EURO CURRENCY MARKET

INTRODUCTION:
It is a market for Borrowing and Lending of currency at the center outside the country in
which the currency is issued. It is different than the Foreign Exchange Market, wherein the
currency is bought and sold. Euro (€) is a single currency which was launched on 1st Jan’1999.
(With 11 of 15 member countries of the European Union participating in the
experiment) .Now Euro (€) is the official currency of 16 of the 27 member states of the
European Union (EU). These 16 states include some of the most technologically advanced
countries of the European continent and are collectively known as the Euro zone. The Euro is an
important international reserve currency. Euros have surpassed the US dollar with the highest
combined value of cash in circulation in the world. The name euro was officially adopted on 16
December 1995. The euro was introduced to world financial markets as an accounting currency
on 1 January 1999, replacing the former European Currency Unit (ECU) at a ratio of 1:1.

The currency was introduced initially in non-physical forms, such as travellers’ checks

and electronic bank in Euro coins and banknotes entered circulation on 1 January 2002.The
Euro is administered by the European Central Bank (ECB) based in Frankfurt, and the Euro
system, comprising of the various central banks of the Euro zone nations.

The states, known collectively as the Eurozone

are Austria, Belgium, Cyprus, Finland,France, Germany, Greece, Ireland, Italy, Luxembourg, Malt
a, the Netherlands, Portugal, Slovakia, Slovenia and Spain. The currency is also used in a further
five European countries, with and without formal agreements. and is consequently used daily
by some 327 million Europeans. Over 175 million people worldwide use currencies which are
pegged to the euro, including more than 150 million people in Africa.

The most important implications of having a common currency, the Euro, are:

 Exchange rate certainty while travelling across Europe

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 No exchange risk and, therefore, no cost of hedging against it

 No transaction costs

 Increased transparency and fewer transactions for importers and exporters

 Increased liquidity in the ‘United Euro’ financial market

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FEATURES EURO CURRENCY MARKET:

1. Types of transactions

2. Control of the country of issue of the currency

3. Huge amounts of transactions

4. Highly competitive Market

5. Floating rates of interest based on LIBOR

6. Dominance of Dollar denominated transactions

7. Four different segments

Types of transactions:

Japanese Exporter, earning USD, keeps these USD in London Bank (say AMEX)as Deposit.
AMEX bank may use such deposits for lending to a French Importer. Indian exporter, earning
Japanese Yen, keeps these Yen in Korea as Deposit .Nigerian Importer avails loan in INR from
Russia to import machinery from India.

Huge amounts of transactions:

Generally they are in only millions of USD.This has lead to Syndication of loans, where
large numbers of banks participate in the lending operations.It also consists of pool of large
number of short term deposits, which provides the biggest single source of funds for
commercial banks .

Highly competitive Market:

There are no entry barriers. There is free access to the new institutions in the market.
The lending rates are low and deposit rate are high, thus allowing a wafer thin margin for
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operations. Consumers, i.e. investors and borrowers derive advantage out of this situation.
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Floating rates of interest based on LIBOR:

The rate of interest in the market is linked to the Base Rate usually LIBOR, i.e. London
Inter-Bank Offered Rate .The rate of interest on advances and deposits is reviewed periodically
and amended according to changed circumstances, if any in LIBOR

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Dominance of Dollar denominated transactions:

Dollar is a leading currency traded in the market (about 90% to 95% market
share).However other currencies are now emerging thus reducing the role of dollar somewhat
(about 80% market share)

 Euro
 Japanese Yen
 Pound Sterling

The following five countries are responsible for the growth of the Euro-Currency Market:

China (fear that its Fx in USD would be blocked).USA (indeed blocked identifiable Fx in
USD in1950, federal Reserve Act, regulation ‘Q’ and ‘M’; control and restrictions on borrowing
funds in US in 1965, and introduction of interest equalization tax in 1963) .Korea (War broke
out in 1950).Russia (erstwhile USSR){because of their banking presence in Paris and London}
.UK (policy of not granting sterling loan outside sterling area in 1957)

Segment 1: Euro-Credit Markets

Tenure: Medium and Long Term Loans [up to 10--15 years 10% of loans, 5—8 years 85% of
loans, 1– 5 years 5% of loans] provided by group of banks.

1. Amount: It is a wholesale sector of the international capital market.

2. Security: Loans are provided without any primary or collateral security. Credit rating is
the essence of lending

3. Type of loan:

A) Revolving [like cash credit]

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B) Term Credit

4. Interest Rate: Generally 1% above the reference rate, rolled over every six moths

5. Currency: Generally USD, but can be any other currency, as required by the borrower
and ability of the lender.

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Syndication of Loan:

– Managing banks, as desired by the borrower

– Lead bank, generally who takes the largest share of lending

– Agent bank, as required to take interest of the banks in syndication and comply
with the procedure

– Common assessment of the borrower and his country

– Common documentation

– In very few cases co-financing with IMF or IBRD is possible

Segment 2: Euro-Bonds

• Euro-Bonds are unsecured securities

• They are therefore issued by borrowers of high financial standing

• When they are issued by government corporation or local bodies, they are guaranteed
by the government of the country concerned

• Euro-Bond is outside the regulation of a single country. The investors are spread
worldwide

• However foreign bonds are issued in only one country and are subject to the regulation
of the country of issue.

• Selling of EB is through syndicates of the banks

• Lead manager advises about size, terms and timing of the issue

• Entire issue is underwritten

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• Lead manager’s fees, underwriting commission and selling commission is somewhere

between 2% and 2.5% of the value of the issue

• Lead manager allocates the bonds to all members of the selling group at face value less
their commission

• Thereafter every member is on his own

• They can sell to investors at whatever price they can obtain

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 • Thus no two investors in the Euro-Bond market need pay the same price for the newly
issued bonds

Features of Euro-Bonds:

• Most Euro-Bonds are bearer securities

• Most bonds are denominated in USD 10,000

• Average maturity of the Euro-Bond is 5 to 6 years

• In some cases maturity extends to 15 years

Types of Euro-Bonds:

• Straight or Fixed Rate Bonds

• Convertible Bonds

• Currency Option Bonds

• Floating Rate Notes

Straight or Fixed Rate Bonds

1. These are fixed interest bearing securities

2. Interest is normally payable yearly

3. Year is considered of 360 days

4. Maturities range from 3 years to 25 years

5. Right of redemption before maturity may be there or may not be there

6. If the right of redemption is there then redemption is done by offering an

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agio(premium)
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Convertible Bonds

1. These are fixed interest bearing securities

2. Investor has an option to convert bonds into equity shares of the borrowing company

3. The conversion is done at the stipulated price and during the stipulated period

4. Conversion price is normally kept higher than the market price

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 5. The rate of interest is lower than the rate of interest on comparable straight bond.

6. Sometimes the bonds are issued in a currency other than the currency of the share. This
provides an opportunity to diversify the currency risk as these bonds are issued with
fixed exchange rate of conversion

7. Bonds with warrants: warrant is part of the bond but is detachable and traded
separately, when the conversion takes place. The investor can keep the bond and trade
the warrant for shares.

Currency Option Bonds

• They are similar to straight bonds

• Generally issued in one currency and option to take interest and principal in another
currency.

• Exchange Rate is either fixed (generally not) or is spot rate prevailing in the market
three business days before the due date of payment of interest and principal

Floating Rate Notes

• FRN is similar to straight bonds with respect to maturity and denomination

• Rate of interest however varies and is based on LIBOR + 1/8%, ¼%,1.5%........

• Rate of interest is adjusted every six months

• Minimum interest rate clause may be included

• ‘drop lock’ clause may also be included, which means if minimum interest rate happens
to be paid then it is locked for the remaining period of the bond.

• Generally it is found that banks issue and invest in FRNs

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Segment 3: Euro-Currency Deposits

1. Euro-bonds represent the funds amassed by the bank on behalf of international

borrower; Euro-currency deposits represent the funds accepted by the bank
themselves.

2. The Euro-currency market consists of all deposits of currencies placed with the banks
outside their home currency.

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 3. The deposits are accepted in Euro-currencies, as well as currency cocktails (SDR, ECU
etc.)

4. The deposits are placed at call (overnight, two days or seven days notice) for USD,
Sterling pounds, Canadian dollars and Japanese Yen; and of two days in any other
currencies

5. Time deposits are accepted for periods of 1,3,6 and 12 months for all currencies

6. USD and Sterling pound can be placed for a period of five years

7. Minimum size of deposit is USD50,000 or its equivalent

Segment 3: Euro-Currency Deposits Certificate of Deposit

1. It is negotiable instrument

2. They are bearer instrument and can be traded in the secondary market

3. Period: 1 year (1 month through 12 months)

4. Minimum amount: USD50,000

5. Currencies: USD, Sterling Pound, Yen

6. Interest Rate: 1/8 % below LIBOR

7. Tranche CD: carries different rates of interest for each tranche

8. Discount CD: they are issued at discount

Segment 4: Euro-Notes Market

1. This market constitutes the instruments of borrowing issued by the corporates in the
Euro-currency market
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2. The instruments issue may be underwritten or may not be underwritten

3. The borrowers directly approach the lenders without the intermediation of the banks or
financial institution.

4. Instruments are of the following categories:

1. Commercial Paper

2. Note issuance Facilities

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 3. Medium Term Notes

Commercial Paper

1. It is a promissory note with maturity less than a year, generally the period varies
between 90 days to 180 days

2. Generally issue is not underwritten

3. Amount: USD 100,000 or equivalent

4. Issued on ‘Discount to Yield ‘ basis, but interest rate works out lesser than that is paid
on bank borrowing and higher than that is paid by the bank on deposits

5. They are unsecured instrument

Note Issuance Facilities (NIF)

1. Borrowers place short term notes of 3 months to 6 months maturity directly with the
investors

2. The notes are rolled over on maturity

3. The banks underwrite at the time of issue as well as when the notes are rolled over

4. With slight variation they are also known as:

1. Revolving underwriting facility (RUF)

2. Standby Note Issuance Facility (SNIF)

3. Note Purchase Facility (NPF)

Medium Term Notes

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1. MTN represents Long Term, Non Underwritten and fixed interest rate source of raising
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finance.

2. It can be comparable with Euro-bonds with a difference that Eurobonds issue is

underwritten, where as MYN issue is not underwritten.

3. Their maturity is somewhere between short term CPs(less than one year) and long term
Euro bonds(more than five years)

4. They are privately placed and have great flexibility

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