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WORLD FINANCIAL MARKETS
Objectives:
• Eurocurrency Market
• Eurobond Market
• Asian Dollar Market
• SDR
(1 SDR = x1$ + x2DM + x3FF + x4 £ + x5¥)
• ECU / Euro
WORLD FINANCIAL MARKETS
• Eurocurrency Market
a. Offshore
b. Time Deposit
c. $, DM, FF, ¥, SF,, £
• Eurodollar Market
a. Largest component of Eurocurrency Market
b. Evolution
- Marshall Plan
- Cold War
- Higher Yield
- £ Crisis of 1957
- US B/P Deficit in ‘60s
WORLD FINANCIAL MARKETS
• Eurodollar Market (cont.)
- Interest Equalization Tax (63 -74)
F.C.R.P Foreign
Credit Restraint
Program
Voluntary Restrictions (65 - 74)
- Mandatory Restrictions (68 - 74)
OFDI (Office of Foreign
Direct Investment)
- Restrictions on Capital Outflow
- Regulation Q (60 - 73) / M
- Petrodollar Deposit by Arab Countries
(1973 - 1974)
Recycling
LDC Debt Problem
WORLD FINANCIAL MARKETS
• Eurodollar Market (cont.)
c. Operation:
- type: CD (overnight - 10-15 Yrs.)
- Marketable or Negotiable Instruments
Secondary Markets (ICDMA)
- Tap CD
Tranche CD
SDR CD
- Rate:
WORLD FINANCIAL MARKETS
• Interest Rate Structure in the Eurocurrency Market:
LIBOR = London Interbank Offer Rate
LIBID = London Interbank Bid Rate
Interbank, or Funding Spread
Lending Spread: short term loans in the Eurocurrency market
are typically priced at LIBOR plus a spread. The bank can
fund the loan at LIBID, earn a 1/8% funding spread, and also
earn the lending spread
WORLD FINANCIAL MARKETS
• Interest Rate Structure in the Eurocurrency Market:
A: The advantage to a
customer in favor of borrowing
in the external market
A
Domestic Lending Rate (PRIME): The
rate charged by banks for loans in the
domestic market
External Market Lending Rate (Fed
Fund Rate): The rate charged on banks
loans in the external market
B: LENDING SPREAD The
spread paid by the customer
over LIBOR on external market
loans
B
C: INTERBANK SPREAD The
difference between a bank’s bid
and offer rate for deposits in
the external market (usually
1/8%)
C
D: The advantage to a
depositor for placing a deposit
in the external market
D
LIBOR: The rate at which a Euromarket
bank is willing to place a deposit at
another Euromarket bank
LIMEAN (London Interbank Mean
Rate): The average of LIBOR and LIBID
LIBID (London Interbank Bid Rate):
The rate that a Euromarket bank is
willing to pay to attract a deposit from
another Euromarket bank
Domestic Deposit Rate: The rate that a
bank pays for a deposit in the domestic
market
WORLD FINANCIAL MARKETS
• Interest Rate Structure in the Eurocurrency Market:
LIBOR Spread is lower:
-
Lack of reserve requirement
-
Regulatory expenses
-
No governmental intervention
-
Most borrowers are well known
-
High volumes / lower margins
-
Some tax profits
at concessionary rates
WORLD FINANCIAL MARKETS
• Eurodollar Market (cont.)
e.Participants:
Supply:
Swiss Banks
Central Banks
Institutional Investors
Demand:
Governments
MNC’s
Speculators
WORLD FINANCIAL MARKETS
• Eurodollar Market (cont.)
e.Advantages:
Narrower Interest Rate Spread
Lower Loan Rates:
Wholesale Nature
Borrower’s Credit
Higher Deposit Rates:
No Reserve Requirement
No Interest Ceiling
No SEC or FDIC
WORLD FINANCIAL MARKETS
• Eurodollar Market (cont.)
f. Disadvantages:
No lender of last resort
No FDIC
Domestic Monetary Policy
Petrodollar Recycling
Overexposure
Extensive Speculation
Volatile FE Rate
Additional Risk
a. Sovereign or Country Risk
b. Foreign Exchange Risk
WORLD FINANCIAL MARKETS
• Eurobond Market
A market for dollar denominated securities offered by a
syndicate of international banks to investors in two or more
nations where their distribution is legal
WORLD FINANCIAL MARKETS
• Foreign Bond:
Evolution:
- Capital outflow restrictions by US (1960’s) e.g. 1963
interest equalization tax:
Yankee Bonds / Samurai / Bulldog / Rembrandt
- Opening of non-dollar sectors (Euro-FF or Euro- £)
- Distribution technique
- Secondary Market or Liquidity
a. Euroclear (1968: Brussels)
b. CEDEL (1971: Luxembourg)
c. Association of International Bond Dealers: A selfregulatory agency
WORLD FINANCIAL MARKETS
• Foreign Bond: (cont.)
Types of Instruments:
- Fixed Rate Bonds: Fixed coupon bid annually. Bullet
- Floating Rate Notes: Floating coupon, 6/3 months, base rate
LIBOR floor rate
- Convertible Bonds: Bonds can be converted to equity
- Bonds with Equity Warrants
- Zero Coupon Bonds
- Zero Coupon Perpetual Bonds
WORLD FINANCIAL MARKETS
• Foreign Bond: (cont.)
Operations:
- Straight Debt
- Convertible Debt
- Currency Option Bond
- FRN (Floating Rate Bond)
Participants:
- Invisible Market
- Secondary Market
No disclosures
Bearer Form
No record of ownership
Free of governmental restrictions
WORLD FINANCIAL MARKETS
• Foreign Bond: (cont.)
Advantages:
- Bearer form
No withheld taxes
- Flexible Rates: Fixed or Floating
- Numerous currencies are available
market
liquid international
Disadvantages:
- Issuing costs and distribution costs are higher
- If mismatched, FE risk is higher
- Assessment of credit risk is difficult
WORLD FINANCIAL MARKETS
• Eurobond Vs. Eurocurrency Loan
Eurobonds
Eurocurrency
1. Cost of Borrowing Fixed Vs. Floating Rate
Floating Nature
2. Maturity
Long-term
Short-term
3. Size
Small - FC higher
Large - FC lower
4. Flexibility
Less flexible
Very flexible (multicurrency)
5. Spread
Higher
Lower
WORLD FINANCIAL MARKETS
• Eurocurrency - Revisited:
1. Syndicated Lending in External Markets:
- Size:
(in US$ billion)
1987
80.3
- By Origin:
(1987-1990)
1988
116.2
1989
114.5
US$ billion
US
81.6
UK
74.4
Italy
28.1
France
21.3
Australia
17.7
Canada
13.6
1990
120
WORLD FINANCIAL MARKETS
• Eurocurrency - Revisited: (cont.)
2. Interest Rate Risk:
- Effects:
Floating Rate Pricing
Long term commitment of funds
Loans can be funded with short term deposits
Interest rate risk passed on to borrowers
3. Size of Funding:
Syndication of Loans
Large volume of funds available to single customers
Need for cooperation among major banks
WORLD FINANCIAL MARKETS
• Eurocurrency - Revisited: (cont.)
4. Syndication:
-
Mandated Banks: Put the deal together
-
Managing Banks: Give an underwriting commitment
Lead Manager
Manager
Co-Manager
-
Participating Banks: Provision of funds
-
Agent Banks: Manages borrowing and repayment of funds
-
Reference Agent: LIBOR rates
WORLD FINANCIAL MARKETS
• Eurocurrency - Revisited: (cont.)
5. Floating Rate Pricing:
Period
LIBOR
SPREAD
Lending Rate
7/1 - 12-31/89
9.50
1.0
10.50%
1/1 - 6-30/89
9.25
1.0
10.25%
7/1 - 12-31/90
8.50
1.0
9.50%
1/1 - 6-30/90
8.25
1.0
9.25%
Borrower
Principal &
Interest
Payment
Rev. Credit
Banks
Ref.
Agent
Agent Bank
Non-bank
& Interbank
Depositors
WORLD FINANCIAL MARKETS
• Eurocurrency - Revisited: (cont.)
6. Cost Structure of a Syndicated Credit:
-
Periodic Costs:
a. Interest Rates (LIBOR) + Spread
b. Commitment Fee
c. Agency Costs
-
Up-front Costs:
a. Management Fees: to Mandated Bank,
Underwriting fee to managing banks,
participation fee
b. Out of Pocket Expenses
WORLD FINANCIAL MARKETS
• Eurocurrency - Revisited: (cont.)
7. Terms of Eurocurrency Borrowing:
-
Type of Credit:
a. Term Credit
b. Revolving Credit
-
Commitment Clause
-
Maturity
-
Currency
-
Repayment Clauses & Prepayment Clauses