INTROCUDTION TO FOREIGN CURRENCY MARKET

Meaning
The foreign exchange market (forex, FX, or currency market) is a form of exchange for the
global decentralized trading of international currencies. Financial centers around the world
function as anchors of trading between a wide range of different types of buyers and sellers
around the clock, with the exception of weekends. EBS and Reuters' dealing 3000 are two main
interbank FX trading platforms. The foreign exchange market determines the relative values of
different currencies.
The foreign exchange market assists international trade and investment by enabling currency
conversion. For example, it permits a business in the United States to import goods from the
European Union member states especially Euro zone members and pay Euros, even though its
income is in United States dollars. It also supports direct speculation in the value of currencies,
and the carry trade, speculation based on the interest rate differential between two currencies.
In a typical foreign exchange transaction, a party purchases some quantity of one currency by
paying some quantity of another currency. The modern foreign exchange market began forming
during the 1970s after three decades of government restrictions on foreign exchange transactions
(the Bretton Woods system of monetary management established the rules for commercial and
financial relations among the world's major industrial states after World War II), when countries
gradually switched to floating exchange rates from the previous exchange rate regime, which
remained fixed as per the Bretton Woods system.

The foreign exchange market is unique because of the following characteristics:

its huge trading volume representing the largest asset class in the world leading to high
liquidity;

its geographical dispersion;

its continuous operation: 24 hours a day except weekends, i.e., trading from 20:15 GMT
on Sunday until 22:00 GMT Friday;

the variety of factors that affect exchange rates;

the low margins of relative profit compared with other markets of fixed income; and

the use of leverage to enhance profit and loss margins and with respect to account size.

As such, it has been referred to as the market closest to the ideal of perfect competition,
notwithstanding currency intervention by central banks. According to the Bank for International
Settlements, as of April 2010, average daily turnover in global foreign exchange markets is
estimated at $3.98 trillion, a growth of approximately 20% over the $3.21 trillion daily volume
as of April 2007. Some firms specializing on foreign exchange market had put the average daily
turnover in excess of US$4 trillion.
The $3.98 trillion break-down is as follows:

$1.490 trillion in spot transactions

$475 billion in outright forwards

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$1.765 trillion in foreign exchange swaps

$43 billion currency swaps

$207 billion in options and other products

The foreign exchange market is the most liquid financial market in the world. Traders include
large banks, central banks, institutional investors, currency speculators, corporations,
governments, other financial institutions, and retail investors. The average daily turnover in the
global foreign exchange and related markets is continuously growing. According to the 2010
Triennial Central Bank Survey, coordinated by the Bank for International Settlements, average
daily turnover was US$3.98 trillion in April 2010 (v/s $1.7 trillion in 1998).[3] Of this $3.98
trillion, $1.5 trillion was spot transactions and $2.5 trillion was traded in outright forwards,
swaps and other derivatives.
Trading in the United Kingdom accounted for 36.7% of the total, making it by far the most
important centre for foreign exchange trading. Trading in the United States accounted for 17.9%,
and Japan accounted for 6.2%.
Turnover of exchange-traded foreign exchange futures and options have grown rapidly in recent
years, reaching $166 billion in April 2010 (double the turnover recorded in April 2007).
Exchange-traded currency derivatives represent 4% of OTC foreign exchange turnover. Foreign
exchange futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are
actively traded relative to most other futures contracts.

Most developed countries permit the trading of derivative products (like futures and options on
futures) on their exchanges. All these developed countries already have fully convertible capital
accounts. Some governments of emerging economies do not allow foreign exchange derivative
products on their exchanges because they have capital controls. The use of derivatives is growing
in many emerging economies.[59] Countries such as Korea, South Africa, and India have
established currency futures exchanges, despite having some capital controls.
The foreign exchange market is the most liquid financial market in the world. Traders include
large banks, central banks, institutional investors, currency speculators, corporations,
governments, other financial institutions, and retail investors. The average daily turnover in the
global foreign exchange and related markets is continuously growing. According to the 2010
Triennial Central Bank Survey, coordinated by the Bank for International Settlements, average
daily turnover was US$3.98 trillion in April 2010 (v/s $1.7 trillion in 1998).[3] Of this $3.98
trillion, $1.5 trillion was spot transactions and $2.5 trillion was traded in outright forwards,
swaps and other derivatives.
Trading in the United Kingdom accounted for 36.7% of the total, making it by far the most
important centre for foreign exchange trading. Trading in the United States accounted for 17.9%,
and Japan accounted for 6.2%.
Turnover of exchange-traded foreign exchange futures and options have grown rapidly in recent
years, reaching $166 billion in April 2010 (double the turnover recorded in April 2007).
Exchange-traded currency derivatives represent 4% of OTC foreign exchange turnover. Foreign
exchange futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are
actively traded relative to most other futures contracts.
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Most developed countries permit the trading of derivative products (like futures and options on
futures) on their exchanges. All these developed countries already have fully convertible capital
accounts. Some governments of emerging economies do not allow foreign exchange derivative
products on their exchanges because they have capital controls. The use of derivatives is growing
in many emerging economies. Countries such as Korea, South Africa, and India have established
currency futures exchanges, despite having some capital controls.
Top 10 currency traders
% of overall volume, May 2012
Rank

Name

Market share

Deutsche Bank

14.57%

Citi

12.26%

Barclays Investment Bank

10.95%

UBS AG

10.48%

HSBC

JPMorgan

Royal Bank of Scotland

5.86%

Credit Suisse

4.68%

Morgan Stanley

3.52%

10

Goldman Sachs

3.12%

6.72%
6.6%

Foreign exchange is an over-the-counter market where brokers/dealers negotiate directly with

one another, so there is no central exchange or clearing house. The biggest geographic trading
center is the United Kingdom, primarily London, which according to The City UK estimates has
5

increased its share of global turnover in traditional transactions from 34.6% in April 2007 to
36.7% in April 2010. Due to London's dominance in the market, a particular currency's quoted
price is usually the London market price. For instance, when the International Monetary Fund
calculates the value of its special drawing rights every day, they use the London market prices at
noon that day.

INTRODUCTION TO EURO CURRENCY

A Eurocurrency Market is a money market that provides banking services to a variety of
customers by using foreign currencies located outside of the domestic marketplace. The concept
does not have anything to do with the European Union or the banks associated with the member
countries, although the origins of the concept are heavily derived from the region. Instead, the
Eurocurrency Market represents any deposit of foreign currencies into a domestic bank. For
example, if Japanese yen is deposited into a bank in the United States, it is considered to be
operating under the auspices of the Eurocurrency Market.
The Eurocurrency Market has its roots in the World War II era. While the war was going
on, political challenges caused by the takeover of the continent by the Axis Powers meant that
there was a limited marketplace for trading in foreign currency. With no friendly government
operations within the European marketplace, the traditional economies of the nations were
displaced, along with the currencies. To combat this, especially due to the fact that many
American companies were tied to the well-being of business behind enemy lines, banks across
the world began to deposit large sums of foreign currency, creating a new money market.

Definition of Eurocurrency Market

The money market in which Eurocurrency, currency held in banks outside of the country where it
is legal t0ender, is borrowed and lent by banks in Europe. The Eurocurrency market is utilized by
large firms and extremely wealthy individuals who wish to circumvent regulatory requirements,
tax laws and interest rate caps that are often present in domestic banking, particularly in the
United States

Rates on deposits in the Eurocurrency market are typically higher than in the domestic market,
because the depositor is not protected by domestic banking laws and does not have governmental
deposit insurance. Rates on loans in the Eurocurrency market are typically lower than those in
the domestic market, because banks are not subject to reserve requirements on Eurocurrency and
do not have to pay deposit insurance premiums.

What Is Euro currency Market

A Eurocurrency Market is a money market that provides banking services to a variety of
customers by using foreign currencies located outside of the domestic marketplace. The concept
does not have anything to do with the European Union or the banks associated with the member
countries, although the origins of the concept are heavily derived from the region. Instead, the
Eurocurrency Market represents any deposit of foreign currencies into a domestic bank. For
example, if Japanese yen is deposited into a bank in the United States, it is considered to be
operating under the auspices of the Eurocurrency Market.

The Eurocurrency Market has its roots in the World War II era. While the war was going
on, political challenges caused by the takeover of the continent by the Axis Powers meant that
there was a limited marketplace for trading in foreign currency. With no friendly government
operations within the European marketplace, the traditional economies of the nations were
displaced, along with the currencies. To combat this, especially due to the fact that many
American companies were tied to the well-being of business behind enemy lines, banks across
the world began to deposit large sums of foreign currency, creating a new money market.
One of the factors that make the Eurocurrency Market unique compared to many other
money market accounts is the fact that it is largely unregulated by government entities. Since the
banks deal with a variety of currencies issued by foreign entities, it is difficult for domestic
governments to intervene, particularly in the United States. However, with the establishment of
the flexible exchange rate system in 1973, the Federal Reserve System was given powers to
stabilize lending currencies in the event of a crisis situation. But one problem that arises is that
these crises are not defined by the regulations, meaning that intervention must be established
based on each case and the Federal Reserve must work directly with central banks around the
world to resolve the matter. This adds to the volatility of the Eurocurrency Market.
Despite its name, the Eurocurrency Market is primarily influenced by the value of the
American dollar. Nearly two-thirds of all assets around the globe are represented by U.S.
currency. The challenge with foreign banks revolves around the fact that regulations enforced by
the Federal Reserve are really only enforceable within the U.S. The taxation level and exchange
rate of the American dollar varies depending on the nation. For example, an American dollar in
Vietnam is worth more than it is in Canada, further influencing the market.

What is Eurocurrency
In the financial world, Eurocurrency is money that is deposited in foreign banks outside
of a country. When these foreign deposits are called euro currency, they are primarily related to
European countries, but over time, euro currency has become a term for any funds deposited in a
foreign bank. The term should not be confused with the monetary unit know as the Euro. From
the standpoint of the domestic bank, euro currency refers to funds that are deposited in a
currency different from that country's own currency.
Some speculate that the term euro currency earned its kind of colloquial global use
because of the unique diversity of the European continent. Many small countries are packed into
a very small space on the land mass, with various laws and cultures meshing and colliding with
each other. In modern times, the diversity of Europe has led to the European Union, and the
subsequent Euro, a European unit of money that serves the entire EU community. In recent years,
the national currencies of most European Union member countries were phased out to make way
for the common Euro.
The extension of the word euro currency, which has nothing to do with the Euro, means
that a deposit from an Asian country to an African country would also qualify as euro currency.
The financial community has also coined terms for specific foreign currency deposits, such as
the Eurodollar, which also does not refer to the European currency. A Eurodollar is a deposit of
American money still denominated in dollars that is in a bank outside of the U.S. Similar terms
like Euro yen have the same meaning relative to the home country of the currency suffix.
It's important for those dealing with these kinds of financial terms to understand that the
term euro currency is something that emerged from informal use. Thinking that this term has to
do with the currency of the European Union will result in misunderstandings about foreign
deposits in domestic banks. It's also important to think about the way that some countries protect
their national economies by limiting foreign deposits or foreign holdings.
In some countries, foreign currency has historically been an illegal asset for citizens.
Though globalism has largely changed the way most of the world's nations view financial
freedoms, some countries still have restrictions in place about changing denominations of funds,
or moving them from one nation to another. Looking at how eurocurrency is used can give one
insight into the kinds of rules and regulations that affect international money transfers.
9

What is Euro credit

The term "Euro credit" refers to loans in a currency that is not the lending bank's national
currency. Euro credit loans are large and long-term, and usually only large corporations and
government agencies request them. Banks that extend these loans usually also participate in
the Eurocurrency Market, where they hold deposits in currencies other than the local currency.
The prefix "euro-" is often used in finance to refer to funds in a foreign currency and has nothing
to do with Euro currency or European countries.
A bank extends a Euro credit loan when the loan is not in the bank's national currency
and the loan is extended in a country other than the one in whose currency the loan is
denominated. For example, an American bank provides a loan denominated in Japanese yen or
Russian rubles for an American company. Euro credit loans increase the flow of capital between
various countries and help companies and governments finance their investments.
Banks set the interest rates on these loans based on the prevailing London Interbank
Offered Rate (LIBOR), with the rates usually being reset every six months depending on changes
in LIBOR. These loans are usually large loans with a fixed term and no provision for early
repayment. The loan size is usually large, so banks sometimes form a syndicate to provide a Euro
credit loan that spreads the risk between syndicate banks and limits the risk exposure any one
bank faces in case the borrower fails to repay the loan.
For example, a company from Germany borrows $200 million US Dollars (USD) through
a syndicated Euro credit facility for five years at an interest rate of 200 basis points (2 percent)
over LIBOR. The interest rate floats and is reset every six months according to the prevailing
LIBOR. LIBOR turns out to be at 5 percent for the first six months of the loan and 4 percent for
the second six months.
In this case, the loan rate becomes 7 percent for the first six months of the loan and 6
percent for the second six months. The company has to pay $7 million USD in interest six
months after taking out the loan and $6 million USD in interest one year after taking out the
loan. If the company fails to make its payments, the whole syndicate absorbs the impact so each
lending institution only has to bear a portion of the loss.
Euro credit facilities also often charge an upfront fee for the loan, usually a percentage of
the loan. For example, the German company might have to pay 2 percent at the beginning of the

10

loan to cover administrative and operative costs. It would have to pay $4 million USD and would
effectively receive only $196 million when taking out the loan.

Features of Euro Currency

The euro is a currency used by many of the member states of the European Union, or EU.
Not all EU member countries use the euro as their basis of trade, and notably, the United
Kingdom, or UK, has elected to keep its own currency, Sterling, and does not use the euro as its
national currency. The initial member countries electing to use the euro, including Germany and
France, introduced the currency on 1 July, 2002, at which time their individual currencies, such
as the Mark and the Franc, ceased to exist.
It is an international market and it is under no national control It has come up as the most
important channel for mobilizing and deploying funds on an international scale. It is short term
money market.

History of the Euro Currency

In 1999, several European nations adopted a single currency called the euro to strengthen
and stabilize the continent's economy. While some goals of the euro have been realized, some
remain out of reach. There has been a lot of interest lately in the Foreign Exchange Markets or
Forex. Now for those that are interested in discovering how this market can build wealth you
should probably understand some of the basics and a little of the history about international
currency trading.
So first things first. The Forex market is big. In fact over 3 Trillions dollars are
exchanged on a daily basis. This is great news for those that decide to trade with Forex because
you have such a large amount of people trading on the exchange that you never have to worry
about whether or not youre going to be able to dump a currency if its not heading in the
direction that you want it to go in because you will always have somebody who is willing to buy
it (meaning this is a liquid market). And theres even trading software out now that if the
currency reaches a certain level your broker will automatically sell your shares so that you will
not even lose a single cent from your initial investment.
Its not going away. The exchange was formed back in 1971 when the gold standard was
removed and countries started using free floating currencies. At first only banks and large
investment actually traded on this exchange and the managers that did it correctly ended up
11

making millions and even billions of dollars from it. Unfortunately the little guy couldnt really
play without an entrance into the market from somebody higher up. That was until the internet
came along and made it so that anybody with a little bit of cash can start doing online foreign
currency trading and make really good money.
The laws of supply and demand are always at work. One thing that has been playing on
the news is the situation that Greece is finding itself in where they are basically having the same
problems that our system was having and banks from all over the EU are trying to keep their
economy afloat. This has caused the weakening of the Euro (currency used in many European
countries) while having a strengthening effect on the dollar because people were afraid of losing
money in the Euro. This is just an example that could go any which way. Some days the dollar
will weaken so you know to bet on the Euro, etc.
intro is just the tip of the iceberg when it comes to international currency trading and all
that can be accomplished in it. Just remember do your homework, run your simulations so that
youll know you can be a success at it and then after that stick to what works.

Euro Currency Information

The formation of a single currency to be used by many European countries is, thus far,
one large economic experiment met with mixed reviews. David Marsh, author of "The Euro: The
Politics of the New Global Currency" explains this relatively new currency poses a challenge to
the U.S. dollar as the world reserve currency. However, Marsh, like many others, is still unsure
of its overall stability as the consolidation of several economies into one unified currency is not
without incredible risk.

The growth of the euro currency markets

The euro currency markets could not develop prior to 1958 since it was only in that year
that the major currencies were made convertible following the Second World War. Even then,
they became convertible only for non-residents. Restrictions on the resident convertibility of the
currency continued in the UK until 1979 and in most of the other major industrial countries into
the 1980s or 1990s. Following the introduction of non-resident convertibility, major US and
European banks began to open branches outside their country of origin.

12

This was particularly true of US banks because restrictions on branch banking within the US
allowed banks to operate only in their home states. Thus the ambitious banks from the major US
financial centres sought expansion outside the USA.

13

EURO CURRENCY MARKET CHARACTERISTICS

The Eurocurrency market has several interesting characteristics:
1. It is a wholesale rather than retail market, which means that transactions tend to be very
large. Public borrowers such as governments, central banks, and public-sector
corporations tend to borrow most of the funds. Also, nearly four fifths of the Eurodollar
market is interbank, which means that the transactions take place between banks.
2. The market is essentially unregulated.
3. Deposits are primarily short term. Most of the deposits are interbank, and they tend to be
very short term. This leads to concern about risk, since most Eurocurrency loans are
for longer periods of time.
4. The Eurocurrency market exists for savings and time deposits rather than demand
deposits. That is, institutions that create Eurodollar deposits do not draw down those
deposits into a particular national currency in order to buy goods and services.
5. The Eurocurrency market is primarily a Eurodollar market. In addition to
ordinary deposits in the Eurocurrency market, there are also certificates of deposit
(CDs) available in dollars, sterling, and yen. Although most are traded in multiples of $1
million or more, The CDs are usually quoted at a discount at a fixed interest rate, but
they can also be quoted at floating interest rates. The Eurocurrency market has shortand medium-term characteristics. Short-term Eurocurrency borrowing has a maturity of
less than one year. However, it is also possible to borrow at maturities exceeding one
year. Anything over one year is considered a Euro credit. These Euro credits may be
loans, lines of credit, or other forms of medium- and long-term credits, including
syndication, in which several banks pool resources to extend credit to a borrower. A
major attraction of the Eurocurrency market is the difference in interest rates as
compared with domestic markets. Because of the large transactions and the lack of
controls and their attendant costs, Eurocurrency deposits tend to yield more than
domestic deposits, and loans tend to be relatively cheaper than in domestic markets.
percentage above the London Inter-Bank Offered Rate (LIBOR), which is the interest
rate banks charge one another on loans of Eurocurrencies. The interest rate above
LIBOR, which his characterized in Fig. 9.3 as the Eurocurrency borrowing rate, depends
14

on the credit-worthiness of the customer and must be large enough to cover expenses
and build reserves against possible losses. The unique characteristics of the
Eurocurrency market allow the borrowing rate usually to be less than it would be in the
domestic market. Most loans are made on variable-rate terms, and the rate-fixing period
is generally six months, although it could also be one or three months. Because of the
variable nature of the interest rates, the maturities can extend into the future.

Budget
Main article: Budget of the European Union
The 2011 EU budget (141.9 bn. in total; commitment appropriations):[86]
Cohesion and competitiveness for growth and employment (45%)
Citizenship, freedom, security and justice (1%)
The EU as a global player (6%)
Rural development (11%)
Direct aids and market related expenditures (31%)
Administration (6%)
The EU had an agreed budget of 120.7 billion for the year 2007 and 864.3 billion for
the period 20072013,[87] representing 1.10% and 1.05% of the EU-27's GNI forecast for the
respective periods. By comparison, the United Kingdom's expenditure for 2004 was estimated to
be 759 billion, and France was estimated to have spent 801 billion. In 1960, the budget of the
then European Economic Community was 0.03% of GDP.[88]
In the 2010 budget of 141.5 billion, the largest single expenditure item is "cohesion &
competitiveness" with around 45% of the total budget. [89] Next comes "agriculture" with
approximately 31% of the total.[89] "Rural development, environment and fisheries" takes up
around 11%.[89] "Administration" accounts for around 6%.[89] The "EU as a global partner" and

15

"citizenship, freedom, security and justice" bring up the rear with approximately 6% and 1%
respectively.[89]
The Court of Auditors aims to ensure that the budget of the European Union has been
properly accounted for. The court provides an audit report for each financial year to the Council
and the European Parliament. The Parliament uses this to decide whether to approve the
Commission's handling of the budget. The Court also gives opinions and proposals on financial
legislation and anti-fraud actions.[90]
The Court of Auditors is legally obliged to provide the Parliament and the Council with
"a statement of assurance as to the reliability of the accounts and the legality and regularity of the
underlying transactions".[91] The Court has refused to do so every year since 1993, qualifying
their report of the Union's accounts every year since then. [92] In their report on 2009 the auditors
found that five areas of Union expenditure, agriculture and the cohesion fund, were materially
affected by error.[93] The European Commission estimated that the financial impact of
irregularities was 1,863 million.
Competences
EU member states retain all powers not explicitly handed to the European Union. In some
areas the EU enjoys exclusive competence. These are areas in which member states have
renounced any capacity to enact legislation. In other areas the EU and its member states share the
competence to legislate. While both can legislate, member states can only legislate to the extent
to which the EU has not. In other policy areas the EU can only co-ordinate, support and
supplement member state action but cannot enact legislation with the aim of harmonising
national laws.
That a particular policy area falls into a certain category of competence is not necessarily
indicative of what legislative procedure is used for enacting legislation within that policy area.
Different legislative procedures are used within the same category of competence, and even with
the same policy area.
Turnover of the euro money market
The total turnover of the euro money market was moribund in the second quarter of 2004
although there was a huge surge in the turnover in the second quarter of 2003. Such
developments were discontinuous across the market. After this upturn in all the market segments
16

in the second quarter of 2003, there was a sharp downturn in the interest rate, cross currency and
FX swaps in the second quarter of 2004. This was contrasted by a rise in the turnover in the
unsecured, secured and other interest rate swaps. The forward rate agreementand the short term
securities also witnessed a rise. The secured segment happens to be the largest money market
segment.
The overnight interest rate swap segment also saw a sharp downfall in the second quarter
of 2004 although it had experienced a strong rise in the second quarter of 2003. this change is
attributed to the interest rate speculation which was high in 2003 but low in 2004. The overnight
interest rate swap segment of the money market is provided impetus by the EUIRIBOR-ACI.
The unsecured, secured and the overnight interest rate swap and the FX swap segments
are characterized by activities that have very short term maturity periods. The instruments like
the cross currency and other interest rate swaps are the money market instruments that are traded
at long maturities.

A convertible currency
A currency that can be exchanged freely for any other currency in any amount by any
holder of the currency. Restrictions on convertibility take many forms limiting the amount that
can be exchanged, the currencies into which exchange is possible, the uses for which foreign
exchange can be obtained or the range of holders who are allowed foreign exchange.
The opening of bank branches abroad meant that foreign currency earned through ordinary
trading transactions could be placed anywhere where there was a demand for such funds,
allowing depositors to seek out banks with the highest yields. The growth of the market can then
be explained by a variety of demand and supply factors and the interaction between them.
The principal causes of the growth in the supply of funds to the market were:
(a) Regular US balance of payments deficits, which produced large dollar holdings by
European
companies.
(b) US central bank regulations that (i) established upper limits on the interest rates that could be
paid on deposits in US banks and that made it easy for euro banks to offer more attractive rates

17

and (ii) forbade the payment of any interest on deposits placed for less than thirty days, whereas
euro banks were able to offer interest even on overnight deposits.
(c) The existence of exchange controls that limited the activities of domestic banks but from
which euro banks were relatively free.
(d) The concern of eastern European countries that their dollar deposits in the USA might be
blocked by the US government for political reasons connected with the then flourishing Cold
War.
(e) From 1973 on, the large volume of oil receipts that the OPEC countries wished to deposit on
favorable terms, again preferably outside the USA for political reasons connected with US
support for Israel.
(f) The dramatic growth of flight capital to Swiss and other banks, encouraged by the
development of financial centres such as Luxembourg and Liechtenstein in which regulation
ensured the protection of the anonymity of lenders.
Thus, the supply of funds to the market increased as a result of a mixture of commercial,
economic and political factors. The market would not have grown in the way that it did,
however, if there had not also been a large demand for euro dollars by borrowers. Reasons for
this included:
(a) US government discouragement from 1963 onwards of borrowing by foreign companies
directly from the US market through the imposition of a tax (the interest equalization tax) that
increased the cost of borrowing in the USA for borrowers in most of the industrial nations.
(b) The fact that the euro banks were free of the reserve requirements imposed on domestic
banks, allowing them to maintain a lower spread between borrowing and lending rates (paying
higher rates to depositors and charging lower rates to borrowers).
(c) The invoicing of a growing proportion of world trade in US dollars, increasing the advantage
to firms of holding their working balances for financial and commercial use in dollars in order to
avoid exchange rate risk.
(d) US government limitations on the amount of capital that US transnational corporations could
shift out of the USA to invest abroad, forcing them to borrow outside the USA and providing the
market with a major group of very credit-worthy borrowers.
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The euro currency market is largely an inter-bank or wholesale market with a chain of interbank
transactions normally occurring en route to an end-user of funds. It deals only in large amounts,
usually of $1 million or more, and loaned are made on an unsecured basis.
The size of the sums involved means that the fixed costs of transactions are spread over large
quantities of funds, increasing still further the attractiveness of the terms the market has been
able to offer to both borrowers and lenders. Efficiency was increased and costs lowered further
by rapid improvements in communications and computer technology.

ISSUES RELATING TO EURO CURRENCY MARKETS

There has been a considerable debate over the years concerning the extent to which the
development of the euro currency market has been a good or a bad thing. The principal
argument for the defence is that it has narrowed the spread between lending and borrowing rates
of interest and has provided important hedging facilities for transnational corporations. It has
thus greatly increased the international mobility of short-term capital and has been a major force
for integrating international capital markets. Supporters also argue that it has played a
particularly important role in the re-cycling of funds from countries with balance of payments
surpluses to those in deficit, most notably in the re-cycling of the surplus of the oil-rich OPEC
countries following the large oil price rises of 1973 and 1979.
The case for the prosecution comprises three issues: the contribution of the markets to
increased world inflation; their impact on the ability of national governments to control their own
economies; and the threat to stability of the international monetary and credit system. These
days, the debate over these issues relates to the whole system of international finance, not just to
the euro currency market. The growth of the offshore markets in the 1960s and 1970s and the
consequent ability of financiers to avoid the regulations imposed by national monetary
authorities was one of the major factors in the decisions by national monetary authorities in the
1980s to remove restrictions on convertibility. This allowed capital to move much more freely
from country to country without the necessary intervention of offshore banking.
The inflation argument rests on the view that the euro currency market has acted to
increase the stock of international money. The usual form of this argument is through a
multiplier model derived from the domestic bank credit multiplier model for domestic economies

19

and can easily be seen from a consideration of Box 1. This view is developed in Box 3 and is
contrasted with the alternative portfolio approach.
The argument that the euro currency market has reduced the power of governments to
control their own economies rests on the proposition that the rapid movement of capital from one
country to another removes the ability of single countries to determine their own interest rates.
Any attempt by governments to control the flow of capital in or out through capital controls can
be avoided with increased ease because of the ability of banks and firms to move bank deposits
around. In the case of developing countries in particular, the euro currency market facilitated
capital flight and put great pressure on many governments, forcing them to operate much more
stringent economic policies than would otherwise have been needed. There has also been an
argument over the impact of euro currency markets on domestic interest rates.
The standard view in relation to euro dollars has been that the euro dollar market is only a
segment of the much larger market for dollar-denominated deposits and loans and, therefore,
euro dollar rates are limited by US rates, rather than the other way around. According to this
view, euro dollar deposits must normally pay an interest rate at least as high as that in the USA
and, thus, that the supply of deposits to euro banks becomes infinitely elastic at the US deposit
rate.
Equally because borrowers consider a loan from a US bank to be as good as, if not better
than, a loan from a euro bank, foreign institutions must offer rates no higher than those charged
by US banks. That is the demand for Eurodollar loans becomes infinitely elastic at the US loan
rate. Indeed, before corporations became better informed about the euro markets, euro dollar
loan rates had to be noticeably below US prime-rate loans. Another reason for the decline in
differential was that domestic loan practice began to incorporate the euro market principles of
roll-over, and cost-plus pricing and both markets were influenced by the fact that the best
borrowers had the alternative of borrowing directly by issuing short-term commercial paper. A
differential remained in borrowing rates between the euro dollar and domestic US markets well
after it had disappeared in lending rates. This is considered in Appendix A
Despite these views on the lack of impact of the euro dollar market on US interest rates, it
has frequently been argued that the euro currency market is large relative to most domestic
European markets and consequently is capable of exerting a considerable impact on domestic
short-term interest rates in Europe.

20

The instability argument has two facets. Firstly, the free movement of large amounts of
capital has increased the ability of speculators to mount attacks on currencies within fixed
exchange rate systems, such as the attacks launched against sterling and the lira in September
1992. It has also increased the volatility of exchange rates of currencies not within fixed
exchange rate systems. Secondly, the fact that the market is largely unregulated and does not
have a formal lender of last resort, as in the case of domestic banking systems, is argued to
increase greatly the possibility of bank failure. Further, any failure of a single bank is likely to
have considerable implications for other banks because of the high number of interbank
transactions in the market. In the early years of the international debt crisis of the developing
countries after 1982, there were widespread fears of the failure of several major international
banks leading to the collapse of a large part of the international banking system. Similar fears
were expressed following the problems in the newly emerging markets in 1998 (dealt with in
Box 4) and the subsequent near-collapse of the US hedge fund, Long-Term Capital Management.
in September 1998.
On the other hand, it is sometimes argued that banks know that the governments of the
industrial countries cannot afford to let the international banking system collapse and will thus
always act to rescue the major banks. This view goes on to suggest that this increases the feeling
of security of banks and encourages them to make risky loans with high profit potential. Thus,
one side of the debate over the causes of the international debt crisis points to irresponsible
behaviour by the banks as a principal factor.

ADVATAGES & DISADVANTAGES

Advantages
1. Transaction costs will be eliminated.
For instance, Uk firms currently spend about 1.5 billion a year buying and selling foreign
currencies to do business in the EU. With the EMU this is eliminated, so increasing profitability
of EU firms Advice to young people: You can go on holiday and not have to worry about getting
your money changed, therefore avoiding high conversion charges.
2. Price transparency. Eu firms and households often find it difficult to accurately compare
the prices of goods, services and resources across the EU because of the distorting
effects of exchange rate differences.

21

This discourages trade. According to economic theory, prices should act as a mechanism to
allocate resources in an optimal way, so as to improve economic efficiency. There is a far greater
chance of this happening across an area where E.M.U exists. Advice to young people: We can
buy things without wrecking our brains trying to calculate what price it is in our currency.
3. Uncertainty caused by Exchange rate fluctuations eliminated.
Many firms become wary when investing in other countries because of the uncertainty
caused by the fluctuating currencies in the EU. Investment would rise in the EMU area
as the currency is universal within the area, therefore the anxiety that was previously
apparent is there no more
4. Single currency in single market makes sense.
Trade and everything else should operate more effectively and efficiently with the Euro. Single
currency in a single market seems to be the way forward.
5. Rival to the "Big Two".
If we look out in the world today we can see strong currencies such as the Japanese Yen and The
American $. America and Japan both have strong economies and have millions of inhabitants. A
newly found monetary union and a new currency in Europe could be a rival to the "BIG TWO".
EMU can be self-supporting and so they could survive without trading with anyone
outside the EMU area.
This fact makes the Euro very strong already, and even George Soros couldn't affect it
(well, hopefully!!!!).
The situation that EMU is in is good as it seems that it can survive on its own, with or
without the help of Japan and U.S.A.
6. Prevent war.
The EMU is, and will be a political project. It's founding is a step towards European integration,
to prevent war in the union. It's a well known fact that countries who trade effectively together
22

don't wage war on each other and if EMU means more happy trade, then this means, peace
throughout Europe and beyond (we hope).

7. Increased Trade and reduced costs to firms.

Proponents of the move argue that it brings considerable Proponents of the move argue that it
brings considerable economic trade through the wiping out of exchange rate fluctuations, but as
well as this it helps to lower costs to industry because companies will not have to buy foreign
exchange for use within the EU. For them, EU represents the completion of the Single European
Market. It is vital if Europe is to compete with the other large trading blocs of the Far East and
North America.
8. The Political agenda.
There is also a political agenda to European bank (the European System of Central Banks
-ESCB), the complete removal of national control over monetary policy and the partial removal
of control over fiscal policy. Individual nation states will lose sovereignty (i.e. the ability to
control their own affairs). It will be a considerable step down the road towards political union.
There are many in the EU who faviour economical dn political union and they are very much in
favor or EMU. There are also many who wish to keep national sovereignty and are struggling to
prevent EMU, whatever its merits might be, from going ahead.

23

Disadvantages
1. The instability of the system.
Throughout most of the 1980s the UK refused to join the ERM (Exchange rate mechanism). It
argued that it would be impossible to maintain exchange rate stability within the ERM, especially
in the early 1980s when the pound was a petro-currency and when the UK inflation rate was
consistently above that of Germany. When the UK joined the ERM in 1990 there had been three
years of relative currency stability in Europe and it looked as though the system had become
relatively robust. The events of Sept. 1992, when the UK and Italy were forced to leave the
system, showed that the system was much less robust than had been thought.

2.

Over estimation of Trade benefits.

Some economists argue that the trade and cost advantages of EMU have been grossly over
estimated. There is little to be gained from moving from the present system which has some
stability built into it, to the rigidities which EMU would bring

3. Loss of Sovereignty.
On the political side, it is argued that an independent central bank is undemocratic. Governments
must be able to control the actions of the central banks because Governments have been
democratically elected by the people, whereas an independent central bank would be controlled
by a non elected body. Moreover, there would be a considerable loss of sovereignty. Power
would be transferred from London to Brussels. This would be highly undesirabel because
national governments would lose the ability to control policy. It would be one more step down
the road towards a Europe where Brussels was akin to Westminster and Westminster akin to a
local authority.
24

4. Deflationary tendencies.
Perhaps the most important economic argument relates to the deflationary tendencies
within the system. In the 1980s and 90's France succeeded in reducing her inflation rates to
German levels, but at the cost of higher unemployent, For the UK, it can be aruged, that
membership of the ERM between 1990 and 1992 prolonged unnecessarily the recessional period.
This is because the adjustment mechanism acts rather like that of the gold standard. Higher
inflation in one ERM country means that it is likely to generate current account deficits and put
downward pressure on its currency. To reduce the deficit and reduce inflation, the country has to
deflate its economy. In the UK, it could be argued that the battle to bring down inflation had been
won by the time the UK joined the ERM in 1990. However, the UK joined at too high an
exchange rate. It was too high because the UK was still running a large current account deficit at
an exchange rate of around 3 Dm to the pound. The UK government then spent the next two
years defending the value of the pound in the ERM with interest rates which were too high to
allow the economy to recover. Many forecasts predicted that, had the UK not left the ERM in
Sept 1992, inflation in the UK in 1993 would have been negative (ie prices would have
fallen).The economic cost of this would have been continued unemployment at 3million and a
stagnant economy. When the UK did leave the ERM and it rapidly cut interest rates from 10% to
five and a half %, there was strong economic growth and the current account position improved,
but there was an inflation cost.

Another problem that the early 1990s highlighted was that the needs of one part of
Europe can have a negative impact on the rest of Europe. In the early 1990s, the Germans
struggled with the economic consequences of German reunification. There was a large increase
in spending in Germany with a consequent rise in inflation. The Bundesbank responded by
raising German interest rates. As a result, there was an upward pressure on the DM as speculative
money was attracted into Germany. Germany's ERM partners were then forced to raise their
interest rates to defend their currencies. However, higher interest rates forced most of Europe
into recession in 1992 - 1993.
Countries such as France couldn't then get out of recession by cutting interest rates
because this would have put damaging strains on the ERM. The overall result was that Europe
suffered a recession because of local reunification problems in Germany.
25

Critics of the ERM and EMU argue that this could be repeated frequently if EMU were
ever to be achieved. Local economies would suffer economic shocks because of policies, forced
on them, designed to meet the problems of other parts of Europe.
One way around this would be to have large transfers of money from region to region when a
local area experienced a recession,
e.g. N. Ireland which suffered structural unemployment for most of the post war period, has had
its economy propped up by large transfers of resources from richer areas of the UK with lower
unemployment. However, regional transfers are very small at the moment unfortunately.
Moreover to approximate the regional transfers which occur at the moment in, say, Britain, there
would have to be a huge transfer of expenditures from national governments to Brussels - just
what anti Europeans are opposed to.

TYPES OF EURO CURRENCY/OFFSHORES NOTE MARKETS:

Euro note are instrument of borrowing issued by borrowers directly to investors without
using banks as intermediaries, with or without the under standing supports for the issue. They
have shorter maturites than bonds . maturities than bonds . Maturities normally range from
15days to 5years.
Commerical Paper :- This is a short term securities issued for maturities of lessn than one year
with out underwriting supports from banks. Theses instruments are there fore issued by borrower
with very good credit rating wishing to leverage the same to raise resources at rate lower than
lending rates of banks. That is the proceeds of such issue in the form of promissory notes on
adiscount to yield basic. Being negotiable instrument, they provided liquidity to inveators.
Note Issuance Facility:- In situation where the borrowing entity requires resources for the
medium terms but investors desire to invest on short term basis, the reconciliation is achieved
through this mechanism. The borrower issue short term note supported by underwriting from
banks. The notes are redeemed on maturitiy by issue of fresh notes. Shortfalls in subscription are
covered by the underwriters. The borrower is thus assured of requisite fiancs for the required
duration while simultaneously fulfilling the needs of the investors .

26

The euro Currency markets in general deals with balancing the assets liability mismatch between
investors and issue . investors normally prefer short maturity commitments whereas borrower
want resources for medium to long maturities .
The nif arrangement combines the features of issues the bank provides a bridge loan until the
next issue. The bank dose not purchase the unsold portion of the note issue . thus the
underwriring in such cases if for providing the balancing loan and not for the note issue it self.
Medium Term Notes :- These Represent medium term, fixed interest rate instrument rate
instrument issued with out underwriting supports from banks. These instruments are issued for
period ranging form One to Ten years with standard maturity being five years.
These instruments are very popular with euro market investors . they are normally listed so as to
provided liquidity.
Bankers Acceptances :- the borrower importing project requirements on credit basic, gets the
bill of exchange accepted by the bank. This provides greater assurance to the supplier regarding
recovery of his dues. Correspondingly, the importer. borrower is able to get better term of trade.
Repurchase Obligation :- In these reaction the borrower seels securities ti the lender with the
commitment to repurchase the same at a predetermined rate on fixed future date .
The difference between the sales and purchase prices represent the return to the lender as
interest. Effectively it represet the most secured form of lending in the euro currency market.

27

DISTINCTION BETWEEN EURO CURRENCY BONDS AND EURO

CURRENCY NOTE
Sr.No

Euro Currency Bonds

This market deals with borrower to

Foregin Exchange Market

Notes are sold the borrower without any
underwriting supports .

syndicate of underwriting banks

Borrower sells the issue to the

underwriters

Borrower sells the instruments directly to retails

investors with out any intermediation

who there after sells the instruments

to retails investors

Issue risk is assumed by the underwriters

The sales of notes is based on the credi rating of

the borrower and hence is critical to issue

and credit rating of the borrower is

Since there is no intermedation, the cost of
of limited impotances

Prices discovers takes palce through

acquaring the notes is the same for all investors.

demand / supply which means the cost

of acquring the bonds differ for individual
investors

28

Financial instruments used in both Euro and Domestic Market

Euro Currency

Time Deposits

Euro Currency Certificates of Deposits (ECDs)

Certificate of Deposits

Euro Commercial Paper

Commercial Paper

Euro Medium Term Notes

Medium Term Notes

The Origin of The Eurocurrency Market

The origin of the Eurocurrency market-that is, the market in currency trading outside their
respective domestic economy. Several factors were behind their birth.
(1). The centrally planned economies were reluctant to hold bank deposits in the United States,
so they put their dollar earnings on deposit in London. Gradually other European dollar holders
did the same, a tendency that was particularly marked when the United States ran large balance
of payments deficits.
(2). Balance of payments pressures made the United Kingdom government limit British banks'
external use of sterling, so they had a strong incentive to develop business in foreign currencies.
(3). By the end of 1958 the main industrial countries had restored full convertibility of their
currencies. The new freedom produced a surge of international banking business.
29

The growth of the Eurocurrency market was also stimulated by certain monetary regulations in
the United States. For instance, Regulation Q put a ceiling on the interest rates that banks
operating in the United States could offer to domestic depositors were naturally attracted to
Eurobanks that were not bound by Regulation Q. In addition, banks in theUnited States were
required to hold non-interest-bearing reserves. By diverting dollar deposits to their offshore
branches or subsidiaries, U.S. banks were able to avoid tying up so much of their funds in
reserve requirements at a zero rate.
General controls on the movement of capital also helped to boost the Eurocurrency markets. One
example was the introduction, in 1965, of the Voluntary Foreign Credit Restraint Program
(VFCR) in the United States. The specific goal of the VFCR was to limit the growth of foreign
lending by U.S. banks. Instead, their foreign branches-which were not subject to the VFCR- took
deposits and on lent them outside the ceiling. Between 1964 and 1973 the number of U.S. banks
with overseas branches increased from 11 to 125. The number of branches increased from 181 to
699 over the same period.
At the end of the 1960s and during the early 1970s the Eurocurrency markets, which had been
located in Western Europe (and centered in London), expanded to a number of other "offshore"
banking centers. These were typically small territories that had tax, exchange control, and
banking laws favorable to international banks. The business was entrepot in nature, with foreign
currency funds deposited by one foreign source and then onlent to another. Offshore centers have
been set up in the Caribbean area, Latin America, the Middle East, and establishment of
international banking facilities (IBFs) in the United States designed to bring the locus of
American banking business back "onshore".
With the recent strong growth of domestic currency lending abroad, total international lending is
now the most meaningful lending aggregate, and it encompasses Eurocurrency market activity.

Countries that use the Euro

In 1999, 11 European countries qualified under the convergence criteria to use the Euro as their
currency: Austria, Cyprus, Belgium, Finland, Germany, France, Ireland, Luxembourg, Italy,
Portugal, Spain and the Netherlands. Cyprus, Greece, Slovenia, Malta and Slovakia were later
admitted, bringing the total countries to 16. Some countries like Turkey and Romania have
expressed a desire to join the EU but have not yet met the criteria to join.

30

Notable holdouts include the Scandinavian countries like Norway, Denmark and Sweden, in
addition to England. Though these countries are members of the European Union, they have
opted out of using the euro as their standard currency.
Some countries, like Montenegro, are permitted to use the euro as their currency but have no
representation in the European Union.
On January 1, 2009, Slovakia started using the euro. Estonia began using the euro on January1,
2011. Lithuania and Latvia are expected to join the Eurozone in the next few years andthus
become countries using the euro.
Only 17 of the 27members of the European Union (EU) are part of the Eurozone, the name for
the collection of EU countries that utilize the euro. Notably, the United Kingdom, Denmark, and
Sweden have thus far decided not to convert to the euro. Other new EU member countries are
working toward becoming part of the Euro zone. On the other hand, Andorra, Kosovo,
Montenegro, Monaco, San Marino, and the Vatican City are not EU members but do officially
use the euro as their currencies .

31

Current Rate of Euro vs. Indian Rupee

1EUR(EURO)= 71.28 INR

(On 07-03-2013)

1INR (INDIAN RUPEE)= 0.0140 EUR

1USD (Us Dollar )= 54.78 Indian Rupee (On 07-03-2013)
eEUR vs. INR 71.28

Calculation of Euro in terms of INR

Example:
Mr.A wishes to invests in Euro Market. He invests in 6 Euros then how much he will getin
return? (in INR)
Sol: 1EUR= 71.28 INR
So, 6 EUR = 6*71.28= 427.68 in INR

EURO V/S DOLLAR

Euros and dollars are one of the most influential global currencies in this modern era. Both of
these currencies play a very significant role in defining the shape of global economics and
finance. Though, the dollar was already established as the worlds most stable and important
currency before the advent of euro but right at this moment, both of these currencies seem to go
parallel in their value and worth.

32

Strengths.
A key strength of the euro is currency stability. Businesses no longer face risk from currency
exchange rates and tourists no longer pay the price of currency conversion. Rising costs
(inflation) are kept at bay because countries must maintain a low inflation rate in order to join.
Furthermore, because the euro inextricably links the economies of its members, the currency
provides a disincentive for countries to go to war with the other.

Weaknesses.
Euro-using countries are unable to set their own monetary policy and instead must abide by the
policies outlined by the European Central Bank. This lack of autonomy creates difficulties when
countries experience an economic downturn. A specific country, such as Greece, is unable to
devalue its currency to keep prices stable and increase exports to raise money. This highlights
another weakness; the economic troubles of one country become the economic troubles of all
euro members. Not all countries will agree on how to handle these problems either. During the
Greek debt crisis of 2010, Germany (regarded as one of the strongest economies in Europe) had
very different ideas than Greek leaders on how to extricate Greece from its debt.

33

Literature Review

The currency component of monetary aggregates is the narrowest definition of money analysed
by central banks. It comprises notes and coins in circulation held by non-Monetary Financial
Institutions. The total amount of currency in circulation is closely controlled by the monetary
authorities, as central banks are, in principle, able to decide precisely about the amount of
currency they put into circulation and know the exact amount of outstanding currency. In
addition, central banks usually accommodate the total demand for currency regardless of its
origin. This notwithstanding, central banks are not able to follow the way that currency takes
once put into circulation. Consequently, there is little direct statistical information on where the
currency circulates, who holds the currency (residents or non-residents) and on the reasons for
which the currency is held (for transactions, hoarding and/or illegal purposes). For monetary
policy purposes, the amount of currency held for transactions within the domestic currency area
is of particular interest, since this part is closely related to domestic spending and hence, to
domestic price developments. By contrast, for hoarding as well as foreign holdings of banknotes
this is probably not the case. Therefore, for monetary policy purposes it would be helpful to have
information on the transactions cash demand by residents. This is the starting point of the present
paper. Based on the demand for the euro legacy currencies at an aggregate level, currency in
circulation in the euro area has been analysed from the beginning of the 1980s until at least the
end of 2001. This enables us to compare the (determinants of the) past demand for euro legacy
currencies with present and future demand for euro banknotes and coins. Major changes in the
demand for currency could influence monetary developments, although the share of currency in
circulation in broad monetary aggregates is relatively limited. In this context, the introduction of
the euro banknotes and coins has raised the question of how the demand for the new currency
will evolve. The move towards the single currency, including changes in the denomination
structure of the banknotes compared with the legacy currencies of the euro may imply a change
in the domestic demand for currency. In this vein, the demand for euro banknotes from abroad
may also differ from the past foreign demand for euro legacy currencies, which mainly
concentrated on the D-Mark. A strong and, in particular, a fluctuating demand for euro banknotes
from abroad could have implications for the assessment of monetary developments in the euro
area. In this respect, the US experience shows that the foreign demand for US currency is
sizeable and important enough to be monitored on a regular basis (Porter/Judson, 1996, United
States Treasury Department, 2000, Lambert/Stanton, 2001). At the same time, payment and
hoarding behaviour only change slowly over time. In order to assess the demand for euro
banknotes and coins, information from the cash changeover at the beginning of 2002 has also
been extracted. The cash changeover provides a unique opportunity to get a more detailed picture
about two fundamental questions, for what purposes and by whom currency is held. For instance,
the reduction of currency in circulation in the course of 2001 and the demand for currency in the
first months of 2002 should give some indication about the amount of currency used for hoarding
purposes on the one hand and transaction purposes on the other. Moreover, the amount of euro
banknotes which has been frontloaded or shipped in the first months of 2002 to countries outside
the euro area, should give a, albeit limited, picture of the demand for euro banknotes abroad. So
far, there are several papers dealing with the situation of specific national legacy currencies of
34

the euro. The usual approach is to estimate a currency demand function within the context of a
narrow definition of money. The traditional arguments a transaction variable and opportunity
cost variable are in some cases supplemented by factors narrowly related to special
characteristics of currency, e.g. its anonymity and secrecy. An international comparison of
currency demand equations including socio-economic factors is presented by Kenny, 1991,
Drehmann/Goodhart, 2000, and Drehmann et al., 2002. Some authors try to capture the amounts
of currency hoarded in the respective country, others analyse foreign holdings of specific
currencies, both from the point of view of a currency exporting country and of currency
importing countries.In some cases, a distinction is made between different denominations,
especially large and small denomination bills, and different holding groups. The relation between
currency holdings and underground economic activity is generally discussed by Schneider/Enste,
2000, and empirically estimated for several EU countries by Schneider/Osterkamp, 2000, and
Caridi/Passerini, 2001. In this respect, Drehmann et al., 2002, find that the ratio of (direct and
indirect) taxes to GDP (an indicator of the size of the underground economy) becomes
insignificant if one looks only at the USA, Germany and Switzerland whose currencies are the
main potential candidates for foreign holdings. By contrast, in the subset of the other countries
considered in their study, the tax ratio has a much larger and significant effect, especially for high
denomination notes. There are also papers which investigate the influence of financial innovation
on the demand for cash.10 Humphrey et al., 1996, especially stress the importance of differences
across countries in cash and non-cash transactions. Attanasio et al., 2002, model both the access
to interest bearing assets and the choice of an ATM card together with the demand for currency
for Italian households. They find substantial economies of scale in cash holdings over time and
significant differences in cash holdings between ATM cardholders and non-ATM cardholders.
Dutta and Weale, 2001, show theoretically how changes in the transaction technology affect the
choice of cash versus other methods of payment for consumption. An implementation of their
model to UK data resulted in a steady improvement of transaction technology from the 1970s
until the end of the 1990s and a high value for the substitution elasticity. Similarly, De Grauwe et
al., 2000, compare the costs of cash and cards of the payment system participants in Belgium and
Iceland. system is low compared to a payment system based on cards. The endogeneity of the
evolution of different payment methods in a cross-country study is analysed by Humphrey et al.,
2001, who find that payment users are quite sensitive to relative prices that reflect relative user
costs. In this respect, van Hove, 2002, strongly argues in favour of correct (i.e. transaction-based
and visible to users) prices for different payment methods on efficiency grounds. As regards
cash, he tries to show that, in general, it is the least efficient way of making payments. There are
only a few papers dealing with the potential demand for euro notes and coins. The ECB, 2003,
discusses the main determinants of currency demand in the euro area with a specific focus on the
impact of the introduction of euro banknotes and coins on currency demand. Oesterreichische
Nationalbank, 2001, Vuc helen/van Hove, 2001, and Hebbink/Peeters, 1999, analyse the
problems connected with the changeover from the legacy currencies of the euro to euro notes and
coins. These problems mainly concerned the exact amounts of currency needed for transactions
and other purposes and the frictions involved with only concentrating on a single motive for
holding currency. Math, 2001, illustrates with the help of a survey that the euro cash
changeover could have more than temporary real economic effects as it may take several years
before people truly and fully accept the new currency and the new denomination of prices. Math
attributes this phenomenon to bounded rationality combined with people using rules of thumb
rather than converting accurately (e.g. 1 = 2 DM instead of 1 = 1.95583 DM). Thus,
35

economic agents make systematic errors. Rogoff, 1998, and van Hove/Vuchelen, 1996, discuss
the relation between the denominational structure of euro banknotes and future currency demand
of the underground economy. They argue that the existence of the two large denomination bills
of 200 and 500 will facilitate tax evasion and illegal activities in the euro area. There are also
some papers analysing the euro cash changeover.14 These deal primarily with logistical aspects
within and outside the euro area and a possible inflationary impact of the introduction of euro
notes and coins. Their general conclusions are that the logistical challenges have been managed
quite well and that the switch to the physical euro currency should and did not lead to a
significant change in the price level. Their investigation unambiguously yields the result that the
cost efficiency of the cash payment The paper is structured as follows. Section 2 presents some
stylised facts on currency in circulation in the euro area countries as well as at the aggregate euro
area level. A theoretical model which tries to capture some non-common determinants of
currency demand is presented in Section 3. In Section 4, a currency demand function for euro
area currency is estimated for overall currency holdings as well as for small and large
denomination notes. Section 5 then tries to extract information on how much currency is used for
transactions purposes within the euro area as well as for hoarding purposes and abroad with the
aid of direct and indirect methods. Section 6 discusses currency developments after the cash
changeover and the implications of the introduction of euro notes and coins for the longer-term
demand for euro area currency. Finally, Section 7 summarises and draws some monetary policy
conclusions.

36

BIBLIOGRAPHY

wikipedia.org/wiki/Euro
www.tradercurrencies.com
http://www.ehow.com/about_6659910_euro-currency-information.html#ixzz2MI4DEp3F

http://www.investopedia.com/terms/e/eurocurrencymarket.asp#ixzz2M0BMhrTo
http://www.ehow.com/about_6659910_euro-currency-information.html#ixzz2MIFaO8wH
http://www.ecb.int/stats/euro/circulation/html/index.en.html

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