Chapter 4 Page 1 of 13

INTERNATIONAL FINANCIAL MARKETS

CONCEPTS

1. Distinction between Euro Credit and Euro Bond Market

Both Euro bonds and Euro credit (Euro currency) financing have their advantages and disadvantages. For a given
company, under specific circumstances, one method of financing may be preferred to the other. The major
differences are:

1. Cost of borrowing
Euro bonds are issued in both fixed rate and floating rate forms. Fixed rate bonds are an attractive exposure
management tool since the known long-term currency inflows can be offset by the known long-term outflows in
the same currency. In contrast, Euro currency loans carry variable rates.

2. Maturity
Euro bonds have longer maturities while the period of borrowing in the Euro currency market has tended to
lengthen over time.

3. Size of the issue

Earlier, the funds available for lending at any time have been much more in the inter-bank market than in the bond
market. But of late, this situation does not hold true. Moreover, although in the past the flotation costs of a Euro
currency loan have been much lower than a Euro bond (about 0.5 % of the total loan amount versus about 2.25 %
of the face value of a Euro bond issue), compensation has worked to lower Euro bond flotation costs.

4. Flexibility
In a Euro bond issue, the funds must be drawn in one sum on a fixed date and repaid according to a fixed
schedule, unless the borrower pays a substantial prepayment penalty. By contrast, the drawdown in a floating rate
loan can be staggered to suit the borrower’s needs and can be repaid in whole or in part at any time, often without
penalty. Moreover, a Euro currency loan with a multi-currency clause enables the borrower to switch currencies
on any roll-over date, whereas switching the denomination of a Euro bond from currency A to currency B would
require a costly, combined, refunding and reissuing operation.

5. Speed
Funds can be raised by a known borrower very quickly in the Euro currency market. Often, a period of two to
three weeks should suffice. A Euro bond financing generally takes more time, though the difference is becoming
less significant.

2. Euro Credit Market

Euro credit or Euro Loans are the loans extended for one year or longer. The market that deals in such loans is
called Euro Credit Market.

The common maturity for euro credit loans is 5 years. Since Euro banks accept short-term deposits and provide
long-term loans, it is likely that asset liability mismatch may arise. To avoid this Euro banks often extend floating
rate euro credit loans fixed to some market interest rate. The London Inter Bank Offer Rate (LIBOR) is the most
commonly used interest rate. It is the rate charged for loans between Euro Banks.

Participants in Euro credit Market

The major lending banks in the Euro credit market are Euro banks, American, Japanese, British, Swiss, French,
German and Asian (specially that of Singapore) banks, Chemical Bank, JP Morgan, Citicorp, Bankers Trust,
Chase Manhattan Bank, First National Bank of Chicago, Barclay's Bank, National Westminster, BNP, etc. Among
the borrowers, there are banks, multinational groups, public utilities, government agencies, local authorities, etc.

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Dealing in Euro credits

When a borrower approaches a bank for Euro credit, a formal document is prepared on behalf of potential
borrowers. This document contains the principal terms and conditions of loan, objectives of loan and details of the
borrower.

Before launching syndication, the approached bank decides primarily, in consultation with the borrower, on a
strategy to be adopted, i.e. whether to approach a large market or a restricted number of banks to form the
syndicate. Each of the banks in syndicate lends a part of the loan. The duration of this operation is normally about
6 to 8 weeks.

Several clauses may be introduced in the contract of Euro-debt:

• Pari-passu clause that prevents the borrower from contracting new debts that subordinate the interest of
lenders;
• Exchange option clause that allows the withdrawal of a part or totality of loan in another currency;
• Negative guarantee clause that commits the borrower not to contract other debts that subordinate the interest of
lenders.

Characteristics of Euro credit

A major part (more than 80 %) of the Euro debts is made in US dollars. The second (but far behind) is Pound
Sterling followed by Deutsch mark, Japanese yen, Swiss franc and others.

Most of the syndicated debts are of the order of $50 million. As far as the upper limits are concerned, amounts
involved are of as high magnitude as $5 billion and more. In 1990, Euro tunnel borrowed $6.8 billion.

On an average, maturity periods are of about five years (in some cases it is about 20 years). The reimbursement of
the loan may take place in one go (bullet) or in several installments.

The interest rate on Euro debt is calculated with respect to a rate of reference, increased by a margin (or spread).
The rates are available and generally renewable (roll over credit) every six months, fixed with reference to
LIBOR. The LIBOR is the rate of money market applicable to short-term credits among the banks of London. The
reference rate can equally be PIBOR at Paris and FIBOR at Frankfurt, etc. It is revised regularly.

The margin depends on the supply and demand of the capital as also on the degree of the risk of these credits and
the rating of borrowers. Financial institutions are in vigorous competition. There is an active secondary market of
Euro debts. Numerous techniques allow banks to sell their titles in this market.

3. Euro Bond Market

Euro Bond issue is one denominated in a particular currency but sold to investors in national capital markets other
than the country that issued the denominating currency. An example is a Dutch borrower issuing DM-
denominated bonds to investors in the UK, Switzerland and the Netherlands.

The Eurobond market is the largest international bond market, which is said to have originated in 1963 with an
issue of Eurodollar bonds by Autostrade, an Italian borrower. The market has since grown enormously in size and
was worth about $ 428 billion in 1994.

Eurobond markets in all currencies except the Japanese Yen are quite free from any regulation by the respective
governments. Straight bonds are priced with reference to a benchmark, typically treasury issues. Thus a
Eurodollar bond will be priced to a yield a YTM (Yield-to-Maturity) somewhat above the US treasury bonds of
similar maturity, the spread depending upon the borrowers ratings and market conditions.
Floatation costs of the Eurobond are comparatively higher than costs indicated with syndicated Eurocredits.
4. Euro CPs
Commercial paper is a corporate short-term, unsecured promissory note issued on a discount to yield basis.
Commercial paper maturities generally do not exceed 270 days. Commercial paper represents a cheap and flexible
source of funds While CPs are negotiable, secondary markets tend to be not very active since most investors hold
the paper to maturity.

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The emergence of the Euro Commercial Paper (ECP) is much more recent. It evolved as a natural culmination of
the Note Issuance Facility and developed rapidly in an environment of securitisation and disintermediation of
traditional banking. CP has also developed in the domestic segments of some European countries offering
attractive funding opportunities to resident entities.

5. Euro CDs
A Certificate of Deposit (CD) is a negotiable instrument evidencing a deposit with a bank. A CD is a marketable
instrument so that the investor can dispose it off in the secondary market whenever cash is needed. The final
holder is paid the face value on maturity along with the interest. It is used by the commercial banks as short- term
funding instruments.
Euro CDs are mainly issued in London by banks. Interest on CDs with maturity more than a year is paid annually
than semi-annually.

6. International Capital Markets

International Capital Markets have come into existence to cater to the need of international financing by
economies in the form of short, medium or long-term securities or credits. These markets also called Euro
markets, are the markets on which Euro currencies, Euro bonds, Euro shares and Euro bills are traded/exchanged.
Over the years, there has been a phenomenal growth both in volume and types of financial instruments transacted
in these markets. Euro currency deposits are the deposits made in a bank, situated outside the territory of the
origin of currency. For example, Euro dollar is a deposit made in US dollars in a bank located outside the USA;
likewise, Euro banks are the banks in which Euro currencies are deposited. They have term deposits in Euro
currencies and offer credits in a currency other than that of the country in which they are located.

A distinctive feature of the financial strategy of multinational companies is the wide range of external services of
funds that they use on an ongoing basis. British Telecommunication offers stock in London, New York and Tokyo,
while Swiss Bank Corporation-, aided by Italian, Belgian, Canadian and German banks- helps corporations sell
Swiss franc bonds in Europe and then swap the proceeds back into US dollars.

Firms have three general sources of funds available: (i) internally generated cash, (ii) short-term external funds,
and (iii) long-term external funds. External investment comes in the form of debt or equity, which are generally
negotiable (tradable) instruments. The pattern of financing varies from country to country. Companies in the UK
get an average of 60-70% of their funds from internal sources. German companies get about 40-50% of their
funds from external suppliers. In 1975, Japanese companies got more than 70% of their money from outside
sources, but this pattern has since reversed; major chunks of finances come from internal sources.

Another significant aspect of financing behaviour is that debt accounts for the overwhelming share of external
finance. Industry sources of external finance also differ widely from country to country. German and Japanese
companies have relied heavily on bank borrowing, while the US and British industry raised much more money
directly from financial markets by the sale of securities. However, in all countries, bank borrowing is on a decline.
There is a growing tendency for corporate borrowing to take the form of negotiable securities issued in the public
capital markets rather than in the form of commercial bank loans. This process known as securitisation is most
pronounced among the Japanese companies.

7. Petro Dollar
During the oil crises of 1973, the Capital markets have played a very important role. They accepted the dollar
deposits from oil exporters and channeled the funds to the borrowers in other countries. This is called ‘recycling
the petrodollars’.

8. Junk Bonds

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A junk bond is issued by a corporation or municipality with a bad credit rating. In exchange for the risk of lending
money to a bond issuer with bad credit, the issuer pays the investor a higher interest rate. "High-yield bond" is a
nicer name for junk bond The credit rating of a high yield bond is considered "speculative" grade or below
"investment grade". This means that the chance of default with high yield bonds is higher than for other bonds.
Their higher credit risk means that "junk" bond yields are higher than bonds of better credit quality. Studies have
demonstrated that portfolios of high yield bonds have higher returns than other bond portfolios, suggesting that
the higher yields more than compensate for their additional default risk.

Junk bonds became a common means for raising business capital in the 1980s, when they were used to help
finance the purchase of companies, especially by leveraged buyouts, the sale of junk bonds continued to be used
in the 1990s to generate capital

9. Samurai Bonds
They are publicly issued yen denominated bonds. They are issued by non-Japanese entities.
The Japanese Ministry of Finance lays down the eligibility guidelines for potential foreign borrowers. These
specify the minimum rating, size of issue, maturity and so forth. Floatation costs tend to be high. Pricing is done
with respect to Long-term Prime Rate.

Shibosai Bonds
They are private placement bonds with distribution limited to banks and institutions. The eligibility criteria are
less stringent but the MOF still maintains control.

Shogun / Geisha Bonds

They are publicly floated bonds in a foreign currency while Geisha are their private counterparts.

10. Yankee Bonds

These are dollar denominated bonds issued by foreign borrowers. It is the largest and most active market in the
world but potential borrowers must meet very stringent disclosure, dual rating and other listing requirements,
options like call and put can be incorporated and there are no restrictions on size of the issue, maturity and so
forth.

Yankee bonds can be offered under rule 144a of Sec. These issues are exempt from elaborate registration and
disclosure requirements but rating, while not mandatory is helpful. Finally low rated or unrated borrowers can
make private placements. Higher yields have to be offered and the secondary market is very limited.

DESCRIPTIVE

1. Trace the development of the International Capital Markets

The financial revolution has been characterized by both a tremendous quantitative expansion and an extraordinary
qualitative transformation in the institutions, instruments and regulatory structures.

Global financial markets are a relatively recent phenomenon. Prior to 1980, national markets were largely
independent of each other and financial intermediaries in each country operated principally in that country. The
foreign exchange market and the Eurocurrency and Eurobond markets based in London were the only markets
that were truly global in their operations.

Financial markets everywhere serve to facilitate transfer of resources from surplus units (savers) to deficit units
(borrowers), the former attempting to maximize the return on their savings while the latter looking to minimize
their borrowing costs. An efficient financial market thus achieves an optimal allocation of surplus funds between
alternative uses. Healthy financial markets also offer the savers a range of instruments enabling them to diversify
their portfolios.

Globalization of financial markets during the eighties has been driven by two underlying forces. Growing (and
continually shifting) imbalance between savings and investment within individual countries, reflected in their

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current account balances, has necessitated massive cross-border financial flows. For instance, during the late
seventies, the massive surpluses of the OPEC countries had to be recycled, i.e. fed back into the economies of oil
importing nations. During the eighties, the large current account deficits of the US had to be financed primarily
from the mounting surpluses in Japan and Germany. During the nineties, developing countries as a group have
experienced huge current account deficits and have also had to resort to international financial markets to bridge
the gap between incomes and expenditures, as the volume of concessional aid from official bilateral and
multilateral sources has fallen far short of their perceived needs.

The other motive force is the increasing preference on the part of investors for international diversification of
their asset portfolios. This would result in gross cross-border financial flows. Investigators have established that
significant risk reduction is possible via global diversification of portfolios.

These demand-side forces accompanied by liberalization and geographical integration of financial markets has
led to enormous growth in cross-border financial transactions. In virtually all major industrial economies,
significant deregulation of the financial markets has already been effected or is under way. Functional and
geographic restrictions on financial institutions, restrictions on the kind of securities they can issue and hold in
their portfolios, interest rate ceilings, barriers to foreign entities accessing national markets as borrowers and
lenders and to foreign financial intermediaries offering various types of financial services have been already
dismantled or are being gradually eased away. Finally, the markets themselves have proved to be highly
innovative, responding rapidly to changing investor preferences and increasingly complex needs of the borrowers
by designing new instruments and highly flexible risk management products.

The result of these processes has been the emergence of a vast, seamless global financial market transcending
national boundaries. But control and government intervention have not entirely disappeared. E.g. South East Asia-
Korea, Taiwan, etc- permit only limited access to foreign investors. However, despite these reservations, the
dominant trend is towards globalization of financial markets.

International financial markets can develop anywhere, provided that local regulations permit the market and
potential users are attracted to it. The most important international financial centers are London, Tokyo and New
York. All the major industrial countries have important domestic financial markets as well but only some such as
Germany and France are also important international financial centers. On the other hand, even though some
countries have relatively unimportant domestic financial markets, they are important world financial centers such
as Switzerland, Luxembourg, Singapore and Hong Kong.

International Capital Markets, also called Euro markets, are the markets on which Euro currencies; Euro bonds,
Euro equity and Euro bills are exchanged. International financing in the form of short-, medium- or long-term
securities or credits has become necessary for the international economy. Financing techniques have diversified,
volumes dealt have increased and the process is continuing to grow.

Notable developments in international capital markets can be traced to the end of 1950s. There are several reasons
for their growth. The significant ones are:

Transfer of assets of erstwhile Soviet Union to Europe. In the 1950s and early 1960s, the former Soviet Union
and Soviet-bloc countries sold gold and commodities to raise hard currency. Because of anti-Soviet sentiment,
these Communist countries were afraid of depositing their US dollars in US banks for fear that the deposits could
be frozen or taken. Instead they deposited their dollars in a French Bank whose telex address was Euro-Bank.
Since that time, dollar deposits outside the US have been called Eurodollars and banks accepting Eurocurrency
deposits have been called Euro banks. International capital markets subsequently came to be known as Euro
markets.

Restrictive measures taken by the administration. Several regulatory measures (initiated particularly in the
USA) also contributed (in an indirect manner) to the development of International capital markets. The important
ones are as follows:

Regulation 'Q'. In 1960, Regulation 'Q' in the USA fixed a ceiling on interest rates offered by American banks on
term deposits and prohibited them to remunerate the deposits whose term was less than 30 days. Besides, at the

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end of the 1960s, the Federal Reserve reduced the growth of total monetary mass. The money market rate went
up. American banks borrowed on the Euro dollar market, which resulted in:
• The increase of indebtedness of these banks on the Euro dollar market;
• The flight of American Capital, attracted by the interest rate on Euro market.

Tax of interest equalization. In 1963, tax was imposed on the purchase of foreign securities (portfolio
investments) by American residents. The objective was to reduce the deficit of BOP of the USA and to establish
equilibrium in international structure of interest rates. In fact, in order to avoid tax payment, some companies
launched the issue of dollar bonds outside the USA. This contributed to the growth of Euro dollar market.
Realizing its adverse effects, subsequently, the tax was withdrawn in 1974.

Program of voluntary restrictions on investments. The USA initiated/imposed various restrictions on its financial
system to tackle BOP problems. For instance, banks were directed not to lend or invest in foreign operations
beyond the limits of the previous year(s). As a result, the business community felt a scarcity of funds. This in turn
led them to take recourse to the Euro dollar market.

Differential of American lending and borrowing rates. The interest rate paid by American banks was low, vis-
à-vis, the expected rate from borrowers. European banks availed of this opportunity; they offered higher rates of
interest at the cost of contenting themselves with smaller margins than those offered by American banks, to attract
investors. They could do so by operating on Euro dollar markets, which were not subject to interest-rate and other
regulations. For instance, banks were neither constrained to respect a certain compulsory reserve ratio on their
deposits in Euro dollars nor constrained to maintain their interest rates below a certain ceiling.

There may be other reasons as well for development of Euro dollars. Globalization of big multinationals has
further boosted this development. The financing system practiced hitherto also was not able to respond to capital
needs of the international economy.

Indian entities began accessing external capital markets towards the end of the seventies as gradually the amount
of concessional assistance became inadequate to meet the increasing needs of the economy. The initial forays
were low-key. The pace accelerated around mid-eighties, but even the authorities adopted a selective approach
and permitted only a few select banks, all India financial institutions and large public and private sector
companies to access the market. After liberalization, during 1993-94 there was a sharp increase in the amount of
funds raised by corporate entities form the global debt and equity markets.

India’s borrowings have mainly been by way of syndicated bank loans, buyers’ credits and lines of credits. Other
instruments such as foreign and Euro bonds have been employed less frequently though a number of companies
made issues of Euro convertible bonds after 1993. Prior to that only apex financial institutions and the public
sector giant ONGC had tapped the German, Swiss, Japanese, and Euro dollar bond markets. Throughout the
eighties, there was a steady improvement in the market’s perception of the creditworthiness of Indian borrowers
(manifested in the steady decline in the spreads they had to pay over LIBOR in the case of Euro loans). The 1990-
91 crisis sent India’s sovereign rating below investment grade and the foreign debt markets virtually dried up to
be opened up again after 1993.

2. Describe the mechanism of the Euro Bond Market.

Euro Bond: issue is one denominated in a particular currency but sold to investors in national capital markets
other than the country that issued the denominating currency. An example is a Dutch borrower issuing DM-
denominated bonds to investors in the UK, Switzerland and the Netherlands.

The Eurobond market is the largest international bond market, which is said to have originated in 1963 with an
issue of Eurodollar bonds by Autostrade, an Italian borrower. The market has since grown enormously in size and
was worth about $ 428 billion in 1994.

Eurobond markets in all currencies except the Japanese Yen are quite free from any regulation by the respective
governments.

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Straight bonds are priced with reference to a benchmark, typically treasury issues. Thus a Eurodollar bond will be
priced to a yield a YTM (Yield-to-Maturity) somewhat above the US treasury bonds of similar maturity, the
spread depending upon the borrowers ratings and market conditions.

Floatation costs of the Eurobond are comparatively higher than costs indicated with syndicated Eurocredits.

Primary market: A borrower desiring to raise funds by issuing Euro bonds to the investing public will contact an
investment banker and ask it to serve as lead manager of an underwriting syndicate that will bring the bonds to
market. The underwriting syndicate is a group of investment banks, merchant banks, and the merchant banking
arms of commercial banks that specialize in some phase of public issuance. The lead manager will usually invite
co managers to form a managing group to help negotiate terms with the borrower, ascertain market conditions and
manage the issuance.

The managing group along with other banks, will serve as underwriters for the issue, that is, they will commit
their own capital to buy the issue from the borrower at a discount from the issue price, if they are unable to place
the bonds with investors. The discount or the underwriting spread is typically in the 2 or 2.5% range. Most of the
underwriters along with other banks will be a part of the placement or selling group that sells the bonds to the
investing public.

The total elapsed time from the decision date of the borrower to issue Eurobonds until net proceeds from the sale
are received is typically 5 to 6 weeks.

The lead manager prepares a preliminary prospectus focusing on economic and financial characteristics of the
project and financial standing of the borrower.

After having consulted a certain number of banks, the lead manager decides on the interest rate. Subsequently, the
issue price is fixed. Clauses of reimbursement before maturity are provided for. After, the issue advertising is done
in International Press in the form of tombstone. This tombstone indicates the lead manager, co-lead managers and
members of the guarantee syndicate.

Secondary Market: Eurobonds purchased in the primary market can be resold before their maturities in the
secondary market. The secondary market is an over the counter market with principal trading in London.
However, important trading is also done in other major European cities. The bonds are quoted in percentage of
their value, without taking into account the coupon already running.

The secondary market comprises of market makers and brokers. Market makers stand ready to buy or sell for their
own account by quoting a two way bid and ask prices. Market traders trade directly with one another, through a
broker, or with retail customers. The bid-ask is their only profit. Brokers accept buy or sell orders from market
makers and then attempt to find a matching party for the other side of the trade; they may also trade for their own
account. Brokers charge a small commission to the market makers that engaged them. They do not deal directly
with retail clients.

Extra Information
What is a bond?
A bond is a loan and you are the lender. The borrower is usually the government, a state, a local municipality or a
big company like General Motors. All of these entities need money to operate -- to fund the federal deficit, for
instance, or to build roads and finance factories -- so they borrow capital from the public by issuing bonds.

When a bond is issued, the price you pay is known as its "face value." Once you buy it, the issuer promises to pay
you back on a particular day -- the "maturity date" -- at a predetermined rate of interest -- the "coupon." Say, for
instance, you buy a bond with a $1,000 face value, a 5% coupon and a 10-year maturity. You would collect
interest payments totaling $50 in each of those 10 years. When the decade was up, you'd get back your $1,000 and
walk away.

A key difference between stocks and bonds is that stocks make no promises about dividends or returns. General
Electric's dividend may be as regular as a heartbeat, but the company is under no obligation to pay it. And while

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GE stock spends most of its time moving upward, it has been known to spend months -- even years -- going the
other way.

When GE issues a bond, however, the company guarantees to pay back your principal (the face value) plus
interest. If you buy the bond and hold it to maturity, you know exactly how much you're going to get back (in
most cases, anyway). That's why bonds are also known as "fixed-income" investments -- they assure you a steady
payout or yearly income. And although they can carry plenty of risk, this regular income is what makes them
inherently less volatile than stocks.

Global Bond: They have a minimum value of $1 billion and are effected simultaneously in Europe, America and
Asia. The salient features of these bonds are that they permit to raise very high amounts. They offer very high
liquidity since they are quoted on several exchanges while secondary market functions round the clock, with
uniform price all over the world. They are especially used by governments, public enterprises, international
organisations and private financial institutions.

External Bond Market: The external bond market refers to bond trading activity wherein the bonds are
underwritten by an international syndicate, are offered in several countries simultaneously, are issued outside any
country's jurisdiction, and are not registered. The Eurobond market is a major external bond market. The external
bond market combined with the internal bond market comprises the global bond market. Examples of an external
bond are the "global bond," issued by the World Bank, and Eurodollar bonds.

Internal Bond Market: The internal bond market refers to all bond trading activity in a given country and is
comprised of both a domestic bond market and a foreign bond market. Also referred to as the "national bond
market." The internal and external bond markets comprise the global bond market

Bulldog Bonds: A sterling denominated foreign bond, priced with reference to the UK gilts.

Rembrandt Bond: Denominated in the Dutch guilder.

(For more information, please refer to page 504-505 in P G Apte)

3. What are the different international financial markets?

The international financial markets consist of the credit market, money market, bond market and equity market.

The international credit market, also called Euro credit market, is the market that deals in medium term Euro
credit or Euro loans.

International banks and their clients comprise the Eurocurrency market and form the core of the international
money market. There are several other money market instruments such as the Euro Commercial Paper (ECP) and
the Euro Certificate of Deposit (ECD).

Foreign bonds and Eurobonds comprise the international bond market. There are several types of bonds such as
floating rate bonds, zero coupon bonds, deep discount bonds, etc.

The international equity market tells us how ownership in publicly owned corporations is traded throughout the
world. This comprises both, the primary sale of new common stock by corporations to initial investors and how
previously issued common stock is traded between investors in the secondary markets.

International Financial Market- (general- can be used in any)

The last two decades have witnessed the emergence of a vast financial market across national boundaries enabling
massive cross-border capital flows from those who have surplus funds and a search of high returns to those
seeking low-cost funding. The degree of mobility of capital, the global dispersal of the finance industry and the
enormous diversity of markets and instruments, which a firm seeking funds can tap, is something new.

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Major OECD (Organization for Economic Co-operation and Development) countries had began deregulating and
liberalizing their financial markets towards the end of seventies. While the process was far from smooth, the
overall trend was in the direction of relaxation of controls, which till then had compartmentalized the global
financial markets. Exchange and capital controls were gradually removed, non-residents were allowed freer
access to national capital markets and foreign banks and financial institutions were permitted to establish their
presence in the various national markets.

While opening up of the domestic markets began only around the end of seventies, a truly international financial
market had already been born in the mid-fifties and gradually grown in size and scope during sixties and
seventies. This refers to the Euro currencies Market where borrower (investor) from country A could raise (place)
funds from (with) financial institutions located in country B, denominated in the currency of country C. During
the eighties and nineties, this market grew further in size, geographical scope and diversity of funding
instruments. It is no more a "euro" market but a part of the general category called “offshore markets”.

Alongside liberalization, other qualitative changes have been taking place in the global financial markets.
Removal of restrictions has resulted into geographical integration of the major financial markets in the OECD
countries. Gradually this trend is spreading to developing countries many of which have opened up their markets-
at least partially-to non-resident investors, borrowers and financial institutions.

Another noticeable trend is functional integration. The traditional distinctions between different financial
institutions-commercial banks, investment banks, finance companies, etc.- are giving way to diversified entities
that offer the full range of financial services. The early part of eighties saw the process of disintermediation get
underway. Highly rated issuers began approaching investors directly rather than going through the bank loan
route.

On the other side, debt crisis in the developing countries, adoption of capital adequacy norms and intense
competition, forced commercial banks to realize that their traditional business of accepting deposits and making
loans was not enough to guarantee their long-term survival and growth. They began looking for new products and
markets. Concurrently, the international financial environment was becoming more volatile- there were
fluctuations in interest and exchange rates. These forces gave rise to innovative forms of funding instruments and
tremendous advances in risk management. The decade saw increasing activity in and sophistication of the
derivatives’ market, which had begun emerging in the seventies.

Taken together, these developments have given rise to a globally integrated financial marketplace in which
entities in need of short- or long-term funding have a much wider choice than before in terms of market segment,
maturity, currency of denomination, interest rate basis, incorporating special features and so forth. The same
flexibility is available to investors to structure their portfolios in line with their risk-return tradeoffs and
expectations regarding interest rates, exchange rates, stock markets and commodity prices.

4. List out the growth and functions of Eurocurrency markets

While opening up of the domestic markets began only around the end of seventies, a truly international financial
market had already been born in the mid-fifties and gradually grown in size and scope during sixties and
seventies. This refers to the well-known ‘Eurocurrencies Market’. It is the largest offshore market.

Prior to 1980, Eurocurrencies market was the only truly international financial market of any significance. It is
mainly an inter-bank market trading in time deposits and various debt instruments. What matters is the location of
the bank neither the ownership of the bank nor ownership of the deposit. The prefix "Euro" is now outdated since
such deposits and loans are regularly traded outside Europe.

Over the years, these markets have evolved a variety of instruments other than time deposits and short-term loans,
e.g. certificates of deposit (CDs), euro commercial paper (ECP), medium- to long- term floating rate loans,
eurobonds, floating rate notes and euro medium-term notes (EMTNs).

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The difference between Euro markets and their domestic counterparts is one of regulation. Eurobonds are free
from rating and a disclosure requirement applicable to many domestic issues as well as registration with securities
exchange authorities.

Emergence of Euro markets:

1. During the 1950s, the erstwhile USSR was earning dollars from the sale of gold and other commodities and
wanted to use them to buy grain and other products from the West, mainly from the US. However, they did
not want to keep these dollars on deposit with banks in New York, as they were apprehensive that the US
government might freeze the deposits if the cold war intensified. They approached banks in Britain and
France who accepted these dollar deposits and invested them partly in US.
2. Domestic banks in US (as in many other countries) were subjected to reserve requirements, which meant that
a part of their deposits were locked up in relatively low yielding assets.
3. The importance of the dollar as a vehicle currency in international trade and finance increased, so many
European corporations had cash flows in dollars and hence temporary dollar surpluses. Due to distance and
time zone problems as well as their greater familiarity with European banks, these companies preferred to
keep their surplus dollars in European banks, a choice made more attractive by the higher rates offered by
Euro banks.

The main factors behind the emergence and strong growth of the Eurodollar markets were the regulations on
borrowers and lenders imposed by the US authorities which motivated both banks and borrowers to evolve
Eurodollar deposits and loans. Added to this are the considerations mentioned above, viz. the ability of Euro
banks to offer better rates both to the depositors and the borrowers and convenience of dealing with a bank that is
closer to home, who is familiar with business culture and practices in Europe.

SHORT NOTES

1. Participants in International Project Financing – a) Sponsors b) Lenders

Sponsors
These are partners in the project who bring in the equity capital or risk capital. Being so, they are keenly
interested in the successful completion of the project and shoulder major responsibilities as regards its execution.
The fact that they bring in the equity capital is an indication of their interest. Also the amount of equity that they
bring has a marked bearing on the extent of debt that can be raised for the project.

Sometimes people who bring in the equity capital are just the initiators of the project. Included in this category are
multinational firms, future buyers of products or services of the project, the public or private investors,
international organisations, development banks etc.

Lenders
They bring in the debt capital. Financing of a big project necessitates intervention of a banking pool consortium
composed of banks, national or international financial institutions, export financing institutions etc.

Guarantors
Guarantees maybe provided by banks, public financing organisations, international financial institutions, private
insurance companies etc.

Project Operators
An operating company intervenes in the erection of the project. It brings its organisational know-how to manage
the project.

2. Risks associated with international projects- financial, political, others

1. Financial risk

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In general, international projects are prone to greater financial risk as a bulk of finance is in the form of debt. The
major factors affecting financial risk are degree of indebtedness, the terms and conditions of repayment of debt
and currency used.

Some projects will have expenses and revenues that involve several currencies. As a result the exchange rate risk
is very high.

Projects maybe financed with floating rates. In view of the volatility observed on the rates like LIBOR, the
interest rate risk is also significant. Therefore it is necessary to plan the coverage of all these risks.

2. Foreign Exchange Risk

As corporations expand their international activities, they begin to acquire foreign assets and foreign liabilities. As
exchange rates change, the values of these foreign assets and liabilities change accordingly. For a corporation,
exchange rate risk is the sensitivity of the value of the corporation when the exchange rates change. Obviously,
the change in the corporation value is related to the net change in the values of the foreign assets and foreign
liabilities. (E.g. foreign direct investment, foreign exchange loss, sales and income from foreign sources.)

3. Economic Risk
Economic risk is risk created by changes in the economy. Typically, it is related to technological changes, the
actions of competitors, shifts in consumer preferences, etc. Ideally, a pure domestic firm is affected only by
domestic economic conditions - the domestic economic risk. However, in today's integrated world economy, the
concept of a pure domestic firm has less practical relevance. Many firms that appear strictly pure domestic
confront foreign economic risk indirectly. (E.g.: local restaurant/dept store, real estate agent)

4. Political Risk
Political risk is risk created by political changes or instability in a country. These factors include, but are not
limited to, nationalization, confiscation, price controls, foreign exchange and capital controls, administrative
hurdles, uncertain property rights, discriminative or arbitrary regulations on business practices (hiring, contract
negotiation), civil wars, riots, terrorism, etc. Each country in the world presents a different political profile and
represents a unique source of political risk that firms must assess and manage when they make foreign
investments.

In order to minimize this risk, local investors or the local government may be associated with the project.
Insurance against political risk is another useful technique recommended for the purpose.

What constitutes political risk and how to measure it?

The political risk management typically involves:
- Identifying political risk and its likely consequences
- Developing policies in advance to cope with the possibility of political risk
- Strengthening a firm's bargaining position
- Devising measures to maximize compensation in the event of expropriation

Country Risk: It refers to elements of risk inherent in doing business in the economic, social, and political
environment of another country.

5. Counter party Risk - The risk that a counter party will default on a financial obligation.

6. Liquidity Risk -The risk that a financial position cannot be sold quickly at prevailing prices.

7. Delivery Risk - The risk that a buyer will not deliver payment of funds after a seller has delivered securities or
foreign exchange that were purchased.

8. Rollover Risk - The risk of being closed out from a financial market and unable to renew (or roll over) a
short-term contract.

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9. Other risks - Other risks relate to the risk of cost overruns and bad management.

3. Financing of MNCs in local or international market

Project financing may be defined as financing of an economic unit, legally independent, created with a view to
setting up of a big project, which is commercially profitable and financially viable.
Project is considered as a distinct legal entity and is financed, to a marked extent, by debt (65 to 75 percent).
Therefore the risk to be borne is substantial.

There are two major methods of financing international projects:

1. Financing with total risk borne by lenders where only the future cashflows ensure the reimbursement of the
loan. This method of financing was used in petroleum and gas industry in the USA and Canada. Due to
increased level of risks, this method of project financing is generally not preferred.

2. In another type of financing, both the lender and the promoter share the risk. The problem sometimes
encountered in this method is to decide the proportion in which the risk is to be shared between two parties.

Domestic v/s Offshore markets

Financial assets and liabilities denominated in a particular currency - say the Swiss Franc - are traded are
primarily in the national financial markets of that country. These financial markets are known as ‘Domestic
Markets’.

In case of many convertible currencies they are traded in the financial markets outside the country of that
currency. These financial markets are known as ‘Offshore Markets’.

While it is true that neither both markets will offer both the financing options nor any entity can access all
segments of a particular market, it is true generally that a given entity has an access to both the segments of the
markets for placing as well as raising funds.

There are theories by experts that suggest that there are no two types of financial markets (viz. Domestic and
offshore markets) but everything is a part of single ‘Global Financial Market’.

Similarity
Experts suggest that ‘arbitrage’ will ensure that both these markets will be closely linked together in terms of
costs of funding and returns on assets.

Differences
Both of these markets significantly differ on the ‘Regulatory dimension’. Major segments of the domestic markets
are subject to strict supervision by the relevant authorities such as SEC in US, Ministry of Finance in Japan and
the Swiss National Bank in Switzerland. These authorities regulate foreign (non-resident) entities’ access to the
public capital markets in their countries by laying down eligibility criteria, disclosure & accounting norms and
registration & rating requirements (similarly for domestic banks, reserve requirements and deposit insurance).

The offshore markets on the other hand have minimal regulation and often no registration.
Finally it must be noted that though the nature of regulation continues to distinguish Domestic from the offshore
markets, there are segments like Private Placements, Unlisted Bonds, Bank loans etc. in domestic markets where
regulation tends to be the least.

4. Eurocurrency Markets

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While opening up of the domestic markets began only around the end of seventies, a truly international financial
market had already been born in the mid-fifties and gradually grown in size and scope during sixties and
seventies. This refers to the well-known ‘Eurocurrencies Market’. It is the largest offshore market.

Prior to 1980, Eurocurrencies market was the only truly international financial market of any significance. It is
mainly an inter-bank market trading in time deposits and various debt instruments. What matters is the location of
the bank neither the ownership of the bank nor ownership of the deposit. The prefix "Euro" is now outdated since
such deposits and loans are regularly traded outside Europe.

Over the years, these markets have evolved a variety of instruments other than time deposits and short-term loans,
e.g. certificates of deposit (CDs), euro commercial paper (ECP), medium- to long- term floating rate loans,
eurobonds, floating rate notes and euro medium-term notes (EMTNs).

The main factors behind the emergence and strong growth of the Eurodollar markets were the regulations on
borrowers and lenders imposed by the US authorities which motivated both banks and borrowers to evolve
Eurodollar deposits and loans. Added to this are the considerations mentioned above, viz. the ability of euro banks
to offer better rates both to the depositors and the borrowers and convenience of dealing with a bank that is closer
to home, who is familiar with business culture and practices in Europe.

5. External Bond Market

The external bond market refers to bond trading activity wherein the bonds are underwritten by an international
syndicate, are offered in several countries simultaneously, are issued outside any country's jurisdiction, and are
not registered. The Eurobond market is a major external bond market. The external bond market combined with
the internal bond market comprises the global bond market. Examples of an external bond are the "global bond,"
issued by the World Bank, and Eurodollar bonds.
The External Bond Market comprises of the :
• Foreign Bond Market and
• Euro Bond Market
Foreign Bond: issue is one offered by a foreign borrower to the investors in a national capital market and
denominated in that nations currency. An example is German MNC issuing dollar denominated bonds to the U.S.
investors.

Euro Bond: issue is one denominated in a particular currency but sold to investors in national capital markets
other than the country that issued the denominating currency. An example is a Dutch borrower issuing DM-
denominated bonds to investors in the UK, Switzerland and the Netherlands.

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