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.
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.

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
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 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 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.

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 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.

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).

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

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.

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

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.