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WORLD FINANCIAL MARKETS

WORLD FINANCIAL MARKETS. Objectives: Eurocurrency Market Eurobond Market Asian Dollar Market SDR (1 SDR = x 1 $ + x 2 DM + x 3 FF + x 4 £ + x 5 ¥) ECU / Euro. WORLD FINANCIAL MARKETS. Eurocurrency Market a. Offshore b. Time Deposit c. $, DM, FF, ¥ , SF, , £ Eurodollar Market

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WORLD FINANCIAL MARKETS

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  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 bank’s 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 • MNC’s • Speculators

  9. WORLD FINANCIAL MARKETS • Eurodollar Market(cont.) • e. Advantages: Narrower Interest Rate Spread • Lower Loan Rates: Wholesale Nature • Borrower’s 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 (1960’s) 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: • PeriodLIBORSPREADLending 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

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