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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,… 5 102 To diversify earnings, so to reduce risks. Product diversification Geographic diversification 6 31- 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 40 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