Forex fund
I. FACTORS FAVOURING GROWTH OF THE MARKET
The foundation of modern Eurocurrency was laid in 1949. The new Chinese Communist Government apprehended that their dollar earnings would be blocked by the USA. To overcome the threat, it began to disguise its dollar earnings by placing them with a Russia owned bank in Paris. Following the outbreak of the Korean War, the USA blocked Peking?s identifiable dollar balances in the USA. Fearing similar action against their holdings, the Russian banks in Paris and London began disguising their balances by placing them with banks in Western Europe instead of depositing them directly in New York. Thus the Western banks had claims on dollar balances in the USA and the Communist depositors had similar claims on the Western Banks.
Another contributing factor was the decision taken by the British Government to impose a ban on new overseas loans, denominated in sterling to finance trade between countries outside the sterling area. During this period exchange control restrictions were relaxed throughout Western Europe, affording commercial banks the freedom to conduct foreign exchange business and to accept deposits in foreign currencies. The situation was utilized by the London banks to offer their restricted non-sterling area clients the alternative of financing in US dollars.
Another regulation that encouraged flow of funds from the USA to European centers. This regulation required the banks to maintain certain percentage as reserves against deposits. Except for a brief period, this regulation was not applied to deposits of European branches of US banks. This resulted in the cost of operations could be passed on the customers in the form of higher rates of interest on deposits at the European centers. The absence of regulations encouraged some US banks to move some of their depositor?s accounts, including those of Americans, to the Europeans market.
All the factors thus far mentioned ensured its sustenance by creating Eurocurrency markets. Certain other factors ensured its sustenance by creating adequate demand for the funds thus generated. One such factor was the controls and restrictions on borrowing funds in the United States for reinvestment abroad, begun as a voluntary restraint programmed and made mandatory. The restrictions the borrowers were driven to seek loans outside the US market and naturally they resorted to the Euro currency.
To discourage flow of dollar from the country, USA introduced the interest equalization tax. This was a tax on US resident?s earnings on foreign securities. To cover the tax, the US lenders charged higher rates of interest from foreign borrowers. Routing the funds through the Eurocurrency market helped to avoid the interest equalization tax and thus enabled the lenders to offer funds at lesser interest rates.
II. SPECIAL FEATURES OF THE MARKET
The following are the special features of the Eurocurrency market :
1. Transactions are the special currency take place outside the country of its issue.
2. Even though the currency is utilized outside the country of its origin, it has to be held only in the country of its issue.
3. Though Eurocurrencies are outside the direct control of the monetary authorities of their respective countries of issue, they are subject to some form of indirect control. This is because the settlement of all transactions has to take place only in the country of issue. If the country of issue imposes any restrictions, the conversion of balances in the currency held outside the country into another currency would involve clearing in the country of issue at some point of the transaction. This automatically subjects them to the restriction.
4. Eurocurrency market is not a foreign exchange market. It is a market for deposits with and between banks inter bank deposits and for loans by banks to the non-bank public. It is a market in which foreign currencies are lent and borrowed as distinct from the foreign exchange market, where they are bought and sold. It consists of a pool of predominantly short term deposits which provide the biggest single source of funds that commercial banks transform into medium and occasionally long term international loans or Euro credits.
5. The transactions in the market involve huge amounts running into millions of dollars. The large scale financing has led to the development of syndications of loans, where a large number of banks participate in the lending operations.
6. Eurocurrency market is a highly competitive market with free access for new institutions in the market. Consequently the margin between the interest rates on deposits and advances has narrowed down considerably.
7. A special feature is the concept of floating rates of interest. The rate of interest is linked to a base rate, usually the London inter bank offered rate. The interest on the deposit or the advance would be reviewed periodically and changed in accordance with change.
8. US dollar remains the leading currency traded in the Eurocurrency market, even though its share is declining.
9. The Eurocurrency market can broadly be divided into four segments :
i. Euro credit markets, where international group of banks engage in lending for medium and long term.
ii. Eurobond market, where banks raise funds on behalf of international borrowers by issuing bonds.
iii. Eurocurrency market, where banks accept deposits, mostly for short term.
iv. Euro notes market, where corporate raise funds.
III. INTEREST RATE IN EUROCURRENCY MARKETS
The interest rates in Eurocurrency markets are determined by a multitude of factors which affect the demand and supply conditions of the currency concerned. Some of the factors are:
i. Volume of world trade transacted in the currency.
ii. Domestic interest rates.
iii. Domestic monetary policy and reserve requirements.
iv. Domestic government regulation, and
v. Relative strength of the currency in the foreign exchange market.
IV. EUROCREDITS
Most of the lending in Eurocurrency markets takes the form of Euro credit. Euro credits are medium and long term loans provided by international group of banks in currencies which need not be those of the lenders or borrowers. Euro credit belongs to wholesale sector of the international capital market and normally involves large amounts.
Euro credits are provided mostly without any collateral security from the borrower. Greater emphasis is laid on the credit rating of the borrower rather than on any tangible security. Providing Euro credits as unsecured facilities also renders the job easy by avoiding complicated procedures to take charge of the security.
The conditions stipulated for drawing and repayment of the facility depend upon the kind of credit provided. Euro credits are normally provided in either of the following two forms:
i. Revolving credit: Revolving credit is similar to cash credit facility. It is a standby facility to meet temporary but recurring financial requirements of the borrower. Interest is charged on the actual amount utilized on the sanctioned but unutilized portion, a commitment fee may be charged. Repayment is arranged by progressively reducing the credit limit till the entire facility is thus reduced.
ii. Term credit: Term credit is similar to medium term loans provided by banks. At the beginning itself both the lenders and borrowers agree on the schedule of drawing the facility. The facility if utilized in full for some time and then in accordance with the agreement already entered into repayment begins. The repayment schedule is fixed taking into account the expected revenue flow from the investment.
The period of Euro credits extends up to 15 years. But most of the credits are for period of 5 to 8 years. On an average about 5% of the total credits are for periods ranging from 1 to 5 years and about 10% from 10 to 15 years.
Interest is fixed at a certain percentage over a reference rate, generally the inter bank rate for Euro currency deposits.
Most of the loans raised are in dollars. Some loan agreements also provide for currency option to roll over the loan in a different currency according to his requirement. This again is possible provided the bank can procure the required currency. The multi currency option helps the borrower in avoiding exchange risk and also does not involve the lending bank in any risk.
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