WORLD FINANCIAL MARKETS

1
WORLD FINANCIAL MARKETS

• Objectives
• Eurocurrency Market
• Eurobond Market
• Asian Dollar Market
• SDR (1 SDR x1 x2DM x3FF x4 x5)
• ECU / Euro

2
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

3
WORLD FINANCIAL MARKETS

• Eurodollar Market (cont.)
• - Interest Equalization Tax (63 -74)
• - 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

F.C.R.P Foreign Credit Restraint Program
4
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

5
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

6
WORLD FINANCIAL MARKETS

• Interest Rate Structure in the Eurocurrency
  Market

Domestic Lending Rate (PRIME) The rate charged
by banks for loans in the domestic market
A The advantage to a customer in favor of
borrowing in the external market
A
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
LIBOR The rate at which a Euromarket bank is
willing to place a deposit at another Euromarket
bank
C INTERBANK SPREAD The difference between a
banks bid and offer rate for deposits in the
external market (usually 1/8)
LIMEAN (London Interbank Mean Rate) The average
of LIBOR and LIBID
C
LIBID (London Interbank Bid Rate) The rate that
a Euromarket bank is willing to pay to attract a
deposit from another Euromarket bank
D The advantage to a depositor for placing a
deposit in the external market
D
Domestic Deposit Rate The rate that a bank pays
for a deposit in the domestic market
7
WORLD FINANCIAL MARKETS

• Interest Rate Structure in the Eurocurrency
  Market
• LIBOR Spread is lower
• - Lack of reserve requirement
• - Regulatory expenses
• - No governmental intervention at
  concessionary rates
• - Most borrowers are well known
• - High volumes / lower margins
• - Some tax profits

8
WORLD FINANCIAL MARKETS

• Eurodollar Market (cont.)
• e. Participants
• Supply Swiss Banks
• Central Banks
• Institutional Investors
• Demand Governments
• MNCs
• Speculators

9
WORLD FINANCIAL MARKETS

• Eurodollar Market (cont.)
• e. Advantages Narrower Interest Rate Spread
• Lower Loan Rates Wholesale Nature
• Borrowers Credit
• Higher Deposit Rates No Reserve Requirement
• No Interest Ceiling
• No SEC or FDIC

10
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

11
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

12
WORLD FINANCIAL MARKETS

• Foreign Bond
• Evolution
• - Capital outflow restrictions by US (1960s)
  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 self- regulatory agency

13
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

14
WORLD FINANCIAL MARKETS

• Foreign Bond (cont.)
• Operations
• - Straight Debt
• - Convertible Debt
• - Currency Option Bond
• - FRN (Floating Rate Bond)
• Participants
• - Invisible Market Bearer Form No record of
  ownership
• - Secondary Market Free of governmental
  restrictions No disclosures

15
WORLD FINANCIAL MARKETS

• Foreign Bond (cont.)
• Advantages
• - Bearer form No withheld taxes
• - Flexible Rates Fixed or Floating
• - Numerous currencies are available liquid
  international market
• Disadvantages
• - Issuing costs and distribution costs are
  higher
• - If mismatched, FE risk is higher
• - Assessment of credit risk is difficult

16
WORLD FINANCIAL MARKETS

• Eurobond Vs. Eurocurrency Loan

17
WORLD FINANCIAL MARKETS

• Eurocurrency - Revisited
• 1. Syndicated Lending in External Markets
• - Size 1987 1988 1989 1990 (in
  US billion) 80.3 116.2 114.5 120
• - By Origin (1987-1990) US billion
• US 81.6
• UK 74.4
• Italy 28.1
• France 21.3
• Australia 17.7
• Canada 13.6

18
WORLD FINANCIAL MARKETS

• Eurocurrency - Revisited (cont.)
• 2. Interest Rate Risk Floating Rate Pricing
• - Effects 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

19
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

20
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

Non-bank Interbank Depositors
Borrower
Rev. Credit
Banks
Ref. Agent
Principal Interest Payment
Agent Bank
21
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

22
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