Greg MacKinnon

Finance 476
Sobey Faculty of Commerce
Saint Marys University
Eurocurrency Markets
Up until the !"#s$ most international tra%e &as con%ucte% in 's (instea% of the
currencies of &hatever countries &ere tra%ing)* +nglish ban,s facilitate% international
tra%e ta,ing %eposits an% ma,ing loans so that importers-e.porters in other countries
coul% simply sign over %eposits in or%er to pay for goo%s* /lso$ financing purchases &as
simple in that firms coul% simply ta,e out loans in 's from these +nglish ban,s*
0n !"6$ the Sue1 Canal crisis put %o&n&ar% pressure on the '* /ttempting to alleviate
the pressure$ the 2an, of +nglan% prohibite% loans of 's to foreign borro&ers (the logic
being that if the foreign investors %i% not have poun%s$ they coul% not put pressure on the
poun% by selling them)* 3he ban,s %i% not li,e this because it too, a&ay a very profitable
piece of their business*
+nglish ban,s %eci%e% to ta,e %eposits an% ma,e loans in 4US so that they coul% continue
to finance international tra%e$ e.cept &ith 4US instea% of 's* 3his &as the start of the
Eurocurrency Market*
+urocurrency is any %eposit of a currency in a country other than that of the currencys
origin* For e.ample$ a %eposit of 4US in a ban, in France is a %eposit of +uro5%ollars* 3he
entire mar,et for loans an% %eposits in +urocurrency is the +urocurrency Mar,et* 3he
+urocurrency Mar,et %oes not have buyers an% sellers$ it has len%ers an% borro&ers* 6ote
that the prefi. 7+uro8 is historical in nature$ referring to the fact that the mar,et &as
initially centre% in +urope* 3o%ay$ ho&ever$ a %eposit of 4US in a 9apanese ban, is still
referre% to as +urocurrency*
From relatively humble beginnings$ the +urocurrency %eposits have %evelope% into a
mar,et measure% in the trillions of %ollars (as of !:! the total value of eurocurrency
%eposits globally &as over 4" trillion US)* 3he +urocurrency mar,et &as create% to avoi%
capital controls impose% by governments* 0t gre& in response to further capital controls$
especially by the U*S* government (for e.ample the 0nterest +;uali1ation 3a. of !6<
applie% to interest earne% from 4US loans to foreign firms (since repeale%)$ an%
=egulation > (also since repeale%) &hich put a limit on the rate that coul% be pai% by
/merican ban,s on %eposits)*
Generally$ +uroban,s are able to pay higher rates on %eposits an% charge lo&er rates on
loans than purely %omestic ban,s* 3hey are able to %o this because they can often avoi%
government regulations such as reserve re;uirements an% the nee% to pay %eposit
insurance* 3his lo&ers the cost of operations for +uroban,s an% these lo&er costs can be
passe% through to the clients* /s &ell$ eurocurrency loans are generally very large an% the
customers are &ell ,no&n firms* 3his means that the ban,s are not sub?ect to as much
%efault ris, an% can charge lo&er margins on the large loans*
@f course$ +uroban,s have to offer higher rates on eurocurrency %eposits because of the
higher ris, to the %epositor* Aart of the ris, comes from the fact that euroban,s %o not
follo& the same regulations as %omestic ban,s (these regulations are usually meant to
protect %epositors)* Bo&ever$ a large part of the e.tra ris, comes from sovereign risk*
3his is the ris, that governments impose ne& regulations that restrict the movement of
Greg MacKinnon
Finance 476
Sobey Faculty of Commerce
Saint Marys University
capital or control foreign currency transactions* 3his may mean that any eurocurrency
%eposits hel% in that country become inaccessible for the o&ner*
Chile euroban,s &ill offer better rates than purely %omestic ban,s$ the %ifference bet&een
eurocurrency rate san% %omestic rate s&ill be limite% by arbitrage* 0t must be thatD
+uro5loan rate E Fomestic %eposit rate
+uro5%eposit rate G Fomestic loan rate
0f one of these %i% not hol% then arbitrageurs coul% simply borro& in the cheaper mar,et
an% %eposit in the money in the in the mar,et &here they &oul% get a higher return*
Generally$ the a%vantage of eurocurrency rates over %omestic rates runs some&here
bet&een H" an% ## basis points*
3here are several eurocurrency centres aroun% the &orl% &here euroban,s con%uct most
of their business* 3he largest areD Ion%on$ the Cayman 0slan%s$ 2ahrain$ Singapore an%
some 70nternational 2an,ing Facilities8 that have been set up in the U*S*
/ppro.imately :#J of the eurocurrency mar,et involves ban,s len%ing to$ an% %epositing
&ith$ other ban,s* 3his is %one on a 2i%5/s, basis &ith the bi% being the rate offere% on
%eposits an% the as, the rate charge% on loans*
/ main characteristic of eurocurrency loans is that they are usually floating rate (this also
referre% to as rollover pricing or as cost-plus pricing) an% are typically set as a
percentage over I02@=*
International Bond Market
2on%s are an important source of long term capital for firms* / bon% is %ebt* / firm (or
government) issues a certificate$ calle% a bon%$ that states that the firm &ill ma,e coupon
payments to the hol%er of the bon% an% &ill$ at maturity pay the hol%er the par value of
the bon%* Coupon payments are simply the interest payments on the %ebt an% the par value
is the principal* Firms sell these bon%s to investors (thereby borro&ing money)* 3he ,ey
%ifference bet&een borro&ing money by issuing bon%s rather than borro&ing %irectly from
a ban, is that there e.ists a secondary market for bon%s* 3hat is$ if you buy a bon% from
a firm (len%ing that firm money) you can later sell the bon% to another investor* 3he act of
firms selling bon%s %irectly to investors is terme% the primary market$ &hile investors
tra%ing bon%s among themselves is the secon%ary mar,et*
3here e.ists a &ell %evelope% %omestic mar,et for bon%s (Cana%ian firms issuing bon%s
%enominate% in Cana%ian %ollars an% selling them in Cana%a)* Bo&ever$ there also e.ists
an international bon% mar,et* 3he international bon% mar,et is really a set of loosely
connecte% in%ivi%ual mar,ets aroun% the &orl%* 3here are many %ifferent bon% mar,ets in
many countries$ ta,en together as a &hole they constitute the international bon% mar,et*
3he international bon% mar,et can be bro,en %o&n into t&o partsD
) Foreign Bonds
H) Eurobonds
Greg MacKinnon
Finance 476
Sobey Faculty of Commerce
Saint Marys University
1) Foreign bonds are simply bon%s issue% in a bon% mar,et by a foreign company* For
e.ample$ a 9apanese firm issuing a U*S* %ollar %enominate% bon% in the U*S* is issuing a
foreign bon%*
2ecause foreign bon%s are simply a part of the %omestic bon% mar,et$ the only real
%ifference is their treatment un%er the la&* 0n many countries$ foreign bon%s are sub?ect to
%ifferent ta. treatment$ registration re;uirements et cetera*
3he most important foreign bon% mar,ets are locate% in Kurich$ 6e& Lor,$ 3o,yo$
Fran,furt$ Ion%on an% /mster%am*
3he reasons that a company may go to another country to issue bon%s inclu%e the simple
fact that there may not be enough %eman% in the %omestic mar,et* Going to a foreign
mar,et opens up a &hole ne& set of potential investors to the firm* For instance$ a
German pharmaceutical firm may &ish to borro& FM "## million* Bo&ever$ its
investment ban, tells it that there is only %eman% for FM H"# million of its bon%s* 0n or%er
to float the rest it &oul% have to offer a much higher yiel%* 2ut$ for some reason there is
%eman% in the US for the %ebt of pharmaceutical firms$ an% that %eman% is not being met
by US companies* 3he German firm coul% then float an issue in Germany (in FM) an%
also float an issue in the US (in 4US) in or%er to sell all of the bon%s it &ants* @f course$
the firm may choose to s&ap its ne& 4US %ebt for FM %ebt at the same time*
6ote that issuing a bon% in Kurich (for instance) %oes not mean that the firm is necessarily
borro&ing from S&iss len%ers* Generally$ a foreign firm issues a S&iss Franc %enominate%
bon% in Kurich an% most of the buyers of that bon% &ill also be foreign* 2asically$ the Sfr
is simply a unit of account for the transaction bet&een the buyer an% the len%er*
/ ta.onomy has arisen for foreign bon%s* Foreign bon%s issue% in the U*S* are terme%
Yankee bonds$ in 9apan they are calle% Samurai bonds$ in +nglan% Bulldog bonds an%
in the 6etherlan%s Rembrandt bonds*
) Eurobonds are bon%s %enominate% in one currency but issue% in a country that is not
the home of that currency* For e.ample$ a bon% %enominate% in 4Can but issue% in
Ion%on is a +urobon%* Similarly$ a Sfr %enominate% bon% issue% in Germany is a
+urobon%*
Most countries have very fe& regulations governing the issuance of +urobon%s (since they
are not %enominate% in that countrys currency$ the government %oes not care all that
much about them)* Chile some countries have trie% to control issues of bon%s
%enominate% in their currency even if issue% in a foreign country$ this is very har% to %o
for obvious reasons* @ne thing that this means is that interest pai% on +urobon%s is usually
free of all !it""olding ta#es*
/ &ithhol%ing ta. is &hen the government ta,es a portion of each interest payment
before the len%er gets it* 3he borro&er (the firm issuing the bon%) &ithhol%s a part
of the interest an% gives it to the government* Cith a &ithhol%ing ta.$ the firm
issuing the bon%s &oul% have to pay a higher rate of interest in or%er to
Greg MacKinnon
Finance 476
Sobey Faculty of Commerce
Saint Marys University
compensate len%ers* 0n the eurobon% mar,et$ therefore$ firms can often pay a
lo&er rate by avoi%ing the ta.*
Most eurobon%s are bearer bon%s* 3he o&ner of the bon% is not registere% &ith the firm
that initially issue% the bon%* /ctually having physical possession of the bon% is evi%ence
of o&nership* 3his ma,es eurobon%s attractive to investors &ho &ish to remain
anonymous (to avoi% ta.es or for other reasons)*
+urobon%s have been popular as a source of fun%s for firms because they allo& borro&ers
an% len%ers to avoi% ta.es an% government regulations* 3he rate of gro&th in the
eurobon% mar,et has slo&e% over the last :5# years because of re%uctions in these
factors in the %omestic bon% mar,et* Governments reali1e% that securities issues &ere
going offshore to avoi% regulations an% therefore &ere force% to re%uce the regulatory
bur%en for %omestic issues* 3his is best e.emplifie% by the intro%uction in the early !:#s
of the $rompt %&&ering $rospectus metho% of issuing securities in Cana%a &hich
re%uce% the time nee%e% for establishe% firms to register an% issue ne& securities from
&ee,s (sometimes months)to a fe& %ays (the Arompt @ffering Arospectus &as intro%uce%
in response to similar legislation in the U*S* ,no&n by the term s"el& registration)*
3he eurobon% mar,et is still large an% is %riven in large part by firms ability an% %esire to
engage in s&aps*