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OFFSHORE MARKETS :
1. They have
- minimal regulations
- no registration formalities
- imp of rating varies
- managing issues, underwriting done by banks in country
of issue & investors are residents2. With deregulation, removal of barriers regulation of fin
markets is not easy
3. Common norms to be applied to reduce probability ofsystemic crises ex. BASEL Accord OECD countriesapply uniform capital adequacy norms.
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EUROMARKETS
- Prior to 1980s, euro currency market was intlfinancial market of significance.
- euro currency market- market located in Europe forlending & borrowing the worlds most convertiblecurrency ($, pound sterling, DM, French franc, yen)
- euro$ deposit is a deposit in a relevant currencywith a bank outside home country of that currency
Ex. US$ deposit with a bank in London
DM deposit in Luxembourg It is interbank trading in time deposits, various debt
instruments
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Money = currency + deposits
Euro money= Eurocurrency + euro deposits
Natl money becomes part of offshore currency when it istransferred to a bank outside its monetary system
Deposit is made in that part of banking structure not regulatedby central bank of that country
$ deposits in that segment of Bank of America which isgoverned by Intl Banking Facility.
Euro bank- Fin inst bidding for time deposits and making loansin offshore market
Offshore deposits are possible by-
taking physical currency out of the country & depositing inbank of another country
when transferred to a bank outside natl monetary system
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Features of Intl banking-
Unregulated mkts
Greater risk Attract deposits at higher rates
Provides loans at less rates
Reasons for growth of Euro mkts :
Unregulated fin intermediaries
Bring together lenders & borrowers of same/ differentcountries.
Substitute for domestic banking system Depositors getting higher int rates while borrowers get
funds at low int rate.
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Offshore banks have lower spread because-
they are unregulated institutions hence no need tomaintain reserves
Not subject to interest rate ceiling
Take advantage of low taxes
High degree of competitiveness, unrestricted entry force
euro banks to keep small margins & low O.H costs. Subjected to less pressure from Govt to allocate credit to
less profitable sectors.
Are subjected to greater risk than domestic banks
Interest rates set by competition as no regulatory authority
Euro mkts & domestic mkts deal in same currency, linkedthru arbitrage and strongly influenced by domestic rates
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Location of bank is imp & not the ownership of bank ordeposit.
Intl. money markets- short term debt
1. Euro currency markets
2. Asian currency markets
Intl. capital markets- long & medium debt
1. Euro bond markets2. Asian bond markets
Capital & money markets are interrelated, arbitrage &
speculation takes place
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DIFFERENCE BETWEEN EXCHANGE AND CURRENCYMARKETS
Exchange markets-
Currencies are exchanged for one other at exchangerate
Currency markets-
Currencies are borrowed & lent for varying maturities
at interest rate .
Currencies should be lent/ exchanged for
- meeting trade & payment requirements
- short/ long term needs of fixed or workingcapital
- debt or other obligations
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-DEALERS IN MARKET
- Intl. banks/ Multinational banks
- Foreign branches of domestic banks
- merchant banks
- other banks
Euro currency markets are-
- wholesale in nature
- highly flexible
- competitive
- well connected with wide network of brokers & dealersIs an intl market for borrowing capital by any countrys
Govt., corporates, institutions
- long term funds market organized by investment banks
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FUNCTIONS OF EUROCURRENCY markets :-
1. Cheap source of W/C
- O/H costs are low
- good credit rating- less cost of credit checking & processing
- less lending rates as compared to domestic market
2. Liquidity
- financial institutions find it very convenient & profitableto
invest in euro markets due to
--few restrictions,--can make investments in bearer securities,
-- absence of tax withholding on interest and
-- for short term
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3. Facilitates intl. trade
--provides loans easily, facilitate intl. trade
--due to low interest rates
--easy procedural formalities
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EUROBONDS
Bonds underwritten by intl syndicate of banks
Marketed internationally in countries other than the
country of that denominated currency
Not subjected to national restrictions
Similar to domestic bonds in many respects
Free of official regulations
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Swap allows borrowers to raise money in one market &swap with interest rates of another
Some borrowers are offering bonds whose value is
weighted average of several currencies. Secondary market for Eurobonds is weak as there is no
organized effort to create such market.
Many commercial banks & securities trading firms act asmarket makers quoting two way price, getting hit on bothsides equally is difficult which increases risk.
Eurobonds retire with repurchase of bonds by issuer at pre
decided price.
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variants of Eurobonds
Long term Medium term short term
straight bond - Euro medium term - BA
Bonds with options notes - CD
Sinking fund bond - NIF - CP
FRN
Deep discount bonds Zero coupon bonds
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LOAN SYNDICATION :-
loans are drawn by big borrowers like Govt &multinational firms.
Its a procedure allowing a bank to diversify some ofsovereign risk arising in intl banking
3 categories of banks in loan syndicate- Lead banks
Managing banks
Participating banks
& co-managers
Most of the loans are led by 1 or 2 banks who obtainmandate from borrower to raise funds
Lead bank commits group to raise funds for borroweron specified terms & conditions
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After obtaining mandate , they assemble banks toform mgt group who commit to provide entire loanif necessary
Placement memorandum is prepared by lead banks
Portion of loans are marketed to participating banks
Lead banks responsibility is to market the loan,other members assist
Participating banks can be selected in 3 differentways :-
1. borrower may specify
2. lead bank may invite participants
3. select the bank on its own
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Syndicated loan is term loan.
Drawdown period:- period within which borrower
can draw the loan. Repayment of loan is done within amortisation
schedule & sometimes it starts immediately
Sometimes entire repayment is done at maturity-bullet loan
Loan requiring repayment acc to amortisationschedule & larger final payment of principal on
maturity- balloon repayment schedule
Period prior to commencement of repayment grace period & can be negotiated.
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They are revolving credit type Greater flexibility in repayment Borrower has to pay fee on undrawn amt of credit line CHARGES ON SYNDICATED LOAN1. Front end fees-charges when loan is signed
- in the range .5%-1% of loan-participation fees- .25%-.5% of entire amt Divided betn participating & lead bank-Management fees-
-lead bank takes premium while rest of mgt fees isdivided among managing banks in proportion of
amt underwritten2. Agents annual fee3. Reserve requirement clause: adjustment for increase
in cost of funds
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Charges on syndicated loans are:
Annual payments=(LIBOR + spread)(TL)+
commitment fee (UDL) +Annual agents fee (if any)+
res. Requirement adj (if any)
Front end fee- lead bank premium(TL) +
participation fee +
mgt fee +
initial agents fee (if any)
Longer maturity loan will have wider spread
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ADVANTAGES OF LOAN SYNDICATION :1. Intl loans are highly profitable for many banks
2. Many banks improved risk-return performance by
diversification3. Developing countries attempted to have high credit
standing with intl banks
4. Safeguards like credit insurance prog, guarantees
reduced the risk of intl lending.
DISADVANTAGES :-1. Country risk cant be exactly forecasted
2. Dramatic increase in country risk
3. Relaxation of credit stds.
4. Critics doubt the ability of debtor countries to servicetheir external debt
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EURO BOND MKT:
In this mkt, lenders lend directly to borrowers
without intermediation of fin inst. They may be at floating rate or have currency
conversion options
They are underwritten by intl syndicate &distributed worldwide in bearer form
Parties lend or borrow away from control ofmonetary authorities.
Off h / i l b d h b d ld id h
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Offshore/ intl bonds are the bonds sold outside thecountry of the borrower
3 types of bonds :-
1. Foreign bonds-bonds issued in a mkt by a foreign entity ,underwritten by syndicate of banks from that country,denominated in that currency
2. Parallel bonds-bonds issued by a borrower in manycountries simultaneously raising funds in many currencies.
3. Euro bonds- bonds sold simultaneously in many countriesother than the country of the currency in which the issue is
denominated. Euro bonds are direct claims on leading multinational
cos, Govts or Govt enterprises.
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KINDS OF EURO BONDS :-
1. STRAIGHT BONDS-
Fixed maturities & rate of interest Repaid by amortization (EMI- incl int+ principal) or in
lumpsum at maturity date
Interest paid at regular intervals
Technically unsecured (secured by any property ofborrower)
In default , bond holders become general creditors
Lenders consider- borrowers assets
earning power
gen credit strength
Adv : int income is exempted from withholding tax
C tibl E b d
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2. Convertible Euro bond :-
Convertibility option makes eurobonds more attractive& easily marketable
Convertible into equity at certain premium above mktprice of equity on bond issue date.
Investors are free to convert debt to equity at any time
before conversion date Borrowing co. should issue new stock for that purpose
Investors have steady income , can participate in rising
stock prices
B d ith t
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3. Bonds with warrants :-
Warrant is an option to buy a stated no. of commonshares at a stated price during a prescribed period
No dividends & voting rights
Becomes worthless at expiry unless price of stockexceeds exercise price.
CURRENCY OPTION BONDS
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4. CURRENCY OPTION BONDS:-
Bond holder gets interest payment & principle in anyspecified currency
Bond holder has the option to choose currency at predetermined exrate
5. CURRENCY BASKET BONDS:-
Have been developed to stabilize purchasing power ofcoupon by taking wtd avg
Amt of each currency is stable but value of basketchanges based on app/ dep of currencies
SHORT TERM INSTRUMENTS
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SHORT TERM INSTRUMENTS :-
1. EURO COMMERCIAL PAPERS :-
Unsecured , negotiable, cheap, flexible, short term loan
issued by bank/ corp in intl money mkt denominated incurrency other than domestic currency
Adv- interest rate less than banks & issued by highly ratedborrowers
Disadv-secondary mkt not active so most investors hold tillmaturity
CERTIFICATE OF DEPOSIT
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CERTIFICATE OF DEPOSIT:-
Issued by depository inst, negotiable, bearer form
Some are regd, small denominations issued to retailinvestors
Large denominations issued to inst investorsexceeding 1 million
Junk bonds
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Junk bonds
Credit rating agencies assign rating based on credit riskassessment.
These are high risk bonds & hence offer high yield. (high yieldbonds). (3-4 % higher than Govt. issued bonds).
Rated lower than Baa/ BBB & considered speculative, ascompared to investment grade bonds.
Investment grade used for bonds having high probability ofbeing paid.
Most common funds during 1980s, as firms required funds forvarious acquisitions & were reluctant to issue new share capital(equity), only was debt.
Sometimes bonds initially investment graded bonds aredowngraded to junk bonds due to credit risks faced bycorporates.
In US, 25% value of bonds are junk bonds.
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Difference between Eurobonds and Euro creditEurobonds Euro credit
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Eurobonds Euro credit
1. Cost of borrowing
Issued in fixed & floatingrate forms.
2. Maturity
Longer maturities.
3. Size of issue
Earlier small, rapidlyexpanding.
4. flexibility
Funds must be drawn inone sum on a fixed date.Repaid according fixedschedule prepaid withpenalty.
5. Speed
More time required fordocumentation
Interest is variable.
Shorter maturities.
Tough competition.
Can suit borrowers needs
Can be prepaid in full or halfwithout penalty