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Unit 4: Eurocurrency Markets

one month to six months maturity range. The balance of these deposits is accounted for by Notes
negotiable Certificates of Deposits (CDs).
Eurocurrency CDs are issued in two forms: These are Tap CDs and Tranche CDs. The former are
issued in relatively large denominations (commonly from $250,000 to $5 million) and for
maturities of less than one year, whenever banks need to “tap” the market for funds. Tranche
CDs are issued in large aggregate amounts (typically $10 million to $50 million), but are offered
to investors in small certificates (typically $10,000). The volatility of interest rates since 1979 has
led to the use of Eurocurrency Floating Rate CDs (FRCDs) and Eurocurrency Floating Rate
Notes (FRNs). Both are negotiable bearer instruments with rates reset at every three to six
months, thus protecting investors against a decline in the principal value of the paper caused by
rise in interest rates.

4.2.2 Growth of the Eurodollar Market

The origin of the Eurodollar market is rather obscure. However, it is generally agreed, that it
originated in the early 1950s by the desire of the Soviet Union and Eastern European countries
to place their dollar holdings in European banks to avoid the risk of such balances being blocked
if deposited in US banks.
Basically the Eurocurrency market has thrived on one basic reason, i.e., government regulation.
By operating in Eurocurrencies, banks, suppliers of funds are able to avoid certain regulatory
costs that would otherwise be imposed.

Briefly, the fast growth of the Eurodollar market in the 1965–1980 period has been attributed
mainly to the following four major factors:
1. Large deficits in the US balance of payments, particularly during the 1960s, which resulted
in the accumulation of substantial dollars held by foreign financial institutions and
individuals.
2. The restrictive environment which prevailed in the United States during the 1963–1974
period to stem capital outflows. These restrictions, which took the form of both voluntary
and mandatory controls, encouraged US and foreign multinational companies to borrow
dollars abroad.
3. The massive balance of payments surpluses realised by OPEC countries due to sharp
increases in oil prices in 1973–1974 and again in 1978. A good proportion of these
“petrodollars” was deposited in financial institutions outside the United States.
4. The efficiency and lower cost base of the Eurodollar market. Being a wholesale funds
market, operating free of restrictions at a substantially lower cost than its counterpart in
the United States, it has been able to attract dollar deposits by offering higher interest
rates, as well as making dollar loans available to borrowers at lower interest rates.

4.2.3 Example of Euro-dollar Creation

U.S dollar denominated time deposits held in foreign bank accounts is known as Euro dollars.
Eurodollars can be held in any foreign bank in the world and they have no connection or
correlation to the Euro currency. Eurodollars can be created in two ways – when a foreign bank
buy U.S. dollars in the forex market and lend these domestically to customers or when U.S.
dollar balances, which reside in a U.S. bank, are placed on deposit in a foreign bank. Foreign
banks holding these dollars are not subject to the rules and regulations imposed by the federal
reserve bank in the United States, reducing regulatory and other costs and improving profitability
margins for banks.

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