 Truong Quang Thong  August 2012  ! " #  $ %$& '($) Lecture 4 : The Eurocurrency Market 1 *+,  Factor price differentials and trade barriers.  Arbitrage and the cost of capital.  Ownership advantages.  Income diversification.  Excess managerial capacity.  Location and the product life cycle. 2 -.  Physical presence through FDI.  Price differentials: cases of US and UK banks with subsidiaries in India; fund raisings by Eurobanks,…  Trade barriers requiring banks to have a physical presence before they can start: case of 100% foreign banks in Vietnam. 3 -  Arbitrage: the practice of taking advantage of price differentials between two or more markets (See more on International Finance course).  The cost of capital: when a currency appreciates, banks find it easier to obtain finance in this currency, causing more international banking… 4 "/-0  Natural disadvantages when entering a new market: new regulatory environment, different customer demand,…  Possession of ownership advantages: superior marketing techniques, managerial expertise, technival know-how,… 5 102  To diversify earnings, so to reduce risks.  Product diversification  Geographic diversification 6 31-  Banks face incentives to build up expertise in many areas even if this expertise would not be required at present.  Given the present excess of managerial capacity, it is then efficient for banks to utilise this capacity by entering a new geographical market.  7 #- Unit Cost Time 1 2 3 4 ACF ACD P=ARF 4 phase location cycle 8 "3-  Follow your customers.  Managerial motives 9 40  Money transmission and cash management.  Credit facilities with range of currencies.  Syndicated lending.  FX transactions and trade finance.  Bond issues.  Equity. 10 [...]... a currency other than that of the currency of the country in which it is located  14 Banks which Eurocurrency are deposited are called Eurobanks Eurocurrency operation that qualifies a bank for the name Eurobank is in fact a department of a large commercial bank History of the Eurodollar Market    15 Born shortly after the WWII The dollars of the Soviet Union and the creations of the two Soviet... 1963: Interest Equalization Tax imposed by the Fed to discourage US investors from investing in foreign securities Thus, non-US borrowers had to sell securities outside the US market  …  American banks have been able to make higher profits lending in the Eurocurrency markets than in the domestic, highly regulated market 18 Participants of the Eurocurrency Markets   MNC  Goverments  Personal Investors... History of the Eurodollar Market  Britain’s policy of GBP replacement by USD in trade financing operations  Balance of payment difficulties of the US during 1960s (hence increasing net US$ balance outside the US)  1973 oil crisis and the petro-dollar 17 History of the Eurodollar Market  Roots from the US banking regulations:  Regulation Q: interest rate ceilings on time deposits in the US (1965-1966)...3 The Eurocurrency markets  One of the truly significant innovations of international banking of the past 50 years  Providing a foundation for a series of innovations in both structure and choices in the financing of the MNCs 11 What is an international currency ?     Size and dynamism of the economy   Convertibility 12 Size of official reserve... financial market Soundness of macroeconomic policies Eurocurrency  Eurocurrency are domestic currencies of one country on deposit in a second country  Eurocurrency markets serve two valuable purposes:   13 An efficient and convenient monay market device for holding excess corporate liquidity; Major source of short term bank loans to finance corporate working capital needs, including the financing... creations of the two Soviet banks: Moscow Narodny Bank in London and the Banque Commerciale pour l’Europe du Nord in Paris 1945-1971: growing role of US$ as international means of payment and reserve asset: “$ as good as gold…” History of the Eurodollar Market  1957: restriction to UK bank lending in sterling to non-residents of the UK  the choice of dollar  1960s: Expansion of US MNC in Western Europe... Personal Investors  19 Large international financial institutions: the WB,… … Advantages of the Eurodollar Market  Low lending rates  High borrowing rate  Reasons of advantages:     20 Economy of scale Admin cost savings Highly qualified customers Independence from supervisory and regulatory policies Advantages of the Eurodollar Market  Competition among banks produces low lending margins  Base... Competition among banks produces low lending margins  Base rate: 6 month LIBOR + Spread  Spread: usually expressed in “basis point” 21 Different Opinions on the Eurodollar Markets  Causing inflation?  FX risk?  Liquidity risk and the role of the lender of last resort?  About a world supervisory and regulatory framework? 22 . securities outside the US market.  ….  American banks have been able to make higher profits lending in the Eurocurrency markets than in the domestic, highly regulated market. 18 -6  Large. shortly after the WWII.  1945-1971: growing role of US$ as international means of payment and reserve asset: “$ as good as gold…”.  The dollars of the Soviet Union and the creations of the two Soviet. deposits and makes loans in a currency other than that of the currency of the country in which it is located.  Eurocurrency operation that qualifies a bank for the name Eurobank is in fact a department