FINS5550International BankingSemester 1Tutorial 4.docx
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FINS5550International BankingSemester 1Tutorial 4.docx
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FINS5550InternationalBankingSemester1Tutorial4
Tutorial4:
ReviewQuestions:
EuroDebtMarkets
1.Identifythedifferencesbetweenintermediatedandnon-intermediatedflowoffundsineurodebtmarkets.
Theformerreferstotheprocessofchannellingloanablefundsthroughafinancialintermediary.Boththesurplusunit(lendersordepositors)anddeficitunit(borrowers)takeafiduciaryrelationshipwithafinancialintermediary.
Whilethelatterreferstodebtinstrumentsissuedbyborrowersintheirownnametothecapitalmarketdirectlyusuallywithahelpfromaninvestmentbankactingasanunderwriter.
Disintermediation
Disintermediationreferstotheprocessoffinancialflowsbetweenborrowersandlenders
withoutanintermediary.Disintermediationpresentssomeproblemsfortheregulatorsandgovernmentsbecausetheproportionoftotaldomesticcreditunderthedirectcontrolofregulatorsbecomeslowerwithaconsequenceofadiminishedeffectivenessofmonetarypolicy,andtotheextendthatintermediariesperformtheroleofcreditallocationtostrategicareasanddisadvantagedborrowers,reducedimportanceoftheirrolehasanimplicationforcreditallocation.
However,disintermediationintheeurocurrencymarketsmaynotposeuniquelyexternal
problemsbecauseitmaybeageneraltrendawayfromfinancialintermediationwhich
affectsbothinternalandexternalmarketsequally,andifdisintermediationisuniquetotheeurocurrencymarket,domesticbankswillbenefitasfundswillmovefromeuromarketstodomesticmarkets.
2.Whatisaeurocurrency?
Isitmoney?
Whatfunctionsdotheyperform?
Alsoexplain
thefunctionsofeurobanks.
a)Aeurocurrencyreferstoatimedepositissuedbyaeurobankinacurrencydenominationotherthanthelocalcurrencyoftheissuingmarket2.
b)Despitetheterm‘currency’eurocurrencyisnotcurrencyintheusualrespect.Acurrecncyisa
monetaryunitthatisalegaltenderinacountrythatperforms
(1)MediumofExchange:
Thecharacteristicsofcurrencyare
acceptability
standardisation
divisibility
portability
durability
(2)UnitofAccount:
Moneyprovidesarelativemeasureofvalueofgoodsandservices.
(3)StoreofValue:
Moneyactsasastoreofwealth.
(e.g.hardcurrenciesareconsideredtobesolidinvestments)
c)eurocurrenciesperformonly(3).
d)“TheEuro-currencymarketissimplyamarketforbanktimedepositsandloans
denominatedinacurrencyotherthanthatofthecountryinwhichthebankislocated.”D-G(1994)(egUSDloangrantedtoanAustralianMNCbyaSwissEuro-bank)
“AEuro-bankisafinancialintermediarythatsimultaneouslybidsfortimedepositsand
makesloansinacurrency,orcurrencies,otherthanthatofthecountryinwhichitis
located.”D-G(1994)
Eurocurrencymarketsaremarketsforintermediatedbankcreditsandrepresentan
extensionofdomesticmoneymarkets,whicharemarketsforshort-termbankcredit.
TheyareessentiallyinterbankmarketscentredinLondonandothermajorregionalfinancialcentressuchasBahrain,HongKongandSingapore(whichishometoAsiaDollarMarket).
Eurodollarmarketaccountsformorethan50%oftheeurocurrencymarketfollowedbytheEuroareacurrenciesandtheYen(SeeFigure1below).
3.Describetheprocessofdepositcreationintheeurocurrencymarket.Arethereany
notabledifferencescomparedtothatinadomesticbankingsector?
Figure3:
OperationsofEuro-currencyMarket
Figure3aboveshowstheroleofeurocurrencymarketsinintermediatingflowofloanable
fundsbetweenborrowersandlenderslocatedoutsideoftheeurocurrencymarkets.Adepositmadebyanoutsidedepositorisrecycledthroughtheeurocurrencymarketinvolvingoneormore(twointhiscase)eurobankstradingeurocurrencycontractswitheachotherbeforeitisloanedouttoanoutsideborrower.Aeurocurrencyreferstoatimedepositissuedbyaeurobankinacurrencydenominationotherthanthelocalcurrencyoftheissuingmarket2.
Noticethatthroughoutthisprocess,the$1mdemanddepositheldwiththeUSbankhas
remainedintheUSbankingsector,onlyitslegalownershipwaspassedaround.3Theend
resultisthedomesticintermediationhasbeenreplacedbyoffshoreintermediationbytwo
eurobanks(couldbeone).TheUSdollartimedeposittradedbetweenthetwoeurobanksiscalledaeurodollar.
Euro-depositsarecreatedwhenadepositofalenderwithaEuro-bankisredepositedwith
anotherEuro-bank,andtheeventualamountofdepositcreateddependsonthenumberof
Euro-banksinvolvedinthechain.(however,euro-creditiscreatedonlywhenthefundis
loanedouttofinalborrower)
TheexampleoutlinedaboveisthecaseofEurocurrencymarketreplacingdomesticfinancialintermediationduetotheircompetitiveadvantageoverdomesticbanksinpricingtheirproducts.TheprocessissummarizedinFigure4below.Theredarrowsshowthedirectionoffundflowsifintermediatedbythedomesticbankingsystem.TheroleoftheEurocurrencymarketinthisinstanceistobypassthedomesticintermediation.Figure5showsanalternativescenariowhereEurocurrencymarketisfacilitatinginternationalcapitalflows.
AssumethattheeurodepositmadebyABCIncispassedontoDEFLtdinAustraliaviathetwoeurobanks.DEFthenusesthefundtopaytheinvoiceofthetradebetweenitandXYZInclocatedintheUS.Attheendoftheprocess,thefundisonceagaindepositedtotheUSbankingsystem.TheredarrowsshowsthefundflowsintheabsenceoftheEurocurrencymarkets.
4.Explainthenatureofeuroloansyndication.Whatarethepotentialbenefitsfora
participatingeurobank?
Theloanstonon-banksaretocreditsextendedtoeventualborrowerswhorepresent
thefinalrestingplaceforeurodeposits.Loanstonon-banksaregenerallylongerterm,haverelativelyhigherdefaultrisk,offeredonacontinuousroll-overbasis(usuallywitha
revolvingcreditfacility,whichisasetamountofloanthatcanbedrawninmultiplesteps
withinaspecifiedperiod),andgenerallysyndicated.Borrowersinthiscategoryincludes
MNCs,sovereignentities,andwealthyindividuals.DuetothelargesizeofEuro-currencyloans,individualeurobanksmaydecidetoformasyndicateoflenderstospreadthecreditriskbydiversificationthroughholdingonlyaportionofmanydifferentloans,andtoreducemonitoringcostsbyrelyingonthemonitoringoftheleadbank.Thesyndicationmethodsleadtolowerborrowingcostssincelendershavebetterinformationregardingtheaggregateamountoflendingtoanyoneborrower,andthetermsandconditionsofothersegmentsoftheloanandotherlendingtothesameborrower(whichallowsbankstohaveabetterideaabouttheborrower’stotalliabilityposition).
5.Describethenatureoftherelationshipbetweendomestic(onshore)andeuro(offshore)
interestrates.Istheideaofinterestratearbitragerelevant?
Explain.
Second,eurocurrencymarketsarebeyondthejurisdictionofanyonecountryandsoarefreefromregulationsthatlimitdomesticbanks.TheusualreserverequirementdoesnotapplytoEurodeposits,andsoEuro-banksCANandDOlendfullamountofdeposittheyreceive.Therearenointerestrateorotherlendingrestrictions.Theinterestrateceilingthatwasbindinginthefaceofrisinginterestratesinthelate70sandearly80sintheUSmadedollardepositswitheurobanksmorecompetitive.Euro-dollardepositsarenotsubjecttodepositinsuranceandsoeurobankscanofferhigherdepositratesthanUSdomesticbanks.Theendresultoftheaboveisnarrowerinterestratespread(eghigherdepositrateandlowerlendingrate)intheeurodollarmarketcomparedtothedomesticUSmarkets.
Eurocurrencyinterestrates(bothdepositandlending)arelinkedwithinaparticular
currencymarket(bothdomesticandEuro)andwithothermarketsofdifferentcurrencies.
Themostimportantelementinthemarketlinkageistheprocessofarbitrage.Thatis,
assumingefficientfinancialmarkets,thenatureofinterestratelinkagesispredictablegivencurrentinformation.Thelinkbetweendomesticandeurointerestratesisthroughtheprocessofinterestratearbitragewithinthatcurrencyandthedifferencebetweenthetwocannotbeconsistentlyabovethenormallevelspecifiedbyeitherorbothofthefactorsexplainedbelow.InterestratesonvariouseurocurrencydepositsandloansareconnectedthroughtheCoveredInterestRateParityrelationship.Thatis,interestratesofvariouscurrenciesarelinkedtoeachotherthroughforeignexchangemarkets,andno-arbitrageconditionrequiresthatyieldsindifferenteurocurrencymarketsshouldbeequalisedonacovered(throughappropriateforwardexchangeratecontracts)basis.
6.Explaintheempiricalrelevanceofthetwopossibleexplanationsoftheequilibrium
depositrategapbetweenonandoffshoremoneymarkets.
7.Identifythemainreasonsforthepopularityofeurobanksandeurocurrencymarkets.
Arethesefactorsstillsignificant?
8.Describetheprocessofunderwritingeuro-noteissues.
9.Describevariousinstrumentsintheeuro-debtmarkets(non-intermediated).
10.Directfinancingintheeurodebtmarketshasgainedpopularity.Whatfactorswere
responsibleforthis?
11.DescribetheimpliedtrendsofinternationalbondissuesreportedinTable5.
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