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Eurocurrency Market
The money market in which Eurocurrency, currency held in banks outside of the country where it
is legal tender, is borrowed and lent by banks in Europe. The Eurocurrency market allows for
more convenient borrowing, which improves the international flow of capital for trade between
countries and companies.
Notes: For example, a Japanese company borrowing U.S. dollars from a bank in France is using
the Eurocurrency market.
Eurocurrency
Currency deposited by national governments or corporations in banks outside their home market.
This applies to any currency and to banks in any country. For example, a Japanese deposit at a
bank in Bangladesh is considered. It can also be defined as a time deposit in an international
bank located in a country different than the country that issued the currency.
For example,
Eurodollars are U.S. dollar-denominated time deposits in banks located abroad.
Euro yen are yen-denominated time deposits in banks located outside of Japan.
The foreign bank doesnt have to be located in Europe.
Most Eurocurrency transactions are interbank transactions in the amount of $1,000,000 and up.
Common reference rates include:
LIBOR the London Interbank Offered Rate
PIBOR the Paris Interbank Offered Rate
SIBOR the Singapore Interbank Offered Rate. A new reference rate for the new euro
currency
EURIBOR -the rate at which interbank time deposits are offered by one prime bank to
another. Also known as "Euro money".
Having "Euro" doesn't mean that the transaction has to involve European countries. However, in
practice, European countries are often involved Funds deposited in a bank when those funds are
denominated in a currency differing from the bank's own domestic currency. Eurocurrency
applies to any currency and to banks in any country. Thus, if a Japanese company deposits yen in
a Canadian bank, the yen will be considered Eurocurrency.
Euro-credits
Euro-credits are short- to medium-term loans of Eurocurrency.
The loans are denominated in currencies other than the home currency of the Euro-bank.
Often the loans are too large for one bank to underwrite; a number of banks form a syndicate
to share the risk of the loan.
Euro-credits feature an adjustable rate. On Euro-credits originating in London the base rate is
LIBOR.
Forward Rate Agreements
An interbank contract that involves two parties, a buyer and a seller.
The buyer agrees to pay the seller the increased interest cost on a notational amount if
interest rates fall below an agreed rate.
The seller agrees to pay the buyer the increased interest cost if interest rates increase above
the agreed rate.
Euro-notes
The International Capital Market of the Late 1990s was Composed of a Number of Closely
Integrated Markets with an International Dimension
Basically, the international capital market includes any transaction with an international
dimension. It is not really a single market but a number of closely integrated markets that include
some type of international component. The foreign exchange market was a very important part of
the international capital market during the late 1990s. Internationally traded stocks and bonds
have also been part of the international capital market. Since the late 1990s, sophisticated
communications systems have allowed people all over the world to conduct business from
wherever they are. The major world financial centers include Hong Kong, Singapore, Tokyo,
London, New York, and Paris, among others. It's not hard to find examples of securities that
trade in the international capital markets.
THE INTERNATIONAL BOND FINANCING
FOREIGN BONDS AND EURO BONDS
A foreign bond is a bond issued in a domestic market for a foreign borrower. Foreign bonds tend
to be more regulated than Eurobonds and are usually issued by a domestic group of banks. A
foreign bond is a debt security issued by a borrower from outside the country in whose currency
the bond is denominated and in which the bond is sold. A bond denominated in U.S. dollars that
is issued in the United States by the government of Canada is a foreign bond. A foreign bond
allows an investor a measure of international diversification without subjection to the risk of
changes in relative currency values.
Three characteristics of foreign bonds
A foreign bond has three distinct characteristics:
Foreign bonds represent an unenforceable claim. The primary risk of a foreign bond is that it is
an unenforceable claim. An investor that owns the bonds of a company in his or her home
country has specific legal recourse in the event of default. Foreign bonds, however, offer no such
protection. An extremist political movement (e.g., Iran in the 1970s) could come to power and
seize or deny all foreign assets and claims. A country may become engaged in a military conflict
and prohibit its currency from leaving its borders. After World War II, for example, investors
holding bonds in Great Britain were paid interest in pounds yet were unable to convert those
pounds to dollars; the money could only be reinvested in pound-denominated investments or
spent within the borders of Britain or her colonies.
EUROBOND
A type of foreign bond issued and traded in countries other than the one in which the bond is
denominated. A dollar-denominated bond sold in Europe by a U.S. firm is a Eurobond. A
Eurobond is usually categorized by the currency in which it is denominated, and is usually issued
by an international syndicate. An example of a Eurobond is a Eurodollar bond, which is
denominated in U.S. dollars and issued in Japan by an Australian company. Note that the
Australian company can issue the Eurodollar bond in any country other than the United States.
Eurobonds are attractive methods of financing as they give issuers the flexibility to choose the
country in which to offer their bond according to the country's regulatory constraints. In addition,
they may denominate their Eurobond in their preferred currency. Eurobonds are attractive to
investors as they have small par values and high liquidity.
Is it risky to invest in foreign securities?
Investing in foreign securities can actually reduce overall portfolio risk and at the same time
modestly increase the potential for returns. The U.S. stock market still remains the largest in the
world; however, foreign markets now account for approximately 50% of the global stock market
capitalization. Consequently, it is becoming more important to diversify portfolios globally,
taking advantage of growth rates in different regions and countries. Proper international
diversification can help balance out returns by reducing or avoiding losses when some markets
are under performing.
The Principal Actors in the International Capital Markets are Banks, Non-Banking
Financial Institutions, Corporations, and Government Agencies.
Commercial banks powered their way to a place of considerable influence in international
markets during the late 1990s. The primary reason for this was that they often pursued
international activities that they would not have been able to undertake in their home countries.
The lack of international regulation fueled bank growth over the decades leading up to the 1990s.
Commercial banks undertook a broad array of financial activities during the late 1990s. They
granted loans to corporations and governments, were active in the bond market, and held
deposits with maturities of varying lengths. Special asset transactions, like underwriting were
undertaken by commercial banks. By underwriting, the bank guaranteed a company issuing
stocks or bonds that it would find buyers for the securities at a minimum price. Non-bank
financial institutions became another fast-rising force in international markets during the late
1990s. Insurance companies, pension and trust funds, and mutual funds from many countries
began to diversify into international markets in the 1990s. Together, portfolio enhancement and a
widespread increase in fund contributors have accounted for the strength these funds had in the
international marketplace.
Corporations often use foreign funds to finance investments. Corporations may sell stock, issue
bonds, or obtain loans from commercial banks. The trend in the late 1990s was for corporations
to issue securities that attracted investors from all over the world. The Eurobond, which we
described above, was an example of this. A Eurobond is a corporate bond not denominated in a
single currency, but gives the lender the right to demand repayment from a preset spectrum of
currencies. For example, a bond may allow its holder the right to be repaid in yen, euro or pound.
When the holding period is over, the holder chooses the most preferable currency at that time.
This partially protects buyers from exchange rate fluctuations. Government agencies, including
central banks, were also major players in the international marketplace during the late 1990s.
Central banks and other government agencies borrowed funds from abroad. Governments of
developing countries borrowed from commercial banks, and state-run enterprises also obtained
loans from foreign commercial banks.
THE INTERNATIONAL EQUITY FINANCING
Worlds Equity Market Capitalization at year-end 2006 was almost $52 trillion. Almost 83% of
the market capitalization is accounted for by the market capitalization of the developed world.
The other 17% is accounted for by the market capitalization of developing countries in
emerging markets like Latin America, Asia, Eastern Europe, Mideast and Africa.
Recently the growth rates in these emerging markets have been strong, but with more volatility
than the developed world.
Benefit of international equity financing includes diversification, reduced regulation,
improvements in computer and communications technology, increased demand from MNCs for
global issuance.
Cross-Listing refers to a firm having its equity shares listed on one or more foreign exchanges.
The number of firms doing this has exploded in recent years. For example, Beximco Pharma is
not only traded in Dhaka and Chittagong Stock Exchange but also listed in London Stock
exchange as well.
Advantages of cross listing:
It expands the investor base for a firm.
Establishes name recognition for the firm in new capital markets, paving the way for new
issues.
May offer marketing advantages.
May mitigate possibility of hostile takeovers.
American Depository Receipts (ADR):
ADR is a receipt that represents the number of foreign shares that are deposited at a U.S. bank.
Bank of New York is the main depository bank. The bank serves as a transfer agent for the
ADRs. There are many advantages to trading ADRs as opposed to direct investment in the
companys shares:
ADRs are denominated in U.S. dollars, trade on U.S. exchanges and can be bought through
any broker.
Dividends are paid in U.S. dollars.
Most underlying stocks are bearer securities, the ADRs are registered.
Factors affecting International Equity returns:
Macroeconomic Factors:
International monetary variables (such as Interest rate differentials, change in domestic
inflation expectations) have only weak influence on equity returns in comparison to
domestic variables. (Solnik 1984)
Exchange Rates:
Changes in exchange rates generally explain a larger portion of the variability of foreign
bond indexes than foreign equity indexes, but that some foreign equity markets are more
exposed to exchange rate changes than are the respective foreign bond markets. (Adler and
Simon, 1986)
Cross-correlations studies among major stock markets and exchange markets are relatively
low but positive. The exchange rate changes in a given country reinforce the stock market
movements in that country as well as in the other countries examined. (Eun and Resnick,
1988)