EURO CURRENCIES

EURO DOLLAR/CURRENCY
Euro Dollar: Loan or deposit in a
bank outside USA. Initially applied to
US $ as EURO $ and later became
applicable to all currencies being
transacted outside home.
Euro CHF, Sterling Yen: Loan or
deposit denominated in CHF,
Sterling, Yen outside Switzerland,
Britain, Japan respectively

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 WHY EURO DOLLAR
HISTORICAL REASON:
Soviet Union in 1950s sold Gold and other
products to get US $ to obtain grains. Moscow
Narodny Bank needed to park these $ for short
term. Banks in USA will take them and provide
some return; but not acceptable to Russians for
fear of cold war turning hot. So these $ were
kept in banks in Britain and France, who in turn
will lend them to USA, and recover cost and
make some profit.

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 REASONS FOR GROWTH
Regulation Q:In 1960s and 1970s the interest
rates on deposits by US banks were subject to
ceiling. US Banks in London and other places
outside of USA did not have such regulation.
Higher interest could be paid on $ deposit outside
USA. These $ were reinvested back in USA as
loans.
Regulation M: Required keeping of reserve
against US $ deposits. Until 1969 this regulation
did not apply to deposits abroad. Reserve means
non-earning funds, therefore increased cost of
funds.

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 REASONS FOR GROWTH
Premium on insuring $ deposits also added to
the cost of funds. This again was not applicable
to deposits held outside USA.
Interest Equalisation Tax in 1963 imposed by
US govt. on foreign debt forced the US
companies to pay more to foreign investors to
attract investment, raising cost of borrowing.
Historically London was the favourite destination
of US Banks to conduct business in US $ to avoid
US legislation.

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 REASONS FOR GROWTH
International Trade was growing rapidly.
Branches of US provided easy access to $ without
having to incur transaction costs.
Tax Heavens of Cayman Islands, Netherlands
Antilles etc were added advantages.
Growth of Euro Dollar was 17% p.a.

US Trade Deficit: was huge implying outflow of

$ to pay for imports. Since banks located outside
USA offered better returns and more convenience
the growth in Euro Dollars continued.

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 EURO $ INSTRUMENTS
Favourable rates: Rates offered on Euro Deposits
are higher and rates charged on Euro loans are
lower than their respective rates in the homelands.
Usually a non negotiable term deposit, or

Certificate of Deposit (CDs): Negotiable deposits

that are traded in secondary market. More liquid
and avoid penalty for premature withdrawal.
SDR denominated instruments are also available

Variable interest rate instruments: to avoid

asset liability mismatch (Euro deposits are ST and
Euro Loans are LT).

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 FUNCTIONS OF EURO MARKET
International conduit of mobilising short and
medium term capital from BOP surplus countries
to BOP deficit countries.
Facilitate covering of operations in foreign
exchange and ensure covered interest arbitrage;
extremely important function for floating
exchange rate mechanism.
Single intermediary within the confines of a
single national currency.
Creates Euro money (The Multiplier Effect).

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