Page 61 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes Self Assessment

Fill in the blanks:
1. A …………………… is any freely convertible currency deposited in a bank outside its
country of origin.

2. The Eurocurrency market consists of those banks which accept deposits and make loans in
…………………… currencies.
3. A Euro credit consists of loans that mature in one to …………………… years.

4. Eurocurrency market is a major source of short-term bank loans to help meet the corporate’s
…………………… capital requirements.

4.2 Eurocurrency Interest Rates

The base interest rate paid on deposits among banks in the Eurocurrency market is called LIBOR,
the London Interbank Offered Rate. (Outside London, which is the centre of the entire Euromarket,
the base rate on deposits is generally slightly higher.) LIBOR is determined by the supply and
demand for funds in the Euromarket for each currency, because participating banks could default
(and, infrequently, do default) on their obligations and the rate paid for Eurodollar deposits in
addition to the spread over LIBOR in the Euromarket. This also helps reduce the cost of using the
Euromarket for borrowers. The total cost of borrowing in the Euromarket for a prime US
corporation historically was marginally below the domestic US prime rate. Because of competition
among lenders in both markets, prime borrowers have been able to obtain the same rate in both
markets since the early 1980s.
Interest rates on other Eurocurrencies generally follow the same pattern, though when capital
controls exist in a particular country (e.g., France), borrowing rates may be higher in the
Euromarket (which is not restricted) than in the domestic market.

4.2.1 Instruments and Rates of Eurocurrency Markets

The most important characteristic of the Eurocurrency market is that loans are made on a
floating rate basis. Interest rates on loans to governments and their agencies, corporations, and
non-prime banks are set at a fixed margin above LIBOR for the given period and the currency
chosen. At the end of each period, the interest for the next period is calculated at the same fixed
margin over the new LIBOR.
The margin, or spread between the lending bank’s cost of funds and the interest charged from
the borrower, varies a good deal among borrowers and is based on the borrower’s perceived
riskiness. Typically, such spreads have ranged from slightly below 0.5% to over 3%, with the
median being somewhere between 1% and 2%.
The maturity of a loan can vary from approximately three to ten years. Lenders in this market
are almost exclusively banks. In any single loan, there will normally be a number of participating
banks that form a syndicate. The bank originating the loan will usually manage the syndicate.
This bank, in turn, may invite one or two other banks to comanage the loan.
The managers charge the borrower a once-and-for-all fee of 0.25% to 1% of the loan value,
depending on the size and type of the loan.
Eurocurrency deposits are held predominantly in the form of fixed rate time deposits with
maturities ranging from overnight to several years. Most of the funds, however, are held in the

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