EURO-CURRENCY MARKET
EURO-CURRENCY MARKET
A PROJECT
in the subject of Economics of Global Trade & Finance
SUBMITTED TO
UNIVERSITY OF MUMBAI
FOR SEMESTER -II OF
MASTER OF COMMERCE
BY.
KHAN MOHD.MOHSIN
Roll No.(14)
Specialization: Business Management
UNDER THE GUIDANCE OF
PROF. K VENKATESWARLU/
DR. AARTI PARSAD
YEAR - 2014-15
DECLARATION BY THE STUDENT
I, Shri Khan Mohd. Mohsin, student of M. Com. Part-I Roll Number
(14), at the Department of Commerce, University of Mumbai do hereby
declare that the project titled,
Euro-Currency Market submitted by me in the subject of Economics
of Global Trade & Finance for Semester II during the academic
year 2014-15, is based on actual work carried out by me under the
guidance and supervision of Prof. K.Venkateswarlu/ Dr Aarti
Prasad
I further state that this work is original and not submitted
anywhere else for any other examination.
Date
Mumbai
Signature of Student
EVALUATION CERTIFICATE
This is to certify that the undersigned have assessed and
evaluated the project on Euro-Currency Market in the subject of
Economics of Global Trade & Finance submitted by Kum/Smt/Shri
Khan Mohd. Mohsin , student of M. Com. Part-I at the Department of
Commerce, University of Mumbai for Semester II during the academic
year 2013-14.
This project is original to the best of our knowledge and has
been accepted for Internal Assessment.
Internal Examiner External ExaminerDirector
Dr. V. Deolankar
University of Mumbai
Department of Commerce
Internal Assessment: Subject: Economics of Global Trade &
Finance
Name of Student
Class
Branch
Roll Number
First Name : MOHD MOHSIN
Fathers : MOHD MOIN
Surname : KHAN
M.COM
PART -I
Business Management
14
Topic for the Project: Euro-Currency Market
Marks Awarded
Signature
DOCUMENTATION
Internal Examiner
(Out of 10 Marks)
External Examiner
(Out of 10 Marks)
Presentation
(Out of 10 Marks)
Viva and Interaction
(Out of 10 Marks)
Total Marks
(Out of 40 Marks)
CONTENT
SL.NO.
PARTICULARS
PAGE NO.
CHAPTER 1 - INTRODUCTION
1.1
Introduction of International Financial Markets
1-3
1.2
Currency Markets
4-5
1.3
Historical Background Of International Financial Markets
6-10
CHAPTER 2 - UNDERSTANDING THE CONCEPT
2.1
Introduction of Euro-currency Market
11-12
2.2
Historical Background of Euro-currency
13-15
2.3
Definitions of Eurocurrency or Eurocurrency market
16
2.4
Characteristics of the Euro-currency Market
17-18
2.5
Reasons for Development of the Euro-currency Market
19-21
2.6
Creation of Euro-currencies and deposits
22
2.7
Instruments of the Euro-currency Market
23
CHAPTER 3 - THE FUTURE
3.1
Economic impact of Euro-currency Market
24
3.2
Advantages of Euro-currency Market
25
CHAPTER 4 - SUMMARY OF STUDY
4.1
Conclusion
26
4.2
Summary of Euro-currency Market
27
4.3
Abbreviation
28
4.4
Bibliography
29
EURO-CURRENCY MARKET
CHAPTER 1
1.1 INTERNATIONAL FINANCIAL MARKET
Introduction (International Financial Market)
International financial market serve as links between the
financial markets of the each individual country and as independent
market outside the jurisdiction of any one country.
The market for currencies is the heart of this international
financial market. International trade and investment are often
denominated in a foreign currency. So the purchase of the currency
precedes the purchase of goods, services, or assets.
The growth of the foreign currency markets in Europe in the
1960s was one of the first developments in the movement towards the
globalization of the financial market. Prior to 1980
euro-currencies markets was the only truly international financial
market of any importance. Eurodollar or Eurocurrency markets are
the international currency markets where currencies are borrowed
and lent. Each currency has demand and a supply. The demand for
foreign currencies arises when tourists visits another country and
need to exchange their national currency for the currency of the
country they are visiting, when a domestic firm wants to import
from another country,when an individual wants to invest abroad and
so on. On the other hand, expenditures in the country arises from
foreign tourists expenditures in the country, from export earnings,
from foreign investments in the country and so on.
The foreign exchange market (forex, FX, or currency market) is a
global decentralized market for the trading of currencies . The
main participants in this market are the larger international
banks. Financial centers around the world function as anchors of
trading between a wide range of different types of buyers and
sellers around the clock, with the exception of weekends.
Electronic Broking Services (EBS) and Reuters 3000 Xtra are two
main interbank FX trading platforms. The foreign exchange market
determines the relative values of different currencies.
The foreign exchange market works through financial
institutions, and it operates on several levels. Behind the scenes
banks turn to a smaller number of financial firms known as dealers,
who are actively involved in large quantities of foreign exchange
trading. Most foreign exchange dealers are banks, so this
behind-the-scenes market is sometimes called the interbank market,
although a few insurance companies and other kinds of financial
firms are involved. Trades between foreign exchange dealers can be
very large, involving hundreds of millions of dollars. Because of
the sovereignty issue when involving two currencies, Forex has
little (if any) supervisory entity regulating its actions.
The foreign exchange market assists international trade and
investment by enabling currency conversion. For example, it permits
a business in the United States to import goods from the European
Union member states, especially Euro zone members, and pay euros,
even though its income is in United States dollars. It also
supports direct speculation in the value of currencies, and the
carry trade, speculation based on the interest rate differential
between two currencies.
In a typical foreign exchange transaction, a party purchases
some quantity of one currency by paying some quantity of another
currency. The modern foreign exchange market began forming during
the 1970s after three decades of government restrictions on foreign
exchange transactions (the Bretton Woods system of monetary
management established the rules for commercial and financial
relations among the world's major industrial states after World War
II), when countries gradually switched to floating exchange rates
from the previous exchange rate regime, which remained fixed as per
the Bretton Woods system.
The foreign exchange market is unique because of the following
characteristics:
Its huge trading volume representing the largest asset class in
the world leading to high liquidity;
Its geographical dispersion;
Its continuous operation: 24 hours a day except weekends, i.e.,
trading from 20:00 GMT on Sunday until 22:00 GMT Friday;
The variety of factors that affect exchange rates;
The low margins of relative profit compared with other markets
of fixed income; and
The use of leverage to enhance profit and loss margins and with
respect to account size.
As such, it has been referred to as the market closest to the
ideal of perfect competition, notwithstanding currency intervention
by central banks.
According to the Bank for International Settlements , the
preliminary global results from the 2013 Triennial Central Bank
Survey of Foreign Exchange and OTC Derivatives Markets Activity
show that trading in foreign exchange markets averaged $5.3
trillion per day in April 2013. This is up from $4.0 trillion in
April 2010 and $3.3 trillion in April 2007. FX swaps were the most
actively traded instruments in April 2013, at $2.2 trillion per
day, followed by spot trading at $2.0 trillion.
1.2 CURRENCY MARKETS
International currency markets are the markets for foreign
currencies where the currencies are borrowed and lent for varying
maturities. The prices paid for borrowing or lending a currency in
the international currency markets is the rate of interest.
The international currency markets are the adjunct of the
foreign exchange markets. The foreign exchange markets one currency
is exchanged for another currency at a rate of exchange which is
the rate at which the currency of a country is exchanged against
the currency of another country. The purpose for which currencies
are exchanged in the foreign exchange market or borrowed in the
currency may be the same, namely, for investment or for meeting
trade and payments requirements, or for short-term or long-term
investment or for meeting debt or other obligations. Foreign
exchange market and the currency market are interrelated.
Foreign currency market structure:
The market for foreign currencies is a worldwide market that is
informal in structure. This means that it has no central placed
like stock exchanges. Themarket is actually the thousands of
telecommunications links among financial institutions around the
world. Its is open 24 hours a day. Someone, somewhere,is nearly
always open for business. For example, the subscribers to
international financial news sources, such as Reuters news network,
are connected to spot exchange computer screen. The screen serves
as a bulletin board, where all financial institutions wanting to
buy or sell foreign currencies can post representative prices.
Although, the rates quoted on these computer screen are
indicative of current prices, the buyer is still referred to the
individual bank for the latest quotation due to the rapid movements
of rates world wide. There are also hundreds of banks operating in
the markets at any moment that may not be listed on the brief
sample of Reuters new bulletin,
The speed with which this market moves, the multiplier of
players playing on a field that is open 24hours a day, and the
circumference of the earth with its time and days differences
procedure many different single prices.
Foreign currency market is the largest and most liquid financial
market in the world. It includes trading between large banks,
central banks, currency speculators, multinational corporations,
governments, and other financial markets and institutions.
Eurocurrency Spreads
A number of fundamental factors explain the smaller spread in
the Eurocurrency markets.
1. Operations: It is a wholesale market; It typically operates
in units of $1 million; It services large and well-known clients;
All these lead to low overhead cost.
2. Regulations: No deposit insurance; Market interest on
voluntary reserves; tax incentives.
3. Asset-liability management: Clients are known with
high-quality credits smaller default risk; Floating rate interest +
maturity matching r educed interest rate risk; No prepayment
risk.
1.3 HISTORICAL BACKGROUND OF INTERNATIONAL FINANCIAL MARKETS
(i) Ancient
Currency trading and exchange first occurred in ancient times.
Money-changing people, people helping others to change money and
also taking a commission or charging a fee were living in the times
of the Talmudic writings (Biblical times). These people (sometimes
called "kollybists") used city-stalls, at feast times the temples
Court of the Gentiles instead. Money-changers were also in more
recent ancient times silver-smiths and, or, gold-smiths.
During the fourth century the Byzantium government kept a
monopoly on the exchange of currency.Currency and exchange was also
a crucial element of trade in the ancient world so that people
could buy and sell items like food, pottery and raw materials. If a
Greek coin held more gold than an Egyptian coin due to its size or
content, then a merchant could trade fewer Greek gold coins for
more Egyptian ones, or for more material goods. This is why the
vast majority of world currencies are derivatives of a universally
recognized standard like silver and gold.
(ii) Medieval and later
During the fifteenth century the Medici family were required to
open banks at foreign locations in order to exchange currencies to
act for textile merchants. To facilitate trade the bank created the
nostro (from Italian translated "ours") account book which
contained two columned entries showing amounts of foreign and local
currencies, information pertaining to the keeping of an account
with a foreign bank. During the 17th (or 18th ) century Amsterdam
maintained an active forex market. During 1704 foreign exchange
took place between agents acting in the interests of the nations of
England and Holland.
(iii) Early modern
The firm Alexander Brown & Sons traded foreign currencies
exchange sometime about 1850 and were a leading participant in this
within U.S.A. During 1880 J.M. do Esprito Santo de Silva (Banco
Esprito e Commercial de Lisboa) applied for and was given
permission to begin to engage in a foreign exchange trading
business.
1880 is considered by one source to be the beginning of modern
foreign exchange, significant for the fact of the beginning of the
gold standard during the year.
Prior to the first world war there was a much more limited
control of international trade. Motivated by the outset of war
countries abandoned the gold standard monetary system.
(iv) Modern to post-modern
From 1899 to 1913, holdings of countries' foreign exchange
increased at an annual rate of 10.8%, while holdings of gold
increased at an annual rate of 6.3% between 1903 and 1913.
At the time of the closing of the year 1913, nearly half of the
world's foreign exchange was conducted using the Pound sterling.
The number of foreign banks operating within the boundaries of
London increased in the years from 1860 to 1913 from 3 to 71. In
1902 there were altogether two London foreign exchange brokers. In
the earliest years of the twentieth century trade was most active
in Paris, New York and Berlin, while Britain remained largely
uninvolved in trade until 1914. Between 1919 and 1922 the
employment of a foreign exchange brokers within London increased to
17, in 1924 there were 40 firms operating for the purposes of
exchange. During the 1920s the occurrence of trade in London
resembled more the modern manifestation, by 1928 forex trade was
integral to the financial functioning of the city. Continental
exchange controls, plus other factors, in Europe and Latin America,
hampered any attempt at wholesale prosperity from trade for those
of 1930's London.
During the 1920s foreign exchange the Klein-wort family were
known to be the leaders of the market, Jap-hets, S,Montagu &
Co. and Seligman's as significant participants still warrant
recognition. In the year 1945 the nation of Ethiopia's' government
possessed a foreign exchange surplus.
(v) After World War II
After World War II, the Bretton Woods Accord was signed allowing
currencies to fluctuate within a range of 1% to the currencies par.
In Japan the law was changed during 1954 by the Foreign Exchange
Bank Law, so, the Bank of Tokyo was to become because of this the
Centre of foreign exchange by September of that year. Between 1954
and 1959 Japanese law was made to allow the inclusion of many more
Occidental currencies in Japanese forex.
President Nixon is credited with ending the Bretton Woods
Accord, and fixed rates of exchange, bringing about eventually a
free-floating currency system. After the ceasing of the enactment
of the Bretton Woods Accord (during 1971 ) the Smithsonian
agreement allowed trading to range to 2%. During 196162 the amount
of foreign operations by the U.S. of America's Federal Reserve was
relatively low. Those involved in controlling exchange rates found
the boundaries of the Agreement were not realistic and so ceased
this in March 1973, when sometime afterward none of the major
currencies were maintained with a capacity for conversion to gold,
organizations relied instead on reserves of currency. During 1970
to 1973 the amount of trades occurring in the market increased
three-fold. At some time (according to Gandolfo during
FebruaryMarch 1973) some of the markets' were "split", so a two
tier currency market was subsequently introduced, with dual
currency rates. This was abolished during March 1974.
Reuters introduced during June 1973 computer screen, replacing
the telephones and telex used previously for trading quotes.
(vi) Markets close
Due to the ultimate ineffectiveness of the Bretton Woods Accord
and the European Joint Float the forex markets were forced to close
sometime during 1972 and March 1973. The very largest of all
purchases of dollars in the history of 1976 was when the West
German government achieved an almost 3 billion dollar acquisition
(a figure given as 2.75 billion in total by The Statesman: Volume
18 1974), this event indicated the impossibility of the balancing
of exchange stabilities by the measures of control used at the time
and the monetary system and the foreign exchange markets in "West"
Germany and other countries within Europe closed for two weeks
(during February and, or, March 1973. Giersch, Paqu, &
Schmieding state closed after purchase of "7.5 million Demarks"
Brawley states "... Exchange markets had to be closed. When they
re-opened ... March 1 " that is a large purchase occurred after the
close).
(vii) After 1973
In fact 1973 marks the point to which nation-state, banking
trade and controlled foreign exchange ended and complete floating,
relatively free conditions of a market characteristic of the
situation in contemporary times began (according to one source),
although another states the first time a currency pair were given
as an option for U.S.A. traders to purchase was during 1982, with
additional currencies available by the next year.
On 1 January 1981 (as part of changes beginning during 1978 )
the Bank of China allowed certain domestic "enterprises" to
participate in foreign exchange trading. Sometime during the months
of 1981 the South Korean government ended forex controls and
allowed free trade to occur for the first time. During 1988 the
countries government accepted the IMF quota for international
trade.
Intervention by European banks especially the Bundesbank
influenced the forex market, on February the 27th 1985
particularly. The greatest proportion of all trades world-wide
during 1987 were within the United Kingdom, slightly over one
quarter, with the U.S. of America the nation with the second most
places involved in trading.During 1991 the republic of Iran changed
international agreements with some countries from oil-barter to
foreign exchange.
FOREIGN EXCHANGE MARKET TURNOVER
CHAPTER 2
2.1 EUROCURRENCY MARKETS
Introduction
Eurocurrency refers to commercial bank deposits outside the
country or their issue. Thus, any currency internationally supplied
and demanded and in which a foreign bank is willing to accept
liabilities and loan assets is eligible to become Eurocurrency. For
example, a US dollar deposit held in London or Paris is a
Euro-dollar deposit. A Deutschemark deposit held in New York,
London, and Paris is a Euro-mark deposit. Similarly, a pound
sterling deposit in a French Commercial bank or in a French branch
of a British bank is Eurosterling, and so on. These balances are
usually borrowed or loaned by major international corporations,and
governments when they need to acquire or invest additional
funds.
The market in which borrowing and lending in euro-currency takes
place is called the Euro-currency market. It has two sides to it,
that is the receipt of deposits and the loaning of that
deposits.
The prefix Euro is now outdated because such deposits and loan
in different currencies are regularly traded outside Europe,
especially in Singapore and Hongkong. Thus, Euromarkets are also
referred to as offshore market if such deposits have more
widespread geographical base.
The most important Euro-currency is Eurodollar. It is followed
by the Euro-mark, Euro-franc (Swiss), Eurosterling and Euro-yen,
Initially, only the dollar was used in this fashion, and the market
was therefore called the Eurodollar market. Subsequently, the other
lending currencies such as the German mark, the Japanese Yen, the
British pound sterling, and the French and Swiss franc, also began
to be used in this way. Thus, the market is now called the
Eurocurrency market. The main reason for the rapid growth of
Euro-currency markets is that they provide better deposit and loan
rates than offered by domestic banks located in the country that
issues the currency.
Eurodollars are deposit liabilities, denominated in US
dollars,of banks located outside the United States and trade in
Europe. The basic characteristics of Eurodollars are that;
(i) They are short-term obligations of banks to pay US dollars,
and
(ii) These banks are located outside the U.S.
The banks themselves need not be be foreign. They are often
European nationality. The depositors range from European centrals
banks, firms and individuals to US banks, Corporations and
residents.
The term Eurodollar came to be used because the market had its
origin and earlier development with dollar transactions in the
European money markets. When the European bank expanded their
operation to accept deposits and make loans in currencies other
than the dollar the more general terms such as Euro-currency and
Euromarkets came into use. With the spread of the practice of the
accepting deposits in dollar and other foreign currencies to other
parts of the world, such as Hongkong and Singapore, the terms such
as Eurocurrency and Euromarket have also become misleading.
The practice of keeping bank deposits denominated in a currency
other than that of the country in which the deposits is held has
also spread to non-European international monetary centers as
Tokyo, Hongkong, Singapore and Kuwait and they are appropriately
called Offshore deposits. The name Euro-deposits is often used also
for such deposits outside Europe. With these geographical
extensions, the Eurocurrency market has become an essentially
24-hour a day operation.
2.2 HISTORICAL BACKGROUND OF EURO-CURRENCY
After World War II, the amount of US Dollars outside the United
States increased enormously, both as a result of the Marshall Plan
and as a result of imports into the USA. As a result, large sums of
US Dollars were in custody of foreign banks outside the United
States. Many foreign countries, including the Soviet Union, had
deposits in US dollars in USA banks.
After the invasion of Hungary in 1956, the Soviet Union feared
that its deposits in American banks could be frozen as retaliation.
A British bank offered the Soviets the possibility of receiving its
US Dollar reserves as deposits, outside the USA. This operation was
considered the first to create so-called Eurodollars.
Gradually, as a result of the successive commercial deficits of
the United States, the Eurodollar market expanded until today where
it is available in virtually every country. Today, Eurocurrency
refers to deposits in any currency residing in banks that are
located outside the borders of the currencys country. For example a
deposit denominated in Yen residing in an Australian bank is a
Eurocurrency deposit, or more specifically a Euro-Yen deposit.
Similar external deposits apply to Euro-Sterling, Euro-Euro,
Euro-Swiss Franc, etc.
A Eurocurrency market is a money market that provides banking
services to a variety of customers by using foreign currencies
located outside of the domestic marketplace. The concept does not
have anything to do with the European Union or the banks associated
with the member countries, although the origins of the concept are
heavily derived from the region. Instead, it represents any deposit
of foreign currencies into a domestic bank. For example, if
Japanese yen is deposited into a bank in the United States, it is
considered to be operating under the auspices of the Eurocurrency
market.
This market has its roots in the World War II era. While the war
was going on, political challenges caused by the takeover of the
continent by the Axis Powers meant that there was a limited
marketplace for trading in foreign currency. With no friendly
government operations within the European marketplace, the
traditional economies of the nations were displaced, along with the
currencies. To combat this, especially due to the fact that many
American companies were tied to the well-being of business behind
enemy lines, banks across the world began to deposit large sums of
foreign currency, creating a new money market.
One of the factors that make the Eurocurrency market unique
compared to many other money market accounts is the fact that it is
largely unregulated by government entities. Since the banks deal
with a variety of currencies issued by foreign entities, it is
difficult for domestic governments to intervene, particularly in
the United States. With the establishment of the flexible exchange
rate system in 1973, however, the U.S. Federal Reserve System was
given powers to stabilize lending currencies in the event of a
crisis situation. One problem that arises is that these crises are
not defined by the regulations, meaning that intervention must be
established based on each case and the Federal Reserve must work
directly with central banks around the world to resolve the matter.
This adds to the volatility of the market.
Despite its name, the Eurocurrency market is primarily
influenced by the value of the American dollar, since nearly
two-thirds of all assets around the globe are represented by U.S.
currency. The challenge with foreign banks revolves around the fact
that regulations enforced by the Federal Reserve are really only
enforceable within the U.S. The taxation level and exchange rate of
the American dollar varies depending on the nation; for example, an
American dollar in Vietnam is worth more than it is in Canada,
further influencing the market.
The origin of the Eurocurrency market can be traced back to the
1950s and early 1960s, when the former Soviet Union and Soviet-bloc
countries sold gold and commodities to raise hard currency. Because
of anti-Soviet sentiment, these Communist countries were afraid of
depositing their U.S.
Dollar in U.S. Bank for fear that the deposits could be frozen
or taken. Instead they deposited their dollars in a French bank
whose telex address was EURO-BANK. Since that time, dollar deposits
outside the U.S. have been called Eurodollar and banks accepting
Eurocurrency deposits have been called Euro-banks.
2.3 Definitions of Eurocurrency or Eurocurrency market
According to the book The current Levich textbook, The
Eurocurrency market is the market for deposits placed under a
regulatory regime different than the regulations applied to the
deposits used to execute domestic transactions.
According to the Grabbe, The money market for borrowing and
lending currencies that are held in the form of deposits in banks
located outside the countries in which those currencies are issued
as legal tender. Eurodollar: A dollar-denominated deposit in a bank
outside the United States or at International Banking Facilities
(IBFs) in the United States.
According to the Eiteman, Stonehill and Moffett, Eurocurrency: A
currency deposited in a bank located in a country other than the
country issuing the currency. Eurodollar: A U.S. dollar deposited
in a bank outside the United States. A Eurodollar is one type of
Eurocurrency.
According to the Gunter Dufey and Ian Giddy The International
Money Market, The Eurocurrency market is simply a market for bank
time deposits and loans denominated in a currency other than that
of the country in which the bank is located. The international
money market consists of the Eurocurrency market and its linkages
to the major domestic money markets.
What are Eurodollars and Eurocurrencies?
According Maurice D. Levi, International Finance, Here is a
short, accurate definition: A Eurodollar deposit is a
U.S.-dollar-denominated bank deposit outside the United States.
Eurocurrency deposits are a generalization of Eurodollars and
include other externally held currencies.
2.4 CHARACTERISTICS OF THE EUROCURRENCY MARKET
The important characteristics of the Eurocurrency market are the
following:
I. Free of government regulation: The Eurocurrency market is an
important channel for mobilizing funds and deploying them on an
international scale. The important centres are London, Paris,
Hongkong and Singapore. It is generally outside the direct control
of any government regulation.. More specially, they do not face
compulsory reserve requirement interest ceiling on deposits and so
on it is generally said that the dollar deposits in London are
Outside the control of US because they are in London, and they are
also outside the control of British government because they are in
dollars.
II. Short-term nature: The deposits and loans of Eurobanks are
Predominantly of a short-term nature. The maturity nature of some
deposits is as short as one day and majority are under six months.
Interest is paid on all of them. The Eurocurrency loans are
generally for short period- three months or less.
III. Close maturity of assets and liabilities: There is a close
matching of the maturity structure of assets (loans) and
liabilities (deposits). This is due to the fact that Eurobanks have
to be cautious about the sudden large withdrawal of short-term
funds by the depositors. Further, the close matching of assets and
liabilities reduce the risk of interest rate fluctuations to the
banks. Here the deposits are for short-term and lending are the
long-term. Therefore it is necessary to maintain a balance.
IV. Eurobanks themselves the users of Eurocurrency: A large
proportion of Eurocurrencies are used by the Eurobanks themselves.
Those Eurobanks with surplus funds loan to Eurobanks having lending
possibilities but are short of funds. The other users of
Eurocurrency market facilitate are non- Eurobank financial
institutions, multinational corporation, international
institutions, like World bank and government. World bank frequently
borrows fund from Eurobanks for lending developing countries.
Multinational Corporations are attracted by higher interest rates
paid on their deposits and competitive borrowing rate.
V. Wholesale market: Eurocurrency market is a Wholesale market
in the sense that their size of transactions is very large.
Generally, the size of individual transaction is about $1 million.
It is centered in London.
VI. Well organized, efficient and large market : Eurocurrency is
well organized and very efficient. It serve a number of role for
multinational business operation. It is an important and convenient
device of multinational corporations to hold their excess
liquidity. It is an important source of short-term loans to finance
corporate working capital need and foreign trade. It is a large
international money market.
2.5 REASONS FOR THE DEVELOPMENT OF THE EURO-CURRENCY MARKET
There are several reasons for the existence and spectacular
growth of the
Eurocurrency market. They are as follows:
I. Soviets deposit of dollar in European banks: In the 1950s
Soviet Union was earning dollars from the export of gold and raw
materials. The Soviets did not want to keep them in the banks in
the United States out of the fear that the US may freeze them due
to the Cold War. The Soviets wanted dollar claims that were not
subject to any control by the US government. The Soviets solved
this problem by depositing their dollar earning with
dollar-denominated deposits with banks in Britain and France. These
Soviets deposits marked the birth of the Eurocurrency market.
II. Restrictions upon sterling credit facilities: In 1957, the
Bank of England introduced restrictions on UK banks ability to lend
sterling to foreigners and foreigners ability to borrow sterling.
This induced the British banks to turn to the US dollars as an
alternative means to finance the world trade. This provided a
stimulus for the growth of the Eurocurrency market.
III. Abolition of the European Payments Union and Restoration
Currency Convertibility: The European Payments Union (EPU) enabled
the European member countries to settle trade credits among
themselves with the minimum use of dollars. In 1958, EPU was
abolished and convertibility of European Currencies was restored.
Thus, European banks could hold US dollar without being forced to
convert their central banks for domestic currencies. This provided
another impetus to the growth of Eurocurrency market.
IV. US dollar as a key currency: The fundamental cause for the
development of Eurocurrency market was the special position of the
dollar as a key, or vehicle, currency. The dollar continues to be
the main currency that is used to carry out the international
transactions. Because of this special role of the dollar as a key
currency, foreign individuals, corporation and governments
preffered to hold dollar balances.
V. Regulation Q: In 1963, the US authorities introduced
Regulation Q which fixed a ceiling on the interest rate that US
banks could pay on time deposits. Since this regulation did not
apply to offshore banks many US banks set up subsidiaries abroad to
escape the banking regulations. Further, as the interest rates in
Europe rose above the ceiling fixed by US authorities. Eurodollar
deposits became more profitable than US deposits. This was another
important causes for the rapid and sustained growth of Eurocurrency
market. Euro banks are also not required to maintain minimum cash
reserve with their central banks enabling them to lend more and
earn more. In USA under regulation M such reserves are
compulsory.
VI. Convenient to hold balances abroad: International
corporation often found it very convenient to hold balances abroad
for short periods in the country in which they needed to make
payments. Since the dollar is the most important international and
vehicle currency in making and receiving international payments, it
is only natural a large proportion of the Eurocurrency to be in
Eurodollars.
VII. Overcome Domestic Credit Restrictions: An important reason
for the growth of the Eurocurrency market is that the international
corporations can overcome domestic credit restrictions by borrowing
in the Eurocurrency market.
VIII. Deposit of surplus funds by OPEC Countries: After the oil
price increase of 1973, the OPEC countries began to deposit large
amounts of dollars in European banks. The Eurocurrency markets
experienced phenomenal growth after 1973. The OPEC countries also
did not want to keep their dollar deposits in the United States for
the fear that US government might freeze them in a political
crisis. This is exactly what happened to the (small-proportion of
the) dollar deposits that Iran and Iraq kept in the US during the
US conflict with these countries in the late 1970s and early 1980s,
respectively. The Eurobanks helped to recycle the surplus funds
from OPEC countries to the deficit oil importing countries.
European banks are willing to accept deposits denominated in
foreign currencies and are able to pay higher interest rates on
these deposits than US banks because they can lend these deposits
at higher rates. However, the spread between lending and borrowing
rates on Eurocurrency deposits is smaller than that of US banks.
Thus, European banks are often able to pay higher deposits rates
and lend at lower rates than US banks. This is the result of :
a) The fierce competition for deposits and loans in the
Eurocurrency market,
b) The lower operating costs in the Eurocurrency market due to
the absence of legal reserve requirements and other restrictions on
Eurocurrency deposits.
c) Economies of scale in dealing with very large deposits and
loans, and
d) Risk diversification.
2.6 CREATION OF EUROCURRENCIES AND DEPOSITS
Eurocurrencies are created when someone who owns convertible
currencies, deposits them with a bank outside the countries of
those currencies. The Eurocurrency market can potentially create
Eurocurrencies in exactly the same way that commercial banks create
money, that is, by making loans which are redeposited in the same
banking system, Eurobanks can generate multiple expansion of Euro
deposits on receiving a fresh injection of cash. In other words,
deposits give rise to deposits which in turn give rise to deposit
creation. This is almost like deposits creation in the domestic
monetary system. In the case of domestic monetary system the cash
reserve ratio is often statutorily fixed, while in the case of
Eurobanks, the cash reserve ratio is voluntarily decided.
The Eurocurrency markets have the potential to create credit and
yet remain unregulated. The rapid growth of the Eurocurrency
markets in the 1960s and 1970s had coincided with rise in the
inflation rates in the industrialized countries. According to some
economists the growth of Eurocurrency markets was partly
responsible for this, since the Eurobanks have the ability to
create deposits.
2.7 INSTRUMENTS OF THE EUROCURRENCY MARKET
I. Time Deposits: A large part of money in the Eurocurrency
market is held in fixed-rate time-deposits. The maturities of most
of them range from one-week to six months. The bulk of Eurocurrency
time deposits are interbank liabilities. They pay a fixed,
competitively determined rate of return.
II. Certificates of deposits: Another important instruments is
the Eurocurrency Certificates of Deposits(CD). A Eurocurrency CD is
a negotiable receipt for a dollar deposit at a bank located outside
the US. There also exist an active secondary market for Eurodollar
CDs. This allows investors to sell Eurodollar CDs before the
deposits mature. Eurodollar CDs are issued by banks to tap the
market for funds and are commonly issued in denominations varying
from $,250,000 to $5 million.
III. Eurodollar floating rate CDs (FRCDs) and Eurodollar
floating rate notes (FRNs) : FRCDs and FRNs came into use as a
means of protecting both borrower and lender against interest rate
risk. By making their coupon (interest rate) payments float with
market rate of interest, they help to stabilize the principal value
of the paper. FRCDs are not very active now-a days.
IV. Note Issue Facilities (NIFs) : NIFs become a significant
Eurodollar instrument in the mid-1980s. It is an arrangement
between a borrower and an underwriting bank under which the
borrower can issue short-term paper known as Euro-notes in its own
name. Under such an arrangement, the under-writing bank is
committed either to purchase any notes the borrower cannot sell or
to provide standby credit. It is something like commercial paper
programmes, the only difference being that it is with underwriting
commitments.
Euro-Currency Interest Rate : Interest rates paid to the
depositors and charged for loans is based on London Interbank
Offered Rate (LIBOR). LIBOR is comparatively cheap as Euro banks
operate with a small spread that is, the difference between
deposits and lending rate. LIBOR rates are calculated as the
averages of the lending rates in the respective currencies of
leading London banks. At present, eight leading banks are not
subject to restrictions by the Central banks, euro banks work with
a smaller spread, that is, deposits are paid higher rate and loans
are charged lower rate of interest.
CHAPTER 3
3.1 ECONOMIC IMPACT OF EUROCURRENCY MARKET
The emergence and the growth of Eurocurrency market and as its
ability to create multiple expansion of credit without any apparent
control mechanism have given rise to certain problems and
advantages.
Problem
i. The important problem associated with it are :
ii. The Eurocurrency market facilities short-term speculative
capital flows. This creates difficulties for central bank in their
efforts to stabilize the exchange rates.
iii. The national monetary authorities lose effective control
over monetary policy since domestic residents can make their
efforts less effective by borrowing or lending abroad. Since
Eurocurrency market contributes to increasing the degree of
international mobility of capital. It makes monetary policy less
effective. Eurocurrency market provides opportunities for avoiding
many of the regulation that the monetary authorities try to enforce
on domestic money market.
iv. Since the Eurocurrency market can be a source of
international liquidity it can contribute to inflationary
tendencies in the world economy.
v. The Eurocurrency market allows the central banks of deficit
countries to borrow for balance of payments purpose. This may make
these countries to postpone the needed balance of payments
adjustments measures.
Originally, the Eurocurrency markets provoked fears among
policymakers because the markets were growing extremely fast and
there was no explicit regulatory supervision of the market. People
feared that a loan default or panic withdrawals at one Eurobank
could lead to a domino effect across other Eurobanks and perhaps
threaten the integrity of the onshore banking system. Now
economists feel that Euro-banking is less risky. It is understood
that Eurobanks can operate at minimal risk by issuing term deposits
matched by floating-rate loans. And the Basel Concordat has
explicitly assigned the regulatory responsibility for Eurobanks
should bankruptcy occur in any offshore branch.
3.2 ADVANTAGES OF EUROCURRENCY MARKET
Advantages:
Despite these problems arising from the growth of Eurocurrency
market, it has given rise to many advantages.
I. It has helped to alleviate considerably the international
liquidity problem.
II. It has provided credit to countries to finance the balance
of payments deficits. In other words, it has played an important
role in recycling funds from surplus to deficits countries.
III. It has helped to meet the short-term credit requirements of
business corporations.
IV. It has provided a market for profitable investment of funds
by commercial banks.
V. It has enabled the exporters and importers to obtain
credit.
VI. This eurocurrency market has helped to accelerate the
economic development of some countries like South Korea, Taiwan
& Brazil.
VII. It has been largely responsible for the increased degree of
financial integration between economies.
The Eurocurrency markets have become important sources of
finance for governments and private firms.. The importance of
Eurocurrency market is likely to grow with the growing integration
of the world economy and globalization. Their competitive deposits
and lending rates prove to be attractive for both both investors
and borrowers of funds. At the same time, the growth Eurocurrency
market has made monetary control more difficult for domestic
authorities.
CHAPTER- 4
SUMMARY OF STUDY
4.1 Conclusion
International financial market serve as links between the
financial markets of the each individual country and as independent
market outside the jurisdiction of any one country.
The market for currencies is the heart of this international
financial market. International trade and investment are often
denominated in a foreign currency. So the purchase of the currency
precedes the purchase of goods, services, or assets.
The market in which borrowing and lending in euro-currency takes
place is called the Euro-currency market. It has two sides to it,
that is the receipt of deposits and the loaning of that
deposits.
The prefix Euro is now outdated because such deposits and loan
in different currencies are regularly traded outside Europe,
especially in Singapore and Hongkong. Thus, Euromarkets are also
referred to as offshore market if such deposits have more
widespread geographical base.
There is a reason of development of the Eurocurrency market are
the following :-
Soviets deposits of dollar in European banks.
Restrictions upon sterling credit facilities
Abolition of the European payments Union and Restoration of
Currency Convertibility
US dollar as a key Currency
Convenient to hold balances abroad
Overcome Domestic Credit Restrictions
Deposits of Surplus Funds by OPEC Countries
4.2 Summary of Eurocurrency Market
Eurocurrency refers to commercial bank deposits outside the
country or their issue. Thus, any currency internationally supplied
and demanded and in which a foreign bank is willing to accept
liabilities and loan assets is eligible to become Eurocurrency.
For example, a US dollar deposit held in London or Paris is a
Euro-dollar deposit. A Deutschemark deposit held in New York,
London, and Paris is a Euro-mark deposit.
According to the Grabbe, The money market for borrowing and
lending currencies that are held in the form of deposits in banks
located outside the countries in which those currencies are issued
as legal tender. Eurodollar: A dollar-denominated deposit in a bank
outside the United States or at International Banking Facilities
(IBFs) in the United States.
Creation of Eurocurrency Market.
In deposits give rise to deposits which in turn give rise to
deposit creation. This is almost like deposits creation in the
domestic monetary system. In the case of domestic monetary system
the cash reserve ratio is often statutorily fixed, while in the
case of Eurobanks, the cash reserve ratio is voluntarily
decided.
Advantages:
Despite these problems arising from the growth of Eurocurrency
market, it has given rise to many advantages.
It has helped to alleviate considerably the international
liquidity problem.
It has provided credit to countries to finance the balance of
payments deficits. In other words, it has played an important role
in recycling funds from surplus to deficits countries.
It has helped to meet the short-term credit requirements of
business corporations.
It has provided a market for profitable investment of funds by
commercial banks.
It has enabled the exporters and importers to obtain credit.
ABBERVATION
Certificates of Deposits
(CD)
Electronic Broking Services
(EBS)
European Payments Union
(EPU)
Foreign Exchange
(Forex, FX,)
International Monetary Fund
(IMF)
International Banking Facilities
(IBFs)
London Interbank Offered Rate
(LIBOR)
Note Issue Facilities
(NIFs)
(OPEC)
5.1 Bibliography
Book and references journal
Economics of Global Trade and Finance (Published by Manan
Prakashan in July 2013 )Johnson P.A., Mascarenhas A.D.
International economics, (Published by wath publishers, USA )
Robert C.Foenstra & Alan M.Taylor.
International Economics,(Published by S.Chand & Co) in
Mithani & Jhingan.
Webilography
The official Website of Eurocurrency market
www.authorstream.com
Investment site www.investopedia.com
The stanford university www.stanford.edu
Wikipedia www.wikipedia.com
$Google www.google.com
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