Eurobond Market

Question 1

What is Eurocurrency?

Answer 1

Currency in a country that is not the origin of the currency

Question 2

What caused the growth of Eurodollar market?

Answer 2

Caused by restrictive US government policies on local banks. By operating in Eurocurrencies, banks and suppliers of funds are able to avoid certain regulatory costs and restrictions that would otherwise be imposed

i.e. HSBC (global bank) have more freedom/access than local banks in domestic markets

Question 3

What are some examples of restriction?

Answer 3

1. D: Reserve requirements on deposits
2. T: Charges and taxes
3. I: Interest rate ceiling
4. C: Required concessionary loan rates
5. C: Rules which restrict bank competition

DICTC
Deposit, interest, competition, taxes, concessionary loans

Question 4

What is a concessionary interest rate?

Answer 4

An interest rate concession is a reduction on interest rate compared to commercial loans. Provided by governments/government grants to commercial banks.

Question 5

What does the creation of eurodollar involve?

Answer 5

1. A chain of deposits between the original depositor and the US bank (home bank for the currency)
2. Changing control over the deposit and the use to which the money is put

Question 6

What is unique about the creation of euro dollar?

Answer 6

1. Only the US bank or the depositor can be the owner of the dollar –> The US dollar never leaves US
2. The control over the deposit changes hands – lend US dollar to domestic banks (London banks)
   US dollar is never sold/bought – it is lend or borrowed.

Question 7

What is the origin of Eurodollar?

Answer 7

Before 1950s, a bank only takes deposits of the domestic currency. When people in Soviet Union export or import, they have to deal with US dollars. However, if they deposit the US dollar in US banks, they are afraid of being frozen. Thus the eurodollar market is created.

When you get your dollar, you can lend it to domestic bank, which can lend to other people.

Question 8

What is the Eurocurrency bond?

Answer 8

Borrow/lend US dollar in foreign countries

Question 9

How does Eurocurrency bond work?

Answer 9

1. Rates from the lender to borrower is calculated based by LIBOR + margin
2. LIBOR rate is reset every 6 month
3. The maturity can be 5 years, 10 years…

The margin/spread is the risk indicator of the loan

Question 10

What is multicurrency clause?

Answer 10

A clause on Eurodollar loan which gives the borrower the right to switch from one currency to another on any rollover date.

“I borrowed in US dollar, but I want to repay in Chinese Yuan”

Question 11

What is the advantage of multicurrency clause?

Answer 11

It is equivalent to lending and hedging (reduce exchange rate risk) at the same time.

Question 12

What is the relationship between Eurodollar and domestic dollar?

Answer 12

1. There should be no interest differential because of arbitrage.
2. Interest differential can be explained by currency controls (current or future) or other risks
3. Eurocurrency spreads:
   - bid: if you want to loan: lower lending rate (because of high volume, lower transaction costs/taxes)
   - ask: if you want to borrow: higher deposit rates (attract deposits and less regulations)

Question 13

What is Eurobonds?

Answer 13

The same with bonds: you borrow money and return the money.

The difference is that you deal with a foreign currency.

Question 14

What is swap?

Answer 14

Two parties with opposite interests (I want US dollar, you want Chinese Yuan). Borrow in the market that they are better at; swap with the other party.

Question 15

What is a sinking fund?

Answer 15

A sinking fund requires the borrower to retire a fixed amount of bonds yearly after a specific number of years.

Question 16

What is main reason for why Eurobond or Eurodollar exists?

Answer 16

They can avoid government regulation

Question 17

What is the difference between Eurobond and Eurocurrency loan?

Answer 17

1. Cost of borrowing: loan - floating; bond - fixed or floating
2. The difference between loan and bond: size, flexibility, time

The fundamental distinction between a Eurobond and a Eurocurrency loan stems from the financing mechanism. A Eurobond is issued by the final borrower directly, whereas a Eurocurrency loan is made by a bank. Thus, Eurobond investors hold a claim on the issuer directly, whereas Eurocurrency loans are funded by investors who hold short term claims on banks that then act as intermediaries to transform these deposits into long term claims on final borrowers.

Question 18

What is the difference between Euro-note and Euro-commercial paper?

Answer 18

Euro-note: unsecured short-term

Euro-commercial paper: Euro-notes that are not bank-underwritten

Question 19

Overall, what are some ways of raising Eurodollars?

Answer 19

1. Eurobonds (long term, syndicate of banks)
2. Eurocurrency loans (LIBOR)
3. Note Issuance facilities (Line of credits, daily, Eurobanks)
4. Euro Commercial paper (non-bank underwritten) Must have really good credit rating
5. Euronotes: unsecured short term

Question 20

What is the difference between a foreign bond and a Eurobond?

Answer 20

A foreign bond is an issue sold in the domestic bond market by a foreign company or government. As such, foreign bonds are subject to local laws and must be denominated in the local currency. By contrast, a Eurobond is sold outside the country in whose currency it is denominated. Eurobonds are also almost entirely free of official regulation.

Question 21

Why lend in Eurobond when domestic bonds yield more?

Answer 21

Eurobonds are issued in bearer form, meaning they are unregistered, with no record to identify the owners. This feature allows investors to collect interest in complete anonymity and, thereby, evade taxes. Although U.S. law discourages the sale of such bonds to U.S. citizens or residents, bonds issued in bearer form are common overseas. As expected, investors are willing to accept lower yields on bearer bonds than on nonbearer bonds of similar risk.

Question 22

What facilitated the growth of NIFs?

Answer 22

The creation of NIFs is one means whereby Eurobanks have responded to the competition from the Eurobond market. It is a low cost substitute for syndicated credits and allows borrowers to issue their own short term notes that are then placed or distributed by the financial institutions providing the NIF. They also allow banks to create fee income without having to maintain expensive equity capital. (However, this factor became less significant when the risk-based capital standards for banks were implemented.) The growth of NIFs has also been facilitated by investors’ increased preference for lending to high-grade borrowers directly instead of through banks.