros. The Japanese yen has been used by some firms to denominated debt
recently because of its extremely low interest rates.
6. Secondary Market:
Eurobonds have a secondary market. It is different from common stock
exchange. The market makers (facilitators to buy and sell) are in many cases the
same underwriters who sell the primary issues. A technological advancement
called Euro-clear helps to inform all traders about outstanding issues for sale,
thus allowing a more active secondary market.

7. Rating:
The bond rating system helps investors determine a companys credit risk.
Think of a bond rating as the report card for a companys credit rating. Blue-chip
firms, which are safer investments, have a high rating, while risky companies
have a low rating.
While ratings are available for most Eurobond issues; there has been a
tendency of the purchasers to ignore ratings in favour of a well-known name.
8. Taxation:
Eurobonds are not subject to tax and largely free from government
regulation.

3.4 EURO BOND MARKET:

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EUROCURRENCY MARKET
The Eurobond market consists of several layers of participants. First there is the
issuer, or borrower, that needs to raise funds by selling bonds. The borrower, which could
be a bank, a business, an international organization, or a government, approaches a bank
and asks for help in issuing its bonds. This bank is known as the lead manager and may
ask other banks to join it to form a managing group that will negotiate the terms of the
bonds and manage issuing the bonds.
The managing group will then sell the bonds to an underwriter or directly to a
selling group. The three levels-managers, underwriters, and sellers-are known
collectively as the syndicate. The underwriter will actually purchase the bonds at a
minimum price and assume the risk that it may not be possible to sell them on the market
at a higher price. The underwriter sells the bonds to a selling group that then places bonds
with investors. The syndicate companies and their investor clients are considered the
primary market for Eurobonds; once they are resold to general investors, the bonds enter
the secondary market. Participants in the market are organized under the International
Primary Market Association (IPMA) of London and the Zurich-based International
Security Market Association (ISMA).
After the bonds are issued, a bank acting as a principal paying agent has the
responsibility of collecting interest and principal from the borrower and disbursing the
interest to the investors. Often the paying agent will also act as fiscal agent, that is, on the
behalf of the borrower. If, however, a paying agent acts as a trustee, on behalf of the
investors, then there will also be a separate bank acting as fiscal agent on behalf of the
borrower appointed.

3.5 FEATURES OF EURO BOND MARKET:

A Eurobond is an international debt security. Basic characteristics are:
1.
2.
3.
4.
5.
6.

Eurobond is transferable.
Eurobond are usually bearer securities.
Eurobond is intended to be traded.
Eurobond is a medium to long term debt security.
Eurobond is generally launched through a public offering.
Eurobond is generally listed on a stock exchange.
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EUROCURRENCY MARKET

3.6 REASONS FOR GROWTH OF EUROBOND MARKET:

1. Avoidance of legal expenses:
As borrowers are generally of good credit standing, euro bonds tend to be
unsecured, so that legal costs as well as the expenses of bonding and monitoring
are avoided.
2. Disintermediation movement:
Another impetus for the growth of the euro-securities market came from
the general disintermediation movement since the mid-70s.
3. Income tax evasion:
Euro bonds being anonymous bearer bonds make it easier to evade
income taxes. Withholding taxes can be avoided by issuing the bonds in tax
heavens; and most OECD countries have recently waived withholding taxes for
non-residents.
4. Private placement:
Swift and efficient private placement.
5. Regulations: Fewer regulations for off-shore public issues because monetary
authorities and capital market regulations are less concerned with issues that do
not involve their own currency and are not (or not primarily) targeted at local
investors
6. Size:
Issues below USD 100 million are rare. The relatively large size of these
issues allows low issuing costs.

3.7 THE ADVANTAGES OF THE EUROBOND MARKET TO

BORROWERS (CORPORATE):
The Eurobond markets possess a number of advantages for borrowers. These
include the following:
a. Large amounts:
Quantum of Money involved in international market is huge. Corporate
can successfully issue bonds amounting to big amounts, frequently.
b. Fewer restrictions:
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EUROCURRENCY MARKET
The Eurobond market has a freedom and flexibility not found in domestic
markets. The issuing techniques make it possible to bypass restrictions, such as
requirements of official authorization, queuing arrangements, formal disclosure,
exchange listing obligations and so forth, which govern the issue of securities by
domestic as well as foreign borrowers in the individual national markets.
c. Low cost:
The cost of issue of Eurobonds, around 2.5 per cent of the face value of
the issue, is relatively low.
d. Lower interest paid:
Interest costs on dollar Eurobond are competitive with those in New York
often US multinationals have been able to raise funds at a slightly lower cost in
the Eurobond market than in the us domestic market.
e. Longer Maturities:
Maturities in the Eurobond market are suited to long-term funding
requirements. Maturities may reach thirty years, but fifteen-year Eurobonds are
more common. In the medium-term Eurodollar loans. But the longer maturities
provide the assurance of funds availability at a know rate.
f. Sound institutional framework:
A key features of the Eurobond market is the development of a sound
institutional framework for underwriting, distribution and placing of securities.

3.8 ADVANTAGES OF EUROBONDS MARKET TO INVESTORS:

There are a number of special characteristics of the Eurobond market which make
it particularly attractive to investors. These include the following:
a. Less tax:
Eurobonds are issued in such a form that interest can be paid free of
income-tax or withholding taxes of the borrowing countries. Also, the bonds are
issued in bearer form and are held outside the country of the investor, enabling the
investor to evade domestic income tax.
b. No risk of losing money (creditworthiness is high):
Issuers of Eurobonds have, on the whole, an, excellent reputation for
creditworthiness. Most of the borrowers governments, international organizations
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EUROCURRENCY MARKET
or large multinational companies have first-class reputations, the market is very
much a name market.

c. Attractive types of bonds:

A special advantages to borrowers as well as lenders is provided by
convertible and exchangeable Eurobonds.
d. Active secondary market:
The Eurobond market is active both as a primary and as a secondary
market. The secondary market expanded in the late 1960s and early 1970s. Just as
telecommunications linkages have integrated foreign exchange markets, so they
have integrated the secondary market in Eurobonds. Since 1968 international
trading in Eurobonds has been greatly facilitated by a clearing house arrangement
formed by Morgan Guaranty Trust Company in Brussels and called Euro clear.
This provides liquidity to the investor.

3.9 TYPES OF EUROBONDS:

Eurobonds are mostly bearer bonds and are generally denominated in U.S. dollar,
issued in the denominations of U.S. dollar 10,000/- The bonds are issued for a period of
about 5 to 7 years though in some cases they are issued for a longer duration. The
following are the types of bonds.
1. Straight Bond:
It is a fixed income bond. It has annual (or sometimes 6 monthly)
payment of coupon interest to the investor. It is issued at par (or at a nominal
discount to attract investors). Principal amount is redeemed (repaid) to the
investor on maturity (after the complete tenure gets over). Straight bonds are
attractive because of known (fixed) periodic income.

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EUROCURRENCY MARKET
Straight Bond Schematic Diagram
Begin
ning

Year
1

Year
2

Year
3

Year.
.n

Year
X

Last
Year

Investor
gets
principal &
last years
Interest

Investor
Invests at
Issue
price

2. Zero Coupon Bonds Zeros:

Zero coupon bond does not pay any interest during its tenure. The interest
is compounded and paid at the end of the tenure, along with principal amount.
Most zero coupon bonds are in the form of deep discount bonds. They mature at
par and are issued at a discounted price. These bonds are ideal financing
instruments for the issuer (company) if the proposed project is not likely to
generate good cash flow in the initial years. However, for the investor, they are
riskier as compared to straight bonds because no interest is received till maturity.
Zero Coupon Bond Schematic Diagram
Begin
ning

Year
1

Year
2

Year
3

Year
X

Last
Year

Investor
gets
principal &
compound
Interest of
all years

Investor
Invests
at Issue
price
Issued at deep
discount

Year.
.n

Matured at
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EUROCURRENCY MARKET
3. Partly-paid bonds:
These are standard straight bonds. However, the initial payment of
principal amount by investors is limited to maximum 33% of the principal
amount. The balance (67% or more) is paid six months later. These bonds are
popular with issuers who can tailor the second payment to their cash flow
requirements.
4. Bonds with Options:
Bonds have long tenures. An option is given to the investor and/or to the
issuing company to redeem and close the bond before the tenure. There are two
types of bonds in this category, namely, callable and puttable bonds. Option to the
issuing company to call back bonds and pay the dues is called as call option. It is
a callable bond. Conversely, a puttable bond allows the investor to sell back the
bond to the issuer before the date of maturity.
5. Convertible bonds:
A convertible bond is a bond that can usually be exchanged or converted
(at the option of the holder-investor) into equity shares or any such security at a
fixed conversion rate. Conversion rate is set at the time of issue of bond. Issuers
benefit from (1) the lower funding costs relative to short-term money markets and
(2) the possibility of no repaying the principal if the conversion right is exercised.
Investors benefit because they receive the benefit of regular coupon payments
plus the option of converting to equity or any such attractive instrument.
6. Bonds with warrants:
To attract investors to the bond issue, bonds carry a detachable warrant
which assures allotment of equity issue for this purpose is indicated at the time of
issue of bond. Convertible bonds simply get converted to equity. Warrants are
attached to the application of equity, and investors have to pay for it, may be at a
lower price.
7. Dual-currency bonds:
Dual-currency bonds are bonds that are purchased in terms of one
currency but pay coupons or repay principal at maturity in terms of a second
currency. Japanese firms have frequently issued CHF-denominated bonds

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EUROCURRENCY MARKET
convertible into common shares of a Japanese company. A foreign investor can
benefit from purchasing this bond in any one of three situations:
a. A drop in the market interest rate on CHF bonds (as on any straight CHF
bond).
b. A rise in the price of the companys stock (because the bond is convertible
into stocks).
c. A rise in the JPY relative to the CHF (because the bond is convertible into
a JPY asset).
8. Composite currency bonds:
Are denominated in a currency basket, such as SDRs or ECUs, instead of
a single currency. They are frequently called currency cocktail bonds. They are
typically straight fixed-rate bonds. The currency composite is a portfolio of
currencies: when some currencies are depreciating others may be appreciating,
thus yielding lower variability overall.
9. Parallel Bonds: In some cases, a firm may issue a variety of bonds in various
countries (more or less simultaneously). The currency denominating each type of
bond is determined by the country where it is sold. These foreign bonds are
sometimes specifically referred to as parallel bonds.
10. Floating Rate Notes (FRN):
Bonds having varying interest rates or coupon rates over their life are called as
floating rate notes. They are issued with maturity period varying from 5 7 years
and their rates are linked to six months LIBOR rates. There are four different
types of Floating Rate Notes (FRNs) as follows.

Flip Flop FRNs: The investors have the option to convert into flat interest

paying instrument at the end of particular period.

Mix Match FRNs: These notes have semi annual interest payments
though the actual rates are fixed monthly. This enables investors to benefit
from arbitrage arising out of differential interest rates.

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EUROCURRENCY MARKET

Mini Match FRNs: These notes include both maximum and minimum
coupons. The investor will earn a minimum as well as maximum rates on

these notes.
Capped FRNs: An interest rate capped is given, over which the borrower is
not required to service the notes even if LIBOR moves above that level.

11. Sinking Fund Bonds:

These bonds provide for repayment of the principal in installments during the
lifetime of the bond. Such bonds are issued by companies with average credit
rating. The repayment in installments assured the investors about the solvency and
credit worthiness of the issuer. It also helps to progressively reduce the liability of
the issuer.
12. Junk Bonds:
Companies with very poor credit rating or entering into high risk business
ventures issue such bonds. These bonds carry coupon rates of at least 3 4%
above the normal rates. A characteristic feature of these bonds is the high turnover
of investors. Such bonds are used by corporate entities and individuals to make
short term gains on temporary surplus liquidity.
13. Deep Discount Bonds:
These bonds are also issued at discount and redeemed at the face value, difference
in values being the cumulative interest earned by investors at specified rate of
interest.

3.10 FOREIGN BONDS:

These are bonds issued by borrowers outside their home capital market
underwritten by a firm that is situated in the foreign market. These bonds are
denominated in the legal tender of the market in which they are issued. At times
they may be denominated in another currency. Thus a foreign bond is issued by
foreign borrowers and is denominated in the currency of the country in which it is
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EUROCURRENCY MARKET
issued. U.S.A., Japan, Switzerland, Germany and U.K. allow foreign borrowers to
raise money from their residents through the issue of foreign bonds.
A foreign bond is underwritten by a syndicate composed of members from
a single country, sold principally within that country, and denominated in the
currency of that country. The issuer, however, is from another country. A bond
issued by a Swedish corporation, denominated in dollars, and sold in the U.S. to
U.S. investors by U.S. investment bankers, would be a foreign bond.
Immediately after the Second World War, USA was the primary market for
foreign bonds. Due to Interest Equalization Tax imposed in 1963, much of the
dollar denominated bonds moved to the Eurobond market. The market trend is
that borrowers prefer Euro market rather than the U.S. market. Foreign
organizations other than U.S. have extensively floated dollar bonds in the United
States taking advantage of the well-developed capital market. US multinational
raised substantial amounts capital during 1970s by issuing bonds denominated in
D-mark in Germany and bonds denominated in Swiss Francs in Switzerland.
Foreign bonds are referred to as traditional international bonds because
they existed long before Eurobonds. Yankee bonds are foreign bonds issued in the
United States. Foreign bonds issued in U.K. are called Bulldog bonds. Those
issued in Japan are called Samurai bonds.

3.11 TYPES OF FOREIGN BONDS:

1. Yankee Bonds:
These are dollar denominated bonds issued in US market by foreign (nonAmerican) borrowers, with no restriction on size of the issue and maturity.
2. Bulldog Bonds:
Pound denominated bonds issued in the United Kingdom domestic
markets by the foreign (non UK) companies are known as Bull Dog bonds. The
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EUROCURRENCY MARKET
tenure ranges between five to twenty five years. These bonds are subscribed by
long term institutional investors such as Pension funds, Life Insurance
Corporation of India. They have redemption on bullet basis.
3. Samurai Bonds:
Yen denominated bond issued in the Japanese domestic markets by the
non Japanese companies are known as Samurai Bonds. The borrowers have a
minimum investments grade rating (Grade A). The maturities range between
three to twenty years. Since this instrument is for public and the arrangements
have to be made for underwriting and selling involving documentation, its issuing
costs are the highest.
4. Shibosai Bonds:
These are yen denominated private placement bonds, limited to financial
institutions. Private placement means they are not by general advertisement. They
are issued to known groups, which trust the issuing corporate.
5. Kangaroo Bonds:
A type of foreign bond that is issued in the Australian market by foreign
(non Australian) companies and is denominated in Australian currency. The
bond is subject to Australian laws and regulations. These bonds are alternatively
known as Matilda Bond.
6. Maple Bonds:
A type of bond that is issued in the Canadian market by foreign (non
Canadian) Companies and is sold by foreign financial institutions and companies.
The Maple bond provides an opportunity to domestic (Canadian) investors to
invest in foreign companies without worrying about effects of currency exchange
fluctuations. Foreign companies can use Maple bonds to raise Canadian Dollars
for setting up operations in Canada.
7. Panda Bonds:
A Panda bond is a Chinese renminbi denominated bond from a non
Chinese user, sold in China. It was agreed eventually, that funds cannot be
repatriated from China.

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EUROCURRENCY MARKET

8. Rembrandt Bonds:
A foreign bond denominated in Euros and traded in the Netherlands is
known as Rembrandt bond. A non Dutch company can choose to sell this bond
to raise capital from Dutch investors.
9. Matador Bonds:
A term used to identify a foreign bond issued in Spain by a company that
is not domiciled in Spain. Matador bonds were bonds denominated in Pesetas and
were usually corporate bonds. The name matador originated from bull fighters in
Spain. Spain followed a systematic approach when accepting new foreign issuers.
Spain initially allowed only AAA rated super nationals to issue Matador bonds.
After a few years sub AAA multinational were allowed access to Spains debt
market and eventually, allowed non investment sovereigns to issue bonds.
10. Matrioshka Bonds:
Matrioshka bond, a Russian Rouble denominated bond issues in the
Russian Federation by non Russian entities. The name derives from Russian
wooden dolls popular with overseas visitors to Russia.
11. Arirang Bonds:
It is a Won denominated bond issued in South Korea named after a Korean
folk song. The market is very small. The Asian Development Bank was the first to
issue Arirang seven year bonds in 1995 for Won 80 billion.
12. Kauri Bonds:
A similar bond but issued in New Zealand in 2004 named after trees and
denominated in NZ dollars. It may be noted that bonds can be issued not only by
corporate, but also by government and government bodies such as municipalities.
Eurobonds are denominated in foreign currency as like any other euro instrument.

3.12 EUROBONDS V/S FOREIGN BONDS:

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EUROCURRENCY MARKET
The two segments of the international bond market are: foreign bonds and
Eurobonds. Eurobond is a publicly traded bond that is sold exclusively in
countries other than the country in whose currency the issue is denominated. For
example, a Eurobond issue will be issue by Airbus (France) of a $-denominated
bonds. In Japan Foreign bonds are bonds sold in country of denominated
currency, however issuer is from another country. For example, if British Airways
offers bond in the United States priced in US$, that would be a foreign bond. Yet
another example of a foreign bond is the Yankee bond- these are foreign bonds
that are sold in the US.

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Eurobonds

Foreign Bonds

EUROCURRENCY MARKET
Eurobond is a security issued in external Foreign bonds are bonds issued in the
(international, offshore) bond market.
International

syndicated

underwriters;

act

underwritten

domestic market of another country.

as

the The bond is issued by a foreign entity

by

the (such as a government, municipality or

underwriters of multinationality.

corporation);

underwritten

by

the

underwriters of the country where they are

issued.
Euro bonds are simultaneously placed The bond is traded on a foreign financial
with investors from different countries.

market.

Bonds are issued outside the jurisdiction Subject

to

government

rules

and

of any specific country and do not have to regulations.

be

registered

and

are

free

from

regulations.
Eurobonds are tailored to the needs of Foreign bonds is determined keeping in
multinational investors.

mind the investors of a particular country.

Securities issued both in the domestic and Issuers of the foreign bond: Market is not
external markets are called global bonds.

officially registered in the country, where

the bond is issued and traded.

A Eurobond is a bond that is issued by an A foreign bond is a bond issued in a host

international

borrower

and

sold

to countrys financial market, in the host

investors in countries with currencies countrys currency, by a foreign borrower.

other than the currency in which the bond
is denominated.
Bonds denominated in one currency but The bond is denominated in a foreign
issued in a country that is not the home of currency. Bonds issued in a bond market
that currency. For example, a bond by a foreign company. For example, a
denominated in $ can be issued in London Japanese firm issuing a U.S. dollar
is a Eurobond.

denominated bond in the U.S. is issuing a

foreign
Page
47 bond.

Most

countries

have

very

few Because foreign bonds are simply a part

EUROCURRENCY MARKET

CHAPTER 4
INTERNATIONAL COMMERCIAL BORROWINGS
4.1 EXTERNAL COMMERCIAL BORROWINGS (ECBs):
Introduction
External Commercial Borrowing (ECBs) is a key component of Indias overall
debt. Policy on External commercial Borrowings (ECB) is framed by the Government of
India in consultation with RBI. For the convenience of investors and borrowers,
Government brings out the consolidated ECB Guidelines in the form of a brochure.
External commercial borrowing is a complicated process. It is not the loan
agreement alone that is sufficient. It involves a number of other documents. The exact
kind and number of documents to be executed in an external commercial borrowing
depend on various factors including the nature of the lenders, that is, whether
it is an international financial institution, a financial institution of a country, an export
import bank, a commercial bank or a syndicate of such banks. The extent and the period
for which the funds are required by the borrower also play an important role in the
process. The purpose of the borrowing is also significant.
The important aspect of ECB policy is to provide flexibility in borrowings by
Indian Corporates, at the same time maintaining prudent limits for total external
borrowings. The guiding principles of ECB policy are to keep borrowing maturities long,
costs low, and encourage infrastructure and export sector financing which are crucial for
overall growth of the economy.
Government has been streamlining /
liberalizing ECB procedures in order to enable
Indian Corporates, to have greater access
to

international

financial

markets.

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EUROCURRENCY MARKET
Government has now empowered Reserve Bank of India to give ECB approvals in
accordance with the guidelines brought out by the RB
ECB includes commercial bank loans, buyers credit, suppliers credit, securitized
instruments such as floating rate notes and fixed rate bonds etc., credit from official
export credit agencies and commercial borrowings from the private sector window of
multilateral financial institutions.
ECBs can be used for any purpose (rupee-related expenditure as well as imports)
except for investment in stock market and speculation in real estate. They are a source of
finance for Indian corporate for expansion of existing capacity as well as for fresh
investment.
ECBs provide an additional source of funds to the companies, allowing them to
supplement domestically available resources and to take advantage of lower international
interest rates.

4.2 ADVANTAGES OF EXTERNAL COMMERCIAL BORROWING:

a) Lower interest rate First, the foreign currency loan is offered in the
international markets frequently against the guarantee from a bank. Therefore the
borrower should add against the guarantee fee payable by him to his bank to the
cost of raising the foreign currency loan. The interest rate the guarantee
commission and other incidental costs should aggregate to less than the cost of
funds in the domestic market.
b) The availability of the funds from the International market is huge as compared to
domestic market and corporate can raise large amount of funds depending on the
risk perception of the International market.
c) Non-encumbrance on assets - The third advantage is that since specific assets
are usually not charged for funds raised abroad, the borrowing capacity
in the domestic company is not affected.
d) Freedom from exchange risk - The exchange loss on conversion can be avoided
provided the purpose for which the loan is raised can be paid for in the currency
of the loan and the source of repayment is also in the same currency. For instance,
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EUROCURRENCY MARKET
the loan is raised to pay in dollars for raw materials imported and export proceeds
are also received in US dollars. If the sources of repayment are in a currency other
than the currency of loan, the borrower will be facing exchange risk. Forward
cover may arrange, but this should be added to the cost of borrowing. Further,
hedging exposures for longer periods is costly.

4.3 DISADVANTAGES OF EXTERNAL COMMERCIAL

BORROWING
a) Interest Rate Risk: As ECBs are issued for a longer period of time and in this
Mean while if the interest rate in domestic country goes down, it can convert ECB
in an expensive source of financing.
b) Exchange Rate Risk: If the domestic currency gets depreciated at the time of
payment of ECB, then borrower will have to pay extra rupee because of the
domestic currency depreciation.
c) Leverage: ECB is a debt instrument, and if it is raised beyond a limit, it can
increase the countrys dependence on the Lenders country. As they will be in a
condition to impose their decision on borrowing county.

4.4 BITCOINS:
Bitcoin is a new currency that was created in 2009 by an unknown person
using the alias Satoshi Nakamoto. Transactions are made with no middle men
meaning, no banks! There are no transaction fees and no need to give your real
name. More merchants are beginning to accept them: You can buy webhosting
services, pizza or even services.
Bitcoin is a new kind of money. Its the first decentralized electronic
currency not controlled by a single organization or government. Its an open
source project, and it is used by more than 100,000 people. All over the world
people every day with no middle man and no credit card companies. Its startup
currency which has never happened before.

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EUROCURRENCY MARKET
Bitcoin is the first digital currency that is completely distributed. The
network is made up of users like yourself so no bank or payment processor is
required between you and whoever youre trading with. This decentralization is
the basis for Bitcoins security and freedom.
Email helps us send letters for free, anywhere in the world. Skype lets us
make phone and video calls for free, anywhere in the world. Now theres bitcoin.
Bitcoin lets you send money to anyone online, anywhere in the world for less than
a cent per transaction! Bitcoin is a community run system not controlled by any
bank or government.
Bitcoin is perhaps the biggest opportunity for innovation that the world
has seen since the industrial revolution. An idea whose time has come.
Bitcoin can be used to buy merchandise anonymously. In addition,
international payments are easy and cheap because bitcoins are not tied to any
country or subject to regulation. Small businesses may like them because there are
no credit card fees. Some people just buy bitcoins as an investment, hoping that
theyll go up in value.

4.5 CHARACTERISTICS OF BITCOINS:

1. Acquiring Bitoins:
Buy on an Exchange: Several marketplaces called bitcoin exchanges
allow people to buy or sell bitcoins using different currencies. Mt. Gox is the
largest bitcoin exchange.
2. Transfers:
People can send bitcoin each other using mobile apps or their computers.
Its similar to sending cash digitally.
3. Mining:
People compete to mine bitcoins using computers to solve complex
math puzzles. This is how bitcoins are created. Currently, a winner is
rewarded with 25 bitcoins roughly every 10 minutes.
4. Owning Bitcoins:
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EUROCURRENCY MARKET
Bitcoins are stored in a digital wallet, which exists either in the cloud or
on a users computer. The wallet is a kind of virtual bank account that allows
users to send or receive bitcoins, pay for goods or save their money. Unlike
bank accounts, bitcoin wallet are not insured by the FDIC.
5. Anonymity:
Though each bitcoin transaction is recorded in a public log, names of
buyers and sellers are never revealed only their wallet IDs. While that keeps
bitcoin users transactions private, it also them buy or sell anything without
easily tracing it back to them. Thats why it has become the currency of choice
for people online buying drugs or other illicit activites.
6. Uncertain future:
No one knows what will become of bitcoin. It is mostly unregulated, but
that could change. Governments are concerned about taxation and their lack of
control over the currency.

4.5 EURO-DEPOSITS:

JYP
LIA
DE
BIL
PO
ITY
SIT
JAPANES
E BANK

JYP
AS LIA
SE BIL
LOA
T
ITY
N
LONDON
BANK

AS
SE
T
INV
EST
OR

Although the deposit is held in the account of a London bank the money doesnt
actually leave Japan; rather it is held in the account of a London based bank in Japan and
becomes an asset of that bank. The depositors (investors) claim is with the London
Bank. The Euro market has its origins in the deposits whereby cash was held in a
banking system outside the country of that currencys origin.
Historically there was a demand for dollars to held in time deposits outside the
US, specifically in Europe, thus they came to be called Eurodollars.
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EUROCURRENCY MARKET
Dollars later came to be held in South-East Asia and the Middle Eastern banking
system, but they are still called Eurodollars. The market subsequently widened to include
a range of currencies held in time deposits outside their country of origin Euro
deutschmarks, Euroyen and so on.
Euro time deposits generally range from 7 days to 6 months. Banks receiving
Eurocurrencies use them to make loans to international and supranational financial
institutions, governments, companies and to each other. Bank borrowing in Eurocurrency
markets is an alternative to borrowing in domestic interbank market. A Euro placement is
an alternative to selling reserve in the domestic interbank market.
With the exception of overnight funds, domestic and euro rates track each other
closely. The euro rate tends to be slightly higher because of the higher risk attached to
holding currency in a foreign country.
These risks include the possibility that the Central Authority where the euro
deposit is held may interfere in the movement of interest or principal. Another risk is that
the Central Bank may not act as the lender of last resort to bail out a Eurobank (the
bank where the deposit is held) which gets into trouble.
The risks of holding euro-deposits are accentuated by the fact that, on average,
euro-deposits tend to have shorter maturities than euro-loans. Euro-deposits are free from
reserve requirements and most other national regulations, and as their attractiveness for
hedgers and speculators moves funds into the market, Central Bank control of financial
intermediaries decline.

Example of Eurocurrency deposit (Eurodollar deposit):

German firm sells medical equipment to institutional buyer in the US. It receives
a US$ check drawn on Citicorp, NY. Initially this check is deposited in a checking
account for dollar working capital use. But to earn a high return (or rate of interest) on the
$1 million the German firm decides to place the funds in a time deposit with a bank in
London, UK.
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EUROCURRENCY MARKET
One million Eurodollars have thus been created by substituting a dollar account in
a London bank for the dollar account held in NY. Notice that no US $ left NY but
ownership of the US deposit has moved from a foreign corporation to a foreign bank. The
London bank would not like to leave the funds idle in NY account. If a government or
commercial borrower is unavailable, the London bank will place the $ 1 million in the
London interbank market. The interest rate at which such interbank loans are made is
called the London interbank offer rate (LIBOR).

CHAPTER 5
EURO BANKING
5.1 INTRODUCTION TO EUROBANKING:

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EUROCURRENCY MARKET
Eurobanking offers many key advantages to the various stakeholders. Depositors
escape from the tax-net of their own country of domicile. Borrowers get liquid money for
working capital as well as for capital investments at a highly competitive interest rate.
To grab this kind of business, banks offer banking services to non-residents.
Depositors would deposit their own home currency or US Dollar and thus Eurodollar
deposit or Eurocurrency deposit is created. This is then lent to an appropriate borrower by
the bank.
This example demonstrates that the Eurocurrency market is a chain of deposits
and a chain of borrowers and lenders. The majority of Eurocurrency transactions involve
transferring control of deposits from one Eurobank to another Eurobank. Loans to nonEurobank borrowers account for less than half of all Eurocurrency loans.
The Eurocurrency market operates like any other finance market, but for the
absence of government regulations on loans that can be made and interest rates that can
be charged.
The preferred location of Eurobanking would be the one which provides the least
regulatory restrictions. In early 20th century, traders from UK used to deposit their money
in Channel Islands (Jersey, Guernsey and Isle of Man); which were offshore to Britain; to
escape from British regulations. This was termed as offshore banking. Thus offshore
banking is just a convenience term used for Eurobanking.

5.2 OFFSHORE FINANCIAL CENTERS:

Offshore Financial Center (OFC) usually refers to low-tax, lightly regulated
jurisdictions which specialize in providing the corporate and commercial infrastructure to
facilitate the use of those jurisdictions for the formation of offshore companies.
The IMF considers the following to be characteristics of an Offshore Financial
Centre:

Jurisdiction that have relatively large numbers of financial institutions

engaged primarily in business with non-residents;
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EUROCURRENCY MARKET

Financial systems with external assets and liabilities out of proportion to

domestic

financial

intermediation

designed

to

finance

domestic

economies; and
Centers which provide some or all of the following services: low or zero
taxation; moderate or light financial regulation; banking secrecy and
anonymity.

The advantages of offshore financial centers (OFCs) to offshore banking typically

include:

Strong privacy
Less restrictive legal regulation
Low or not taxation (i.e. tax heavens)
Easy access to deposits (at least in terms of regulations)
Protection against local political or financial instability

Offshore banking is an important part of the international financial system.

Experts believe that as much as half the worlds capital flows through offshore centers.
Tax heavens have
1.2% of the worlds population and hold 26% of the worlds wealth, including 31% of the
net profits of United States multinationals. According to Merrill Lynch and Gemini
Consultings World Wealth Report for 2000, one third of the wealth of the worlds
high net-worth individuals nearly $6 trillion out of $17.5 trillion may now be held
by international business companies (IBCs) and trusts.
The offshore activities give capitalism new dynamism and generated additional
profits, but also leave major social scars. They do not enable elected governments to
eradicate poverty, fight environment degradation, finance education, healthcare, pensions
and much needed social infrastructure.

5.3 ADVANTAGES OF OFFSHORE BANKING:

1. Access to stable jurisdictions to park funds:
Offshore banks provide access to politically and economically stable
jurisdictions. This may be an advantage for those residents in areas where there is
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EUROCURRENCY MARKET
a risk of political turmoil, who fear their assets may be frozen, seized or
disappear.
2. Better interest on deposits:
Some offshore banks may operate with a lower cost base and can provide
higher interest rates than the legal rate in the home country due to lower
overheads and a lack of government intervention. Also in most of the popular
offshore banking centers, interest rate is not controlled. Banks are free to decide
their interest rates. This is a great advantage for the banks.
3. Tax Evasion:
Interest is generally paid by offshore banks without tax deducted. This is
an advantage to individuals who do not pay tax on worldwide income, or who do
not pay tax until the tax return is agreed, or who feel that they can illegally evade
tax by hiding the interest income. In popular offshore banking centers, banks also
save on their own direct taxes.
4. Non conventional Facilities:
Some offshore banks offer banking services that may not be available
from domestic banks such as anonymous bank accounts, higher or lower rate
loans based on risk and investment opportunities not available elsewhere.
5. Other advantages to the banks:
In most offshore banking centers; banks get exemption from reserve
requirements, entry is easy to establish a branch, license fees are low etc.

5.4 DISADVANTAGES OF OFFSHORE BANKING:

1. Crime and illegal activities:
Offshore banking has been associated with the undergone economy and
organized crime, through money laundering. Following September 11, 2001,
offshore banks and tax heavens, along with clearing houses, have been accused of
helping various organized crime gangs, terrorist groups, and other state or non
state actors.
2. Tax loss to Governments:
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EUROCURRENCY MARKET
The existence of offshore banking encourages tax evasion, by providing
tax evaders by providing tax evaders with an attractive place to deposit their
hidden income.
3. Capital outflow and volatility:
Developing countries can suffer due to the speed at which money can be
transferred in and out of their economy.
4. Widens rich poor gap:
Offshore banking is usually more accessible to those on higher incomes,
because of the costs of establishing and maintaining offshore accounts. The tax
burden in developed countries thus falls disproportionately on middle income
groups. Offshore Banking centers cause tax loss to other countries and they also
influence currency value variation. Switzerland is one of the largely criticized
centers. Swiss banks were referred to as Gnomes of Zurich by some finance
ministers across the world.

5.5 LIST OF POPULAT OFFSHORE BAKING CENTERS:

London, Switzerland, Singapore, Hong Kong, The Cayman Islands, The
Bahamas, Bahrain, Bermuda, British Virgin Islands BVI, Guernsey, Jersey, Isle of Man,
Luxemburg, Liechtenstein, Monaco, Panama, Uruguay and some more.

CHAPTER 6
FLOATING RATE NOTES
6.1 FLOATING RATE NOTES (FRNS):
The floating-rate note is an instrument whose interest rate floats with prevailing
market rates. It pays a three-month or six-month interest rate linked to LIBOR such as
LIBOR + 1%. This interest rate is reset every three or six months to a new level based
on the prevailing LIBOR level at the reset date. The framework we use places pricing at
the center of what defines an instrument, and FRNs are priced in part like money-market
instruments and in part like conventional fixed-rate bonds.
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EUROCURRENCY MARKET
The floating-rate note has grown up with the Euromarket as a whole. The
instrument was introduced in the early 1970s after many investors had gotten their finger
burned by dabbling in the fixed-rate Eurobond market, in which prices fell as inflation
drove interest rates up to historically high levels.

6.2 BANKS ARE MAJOR INVESTORS IN FRNs:

Investment banker through that they would have a ready demand for floating-rate
notes among that investor who wanted longer maturity instruments than bank deposits,
ones that would maintain their value in the face of higher interest rates. It turned out that
the biggest buyers of floating rate notes were not banks customers, but banks themselves.
Some saw them as another trading instrument buy today, sell later at a profit. Most,
however, bought them as medium-term substitutes for loans. Other banks preferred them
to bank loans because they were treated by the regulators as securities, a treatment that
improved the liquidity of the banks asset portfolio. Whatever the reason, the bulk of
FRNs are today held by financial institution whose cost of funds varies with short-term
rates, because an FRN pays a rate that is tied to changes in short-term interest rates.

6.3 FEATURES OF FRNs:

All floating-rate notes have a coupon that is reset at fixed intervals in accordance
with some preset formula, but there are many variations on this theme. Most FRNs can be
characterized by the following features:
1. The reference rate:
The reference rate is the interest rate to which the coupon payment is
linked. This is normally a short-term rate, so that some see FRNs as a substitute
for money-market instruments. In the Euromarkets, the reference rate is usually
LIBOR, although a few FRNs have used other reference rates (such as LIBID,
LIMEAN, or the U.S.-Treasury-bill rate). The rate is normally reset at the
beginning of each coupon period, and interest is paid.

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EUROCURRENCY MARKET
2. The margin:
The margin is the spread between the coupon payment and LIBOR. For
instance, in case it is LIBOR + 1%, then 1% is called as margin. In fact it is
called as basis points (bps); 100 bps = 1%. This depends on the risk rating of the
issuer.
3. The reference-rate period:
The reference-rate period is the maturity of the security to which the
FRNs coupon is linked, such as three- or six-month. Eurodollar deposits. An
FRN coupon is quoted as the LIBOR-period rate and the margin for example, sixmonth LIBOR plus 3/16 percent.
4. Frequency of reset:
Reset frequency is the period between coupon-reset dates, and normally
coincides with the reference-rate period.
5. Coupon-payment frequency:
This is the interval between coupon payments, and normally coincides
with the coupon-rest periods.
6. Maturity:
The date on which the principal on an FRN will be redeemed is the
maturity date. Many FRNs have call features-that is, the issuer may, are its option,
redeem the FRN at certain prespecified dates prior to maturity.

6.4 ADVANTAGES OF FLOATING RATE NOTES:

The specific advantages in investing in Floating Rate Notes include:
1. known return over LIBOR;
2. known quarterly cash flow coupon resets typically every 90 days in line
with interests rate movements;
3. Tradeable on secondary market in normal market conditions;
4. Provide protection against rising interest rates;
5. Minimal administration as the coupon is automatically paid and reset
every quarter (typically) until maturity;
6. Principal is repaid in full upon maturity (subject to the issuer remaining
solvent until maturity); and
7. No ongoing fees.

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EUROCURRENCY MARKET

6.5 EUROBONDS V/S FRNs

Tenure

Eurobonds
FRNs
Longer (10 to 30 years is Medium Term (3 to 10 years is

Coupon Rate

common)
Fixed percent on face value

common)
Floats based on its linkage
with

Type of Instrument

Capital Market instrument

reference.

Common

Reference is LIBOR
Mix of capital and money
market.

Legally,

Preferred when
Main investors

Interest rates are falling

Corporate, Individuals

market instrument.
Interest rates are rising
Banks

Interest payment Frequency

Yearly and 6-monthly

Quarterly

CONCLUSION
The creation and growth of the Eurocurrency market has been an important side
effect of the increase of international economic activity over the past few decades. The
market has expanded largely as a means of avoiding the regulatory costs involved in
dollar-denominated financial. Due to the size and importance of the foreign exchange
market, it remains largely unregulated. There is no international organization to look over
it or any institutions that sets rules. The name Eurocurrency market is given to any bank
deposits in any country held in a different countrys currency. An example of this is
United States dollar depositing in a British bank. These banks are called Euro banks. The
emergence of eurobanks has facilitated trade and investment between countries. A
Eurocurrency is any currency that is deposited outside of the home country. Since
approximately two thirds of Eurocurrency is U.S. dollars, central banks and regulators are
concerned about Eurocurrency because they are stateless money. Eurocurrency market
has very little regulations, such as taxes, restrictions on capital movements and exchange
controls. Thus, the market attracts more investors. It is easier for banks around the world
to use the Eurocurrency market to move and store funds more profitably than they could
in many countries. Since the market is relatively free of regulation, Eurodollar market
must operate on narrower margins than banks in the United States. The Eurocurrency
market gives investors the opportunity to hold short-term claims on commercial banks,
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which also act as intermediaries to transform these deposits into long-term claims on final
borrowers. Not only does Eurocurrency market allow for more convenient borrowing, it
also improves the international flow of capital for trade between countries and
companies. This market also attracts domestic deposits because it offers a higher interest
rate. The largest Eurocurrency markets are located in London, New York, and Tokyo.
One of the factors that make the Eurocurrency Market unique compared to many
other money market accounts is the fact that it is largely unregulated by government
entities, it is difficult for domestic governments to intervene, particularly in the United
States. However, with the establishment of the flexible exchange rate system in 1973, the
Federal Reserve System was given powers to stabilize lending currencies in the event of a
crisis situation.

BIBIOLOGRAPHY

Chandra Hariharan Iyer, Kajal Dinesh Bhojwani, International Banking and Finance,

Vipul Prakashan
Dileep Mehta and SHung Gay Fung, International Bank Management
Dipak Abhyankar, International Finance, Vipul Prakashan
Federal Reserve Bank of Philadelphia Business Review, The Eurocurrency Interbank

Market: Potential for International Crises?

Journal of Banking and Finance, A Note to Euroyen and Domestic Yen Interest Rates.

WEBILOGRAPHY

www.investopedia.com
www.scribd.com
www.managementparadise.com
www.wisegeek.com
www.tradecurrencies.com
www.docslide.com
www.slideshare.net

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