Topic 5

EUROCURRENCY
MARKET
 Eurocurrency Market

 A Eurodeposit is a deposit that is traded (either as a

deposit or a loan) outside the country of its origin.
- Such deposits are often referred to as an offshore deposit or
“foreign currency”
- A Eurodollar deposit, for example, is a US deposit that is held or
traded outside the United States or yen held outside Japan
 Why the name “Euro”?
- Market for such deposits started in Europe in 1950s and since then
the term “Euro” has been accepted and used to refer to such deposits
 Eurocurrency market started historically with Eurodollar
market
- Eurodollar = short term dollar denominated time deposits held
outside of U.S.
 History of Eurodollar Market

 Many contracts around the world call for payment in U.S.

dollars due to its stability.
 For this reason, many companies and governments choose to
hold dollars and deposit held in New York money centre.
 Eurodollar market has continued to grow rapidly as
depositors may receive a higher rate of return on one
dollar deposit in Eurodollar market than in domestic market.
 At the same time, they will be able to receive more
favorable rate compare to domestic market.
- This is because multinational banks are not subjected to the same
regulations restricting U.S banks and they are willing to accept
narrower spreads between interest paid on deposits and receive
on loans.
Eurocurrency Market vs Domestic Market

 The main difference is that there is no reserve requirements

are required when transacting in Euros, domestic deposits are
subject to minimum reserve requirements imposed by the
respective central banking authorities.
- It is due to the need to provide minimum statutory reserves
that banks have to consider
- The cost of reserves need not be taken into consideration when
one lends foreign currencies
 As the US dollar is the most actively traded deposit, one
often refers Euromarket as the Eurodollar market.
- However, its share of the total global volume has declined in
recent years with the Yen and Euro becoming more popular as
funding and trading currencies
 Role of Eurodollar Market

 Source of attractively priced working capital

loans for multinational firms.

 Serves to store excess liquidity for

multinational companies, countries, and
individuals.

 The market facilitates international trade by

providing reasonably priced credit.
 Forms of Eurodollar Market

 The major forms of Eurocurrency facilities are:

 Short-term bank advances

 Eurocurrency stand-by facilities

 Medium-to long-term Eurocurrency loans

 Short-Term Bank Advances

 Similar to term loans or fully-drawn advances

 Term determined, and full amount drawn-down on
approval
 Commitment fee may be charged if advance not
drawn-down immediately after approval
 May be extended by ‘revolving credit’, where a mixture
of currencies can be chosen at each rollover (to match
borrower’s currency inflows)
 LIBOR typically used as indicator or references rate,
and other rate, i.e. Malaysia is KLIBOR, Singapore is
SIBOR, and other
 Eurocurrency Stand-by Facilities

 A source of ‘back-up’ funds to meet short-term cash

shortfalls
 Funds more likely to be available offshore in the periods
of tight domestic liquidity
 Short-term finance (up to two years)
 Interest charge and commitment fee is applied
Medium-to-long-term Eurocurrency Loans

 Loan size about USD3 - USD100 million

 Larger loans may involve a syndicate of banks
 Term of loans is typically range between 5 to 10 years
 Loans usually fully drawn-down at commencement of
loan unless an availability period is arranged, which involve
a commitments fee
 Interest rate normally above LIBOR and fixed for a
period of 1 to 12 months, plus other fees apply.
 Eurocurrency Market Today

 London is by far the biggest and is regarded as the

“premier” financial centre whereby most of the major
international banks and financial institutions are
represented.
 New York comes in next, followed by Tokyo.
 In the Far east, Hong Kong, Singapore, and Sydney
are established Eurocurrency centers.
 Bearing in mind that profits arising from Euro
operations are taxable, “booking” or “tax haven”
centers have also been set up in several international
locations, for example in Nasau, Cayman, Bahrain, and
Labuan, offering favorable tax concessions.
 Features of Eurodeposits

 Trading in Eurodeposits is unregulated

- It must be free from any financial centre and domestic
regulations

 There are no reserve requirement imposed on

Eurodeposits transactions
- A bank taking a Eurodollar deposit of say, $10 million can relend
out the exact amount

 Eurodeposits are short-term interbank deposits with

maturities range one day to one year
- There is also a market for 2 to 5 years deposits, but this is not
actively traded
 Features of Eurodeposits

 Eurodeposits transactions are mainly on a “clean basis”

- Inter-bank placements or borrowing are without any collaterals
or securities backing

 Eurodeposits are vulnerable to extreme market

volatility and are subject to cyclical ups and downs
- Eurodeposit interest rates are affected by recurrent ups and
downs in business and economic cycles
- Such rates tend to rise during pick up in business cycle and fall
during business slowdown
Euro & Domestic Interest Rate Structure

 Short date deposits comprise the following:

 O/N—Overnight funds, usually 1 day money
 T/N—Tom Next funds, (or Tomorrow – Next funds), usually 1 day
money
 S/N—Spot Next funds, also usually 1 day money
 W/E—Week-end funds, usually 3 days money
 1 Week—7 days money
 2 Weeks—14 days money and
 3 Weeks—21 days money

 The fixed dates comprise 1-month to 12-month money:

– The shorter-end of the market refers to 1 up to 3 months
– The longer end of the market refers to 9 up to 12 months deposits
 Concept of LIBOR

 LIBOR is London inter-bank offer rate at 11a.m. London

time.
 It can be defined as the rate at which funds are offered
to first-class banks in London.
 Eurodollars are an alternative to federal funds where
banks around the world will buy and sell overnight
funds in this Eurodollar market.
- Rate paid for buying funds is London Inter-Bank Bid Rate
(LIBID)
- Rate for funds offered for sale is London Inter-Bank Offer
Rate (LIBOR)
 LIBOR rates can be in any of the actively traded
currencies and for a particular tenor (for example, 1 week
to 1 year)
 Concept of LIBOR

 On a daily basis, a group of banks in London is given the

task to quote the fixed dated deposit rates, and the average
of the respective offer rates are “officially fixed” at 11a.m.
London time
 LIBOR attempts to measure a bank’s cost of raising
new funds in the inter-bank market and as such forms
the basis for almost all floating rate lending in the
Euromarkets.
 Many of the larger corporations have access to borrowing
money from banks based on the cost of funds plus a
loan margin.
- This cost of funds is the prevailing inter-bank offer rate for a
particular currency and tenor
 Concept of LIBOR

 As interest rates tend to fluctuate throughout the day, a

corporation requesting for the cost of 6-month US funds
may be quoted a slightly different rate if it calls the bank
at different times of the day.
- Cost of funds (lending rate) quoted by a few of its bankers may
be different due to the credit rating of each bank
- Hence, there is always the problem of disagreements between
banks and their corporate customers as to whether the right
cost of funds is being used to price the loan
- To solve this problem, many of the larger corporations nowadays
borrow from banks based on LIBOR plus a loan margin
 Concept of LIBOR

 Apart from “fixing” the cost of commercial loans, LIBOR is

also used to determine the cost of Certificate of
Deposits (CDs), Floating Rate Certificate of Deposits
(FRCDs), other syndicated loans and settlements for
interest rate derivative instruments like Forward
Rate Agreements (FRAs), Interest Rate Swaps (IRS) and
Options.
 KLIBOR is the average of the best 10 quotes offered by
20 selected money market participants in the Kuala
Lumpur Interbank Market at 11:00a.m. on each business
day on the KLIBOR Reuters page.
 Interpreting Bid & Offer Rates

 In both Euro and domestic deposit markets, 2-way prices

are quoted for each of the given maturity.
 A 2-way price is a quotation that consists of an offer and
bid rate, the spread between the offer and bid rate
normally being one eighth of a percent (±1/8%) =
±0.00125).
- The spread tends to widen with increased market volatility
and uncertainties
 When quoting a 2-way price, one can quote the offer or the
bid first, but in market practice to quote the offer
rate first, followed by the bid rate.
 Interpreting Bid & Offer Rates

 In the case of Ringgit deposit, the bid rate is quoted first

followed by the offer rate.
 The higher rate is always the offer rate, and the lower is bid
rate.
 Ex of Ringgit deposit: RM3.6800/$ - RM3.6900/$

Bid rate Offer rate/

Ask rate
 Offer Rates / Bid Rates

 The offer rate is the rate at which the market is prepared

to lend funds (lending rate) for each of the particular
maturities.
 Ex: Referring to the Eurodollar rates, the 6-month offer
rate of 5 7/8% is the rate at which banks in the market are
willing to lend six month dollar.
 The bid rate is the rate at which banks in the market are
prepared to accept funds (deposit rate) for each of the
particular maturity.
 Ex: Referring to the Eurodollar deposit rates, the 6-month
bid rate of 5 3/4% is the rate at which banks in the market
are willing to accept 6 months deposit
 Offer Rates / Bid Rates

 It should be noted that the offer rate is only made

available to “good-class” banks (i.e. banks of the
highest credit standing).
- A bank with a poorer credit risk will have to pay a premium
risk on top of the interbank offer rate when borrowing
money.
- Such “premium” can range from 1/16% to as much as 2% for a
very small bank.
- From the above, it can be seen that the cost of funds for the
smaller banks will always tend to be higher than the “prime”
banks as these smaller banks will have to pay an extra margin
when they borrow from the interbank market.
 Price Caller

 Price caller refer to a party call another party for

price/ quote.
 Price caller is also known as price taker whereby they will
be at disadvantage position as borrow at a higher
rate and lend at a lower rate.
 Example:
If you call a bank for a 3-month Ringgit deposit and is
quoted 7.1000-7.2000, you will have to deposit the fund
at 7.1000 to the bank and borrow at 7.2000.
 Price Quoter

 Price quoter is a party who quote price/ rate to price

caller.
 Price quoter is also known as price maker whereby they
will be at advantage position to borrow at a lower rate
and lend at a higher rate.
 Example:
If you quote 7.1000-7.2000 for a 3-month Ringgit deposit
to another bank, you will lend at 7.2000 and borrow at
7.1000.
 Common Market Dealing & Practice

 Money brokers perform the role of financial intermediaries,

matching lenders and borrowers for which a commission or
brokerage is earned on deals closed.
 In the case of a “choice” price quoted by a money broker, it
could be that there is a lender cannot lend the money to
the borrower due to the following reasons:
- Lenders do not possess any money market (credit) lines (limits)
for the borrower
- Lenders is “full” on the counterparty or country limit
- It could be that the amount could not be agreed upon, for
instance, the borrower wants to borrow only US$10 million while the
lender wishes to lend in minimum amounts of US$50 million