Page 59 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes more convenient and flexible borrowing which improves the international flow of capital for
the purpose of trade between countries and companies. For example a company in UK borrowing
US dollars from a bank in France is using the eurocurrency market. Banks in which Eurocurrencies
are deposited are called Eurobanks. Thus Eurobanks are major world banks that conduct a
Eurocurrency business in addition to all other banking functions. On the other hand, a Eurobond
is a bond sold outside the country in whose currency it is denominated. In the Eurobond market,
these Eurobonds are issued directly by the final borrowers, whereas the Eurocurrency market
enables investors to hold short-term claims on commercial banks, which then act as intermediaries
to transform these deposits into long-term claims on final borrowers.
The dominant Eurocurrency is the US dollar as the US dollar is widely used by many foreign
countries as a medium for international trade However, the importance of the Eurodollar has
decreased over a period of time. Also, with the weakening of the dollar in the latter parts of both
the 1970s/80s, other currencies – particularly the Deutsch-mark and the Swiss franc – have
increased in importance. Thus a Eurocurrecny market serves two important purposes. First, it is
a convenient and efficient money market device for holding excess corporate liquidity and
Second, it is a major source of short-term bank loans to finance corporate working capital.

4.1 Characteristics of the Eurocurrency Market

The various characteristics of the Eurocurrency market are:

1. It is a large international money market relatively free from government regulation and
interference, i.e., the market is essentially unregulated.
2. The deposits in the Eurocurrency market are primarily for short-term. This sometimes
leads to problems about managing risk, since most Eurocurrency loans are for longer
periods of times.
3. Transaction, in this market are generally very large with government, public sector
organisations tending to borrow most of the funds. This makes the market a wholesale
rather than a retail market. Also, approximately 80% of the Eurodollar market is interbank,
which means that the transactions take place between banks.
4. The Eurocurrency market exists for savings and time deposits rather than demand deposits.

5. The Eurocurrency market is mainly a Eurodollar market. Generally, the Eurocurrency
borrowing rate depends on the creditworthiness of the customer and is large enough to
cover various costs as also build reserves against possible losses. Traditionally, loans are
made at a certain percentage above the London InterBank Offered Rate (LIBOR), which is
the interest rate banks charge one another on loans of Eurocurrencies. Most loans are
made on variable rate terms and the rate fixing period could be one month, three months
or six months. Because of the variable nature of the interest rates, the maturities can extend
into the future.
The Eurocurrency market has both short-term and medium-term characteristics. Short-term
Eurocurrency borrowings have a maturity of less than one year. Borrowing at maturities
exceeding one year is also feasible and is known as Euro credit. A Euro credit consists of loans
that mature in one to five years. These Euro credits may be in the form of loans, lines of credit or
medium and long-term credit including syndication. Syndication occurs when several banks
pool their resources to extend a large loan to a borrower so as to spread the risk.
Another special feature of the Eurocurrency market is the difference in interest rates as compared
with domestic markets. Eurocurrency loans generally carry a lower rate of interest than the
rates in the domestic markets.

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