Lecture 13: International Money Markets

1
Lecture 13 International Money Markets

• The Eurocurrency Markets

2
Where is this Financial Center?
3
Grand Cayman

• Stingray City

• Turtle Burgers

4
Grand Cayman Islands as an Offshore Financial
Center

• Offshore Financial Center Countries or
  jurisdictions with financial centers that contain
  financial institutions that deal primarily with
  nonresidents and/or in foreign currency on a
  scale out of proportion to the size of the host
  economy (OECD definition).
• Characterized by a low (or zero) tax environment
  and specializing in providing corporate and
  commercial services (including investment
  services) to non-resident entities on a
  confidential basis. .

• Grand Cayman Islands (population 52,000)
• 533 banks, with approximately US415 billion in
  deposits (making it fifth largest financial
  center in the world). Other financial companies
  include insurance, cash management, asset
  management (including hedge funds).
• Foreign companies generally register as an
  exempted company because they are guaranteed
  against any future taxes for at least 30 years.
  In addition, its list of shareholders is not
  open to public inspection, they do not have to
  file annual returns and no annual audits are
  required.
• Total start-up costs to form an exempted company
  range between 2,300 and 3,000. Annual
  maintenance costs and government fees thereafter
  run about 2,000
• There are no personal income taxes, no corporate
  income taxes, no capital gains taxes, no
  withholding taxes, no estate, gift or inheritance
  taxes, no sales taxes in the Cayman Islands. The
  Caymans have no tax treaties with any nation.

5
Examples of Offshore Financial Centers IMF Data
(1999)
6
The International Financial Market

• It is the overall financial environment in which
  global businesses and global investors operate.
  It is represented by the following three sectors
• (1) Foreign Exchange Markets
• Currency markets (including foreign exchange
  regimes)
• (2) International Money Markets (Markets for
  short term funds)
• Traditional Financial Centers servicing both
  their domestic markets and non-residents (e.g.,
  London, New York, Chicago, Tokyo)
• Offshore Financial Centers Markets consisting
  primarily of non-resident financial institutions
  and non-resident clients (e.g., Cayman Islands,
  Singapore, Hong Kong).
• (3) International Capital Markets (Markets for
  long term funds)
• Bond markets (Lecture 14)
• Equity markets (Lecture 15)

7
International Money Markets

• The International Money Market represents the
  short and intermediate term borrowing and
  investment market.
• Global firms have access to the international
  money markets either through (1) financial
  intermediaries (primarily large global banks) or
  through access to (2) direct financial markets.
• Intermediary markets include
• Eurocurrency Loan Market (i.e., Euro-Lines of
  Credit)
• Eurocredits Market (i.e., Syndicated Eurocredits)
  
• Direct markets include
• Short Term and Medium Term Euro-notes Market
• Eurocommercial Paper Market

8
The Eurocurrency Market

• The international money market has as its core
  the euro-currency deposit market, also called the
  offshore currency market.
• A Eurocurrency is a freely convertible currency
  deposited in a bank outside its country of
  origin.
• For example, Eurodollars are U.S.
  dollar-denominated time deposits in banks located
  outside of the United States.
• This deposit market supports the borrowing and
  lending of offshore currencies.
• Banks accepting euro-currency deposits can be
  local banks (i.e., domestic to the financial
  market), or foreign banks operating in the local
  market (including U.S. banks).
• These banks are referred to as Eurobanks. Major
  Eurobanks include Citi, Deutsche, and UBS.

9
History of the Eurocurrency Market

• Market originated in the 1950s, when communist
  governments (mainly the Soviet Union) needing
  dollars for international trade and concerned
  about a potential freeze of their dollar accounts
  in US banks, shifted their deposits to London.
• The first bank in the London market accepting
  these dollar deposits was the Banque Commercial
  pour I'Europe du Nord was also known by its cable
  code, EUROBANK.
• In the 1970s the market received a further boost
  when OPEC countries re-cycled their dollar
  earnings into the London markets.
• Londons advantage was two fold (1) deposits
  were not subject to reserve requirements and (2)
  unlike the U.S. at that time there were no
  limitations on interest which could be paid on
  such deposits.
• London banks recycled these deposits in the form
  of loans to governments and corporates.

10
Eurocurrency Market Structure

• The Eurocurrency market is essentially a
  wholesale market (as opposed to a retail market).
  
• Participants include large global banks and other
  large financial institutions, large multinational
  corporations, and governments.
• Estimated size of market (2011) 6 trillion.
• Transactions tend to be large (multiples of
  1,000,000).
• Approximately 80 of the market is interbank.
• The market is confined to time deposits.
• The market is essentially unregulated and
  deposits are not insured.
• The Eurocurrency market is primarily a Eurodollar
  market (approximately 2/3rds).
• Eurocurrency markets exist all over the world,
  but the major and largest market is in London
  (with an estimated 20 of the total market).

11
Interest Rates in the Interbank Eurocurrency
Market

• In the London interbank Eurocurrency market there
  are two important interest rates
• (1) London Interbank Bid Rate The interest rate
  which a Eurobank will offer on (deposit rate)
  referred to at LIBID.
• (2) London Interbank Offer (Ask) Rate The rate
  which a Eurobank will charge to lend a
  eurocurrency (lending or borrowing rate)
  referred to as LIBOR.
• LIBOR rates will always be higher than LIBID
  rates (by about 1/8).

12
LIBOR and the BBA

• Each morning a panel of banks submit their LIBOR
  data for 15 different maturities (overnight out
  to 1 year) in 10 currencies (including the US
  dollar) to the British Bankers Association
  (BBA). BBA LIBOR is an average of this data.
  LIBOR is announced around 1100am in London.
• For up to date data see http//www.global-rates.c
  om/interest-rates/libor/libor.aspx
• For a list of panel banks and historical data
  see http//www.bbalibor.com/rates/historical\
• LIBOR is important because it is used by banks to
  scale loan rates (i.e., as a benchmark rate) to
  clients in the retail market.

13
USD LIBOR, November 9, 2011
14
USD LIBOR Panel, As of May 2011
15
EURIBOR Market

• Euribor stands for Euro interbank offered rate.
• These interest rates for the Euro deposits are
  compiled by the European Banking Federation
  (FBEFédération Bancaire de l'Union Européenne)
• Rates are released at 1100 AM Brussels time,
  each business day.
• Rates are quoted for one week and monthly
  maturities out to a year.
• Overnight rates are referred to as EONIA (Euro
  Overnight Index Average) rates
• Euribor is more widely used than Euro Libor.
• For up to date EURIBOR data see
  http//www.global-rates.com/interest-rates/libor/l
  ibor.aspx

16
EURIBOR, November 9, 2011
17
Eonia (Euro Overnight Index Average) Rates
18
The Eurocurrency Markets and Global Firms

• The Eurocurrency market serves two valuable
  functions for global firms
• (1) Investment Market The market allows global
  firms to earn a return on their excess (i.e.,
  idle) funds.
• Can be tailored to the needs of clients as
  Eurocurrency time deposits have maturities from
  overnight to 12 months.
• They generally offer higher rates than domestic
  deposits.
• (2) Borrowing Market Eurocurrency loans are an
  important source of short-term and intermediate
  term loans for global firms (generally to finance
  working capital needs).
• These Eurocurrency loans generally carry lower
  interest rates than domestic loans.

19
Interest Rate Comparisons Investing Market
20
Interest Rate Comparisons Borrowing Market
21
LIBOR and Domestic Interest Rates

• Summary LIBOR rates will generally parallel the
  rates on equivalent borrowing and deposit
  opportunities in each countrys domestic
  financial market.
• As noted lending rates will generally be lower
  than equivalent domestic market rates, and
  deposit rates will generally be higher than
  equivalent domestic market rates.
• This interest rate structure reflects
• Smaller spreads (between deposit rates and
  lending rates) in the offshore markets than in
  the domestic markets due to cost advantages in
  the market (arising from less regulations and
  domestic lending requirements e.g.,
  compensating balances).

22
External Financing of the Global Firm
23
Eurocurrency Loans (Euro-Lines)

• Eurocurrency loans (also called euro lines) are
  short term lines of credit against eurocurrencies
  offered by Eurobanks.
• Specifically these are arrangements between a
  Eurobank and a customer allowing the customer to
  borrow up to a pre-specified amount of a
  designated euro-currency.
• There are two cost elements in a Euroline
• (1) There is a fee for the line of credit itself
  (about 1/4 to 1/2 of 1 per annum on the unused
  portion of the line).
• (2) Plus an interest rate applied against any
  borrowed amount.
• Interest rate on borrowed amount is scaled to
  LIBOR

24
Eurocredits

• Eurocredits are short- to medium-term
  euro-currency loans made by Eurobanks.
• Often these loans are too large for one bank to
  underwrite, thus many banks will form a syndicate
  to share the size and risk of the loan (hence,
  they are called syndicated eurocredits).
• Eurocredits generally feature a roll over
  provision.
• At maturity, the loan can be extended by mutual
  agreement between lender and borrower.
• At roll over, the interest rate is re-scaled to
  the new LIBOR.

25
Rolling Over a Eurocredit
Example Roll Over of a 6 Month Euro-Credit
years
1
2
3
4
5
6
Today
etc.
etc.
etc.
Loan is re-scaled at new LIBOR every six months,
with interest payments made on those roll-over
dates
26
Euronotes

• Euronotes are short term promissory notes issued
  by a corporation and sold to institutional or
  private investors.
• Maturity is typically three to six months.
• Euro-notes are underwritten by international
  investment banks or international commercial
  banks through Euronote Programs.
• The program identifies the dealer(s) who will act
  on behalf of the borrower in placing issues with
  investors.
• Euro-notes are originally sold at a discount from
  their face value and pay back the full face value
  at maturity and can trade in secondary markets.

27
Euro-Medium-Term Notes (MTNs)

• MTNs are fixed or floating rate notes issued by a
  corporation or government to investors.
• Maturities of 9 months to 10 years (but most
  under 5 years)
• MTNs are offered on an on-going basis rather than
  all at once like a bond.
• Issued through a Euro-MTN Program.
• With this type of program, the issuer can vary
  the amount of notes to be issued at any one time
  depending upon its needs and windows of
  opportunity.
• Thus, a Euro- MTN-program offers issuers
  flexibility in the raising of medium and
  longer-term funds.
• MTNs are placed by dealers and they can trade in
  secondary markets (many do on the London Stock
  Exchange).
• These instruments generally bridge the maturity
  gap between Eurocommercial paper and Eurobonds.

28
Eurocommercial Paper

• Eurocommercial paper are unsecured short-term
  notes issued by corporations and banks in the
  Eurocurrency markets.
• Maturities typically range from one month to 6
  months.
• Historically, U.S. dollar denominated (about
  75) but euro is becoming more important.
• Placed directly with investors through a dealer.
• Through a Eurocommercial Program with a dealer
  who places the issues with potential investors.

29
Appendix 1

• Offshore Financial Centers

30
History Offshore Financial Center

• Origins of offshore financial centers
• In the 1920, wealthy American, UK and Canadian
  citizens established offshore trusts in the
  Bahamas and the Cayman Islands (to minimize their
  taxes).
• See http//www.offshore-manual.com/taxhavens/Caym
  anIslands.html
• In the 1960s and 1970s, US banks established
  offshore branches to escape US regulations and to
  book euro-currency loans.

31
Characteristics of Offshore Financial Centers

• Many (but not all) offshore financial centers are
  sparsely populated small island states
  (Switzerland is an exception).
• These locations provide some or all of the
  following advantages low or zero taxation
  moderate or light financial regulation banking
  secrecy and anonymity.
• Since the 1980s, the number of offshore financial
  centers (as identified by the IMF) has risen from
  about 30 to just under 70.
• See following slides for IMF data.

32
Examples of Offshore Financial Centers IMF Data
(1999)