International Money and Capital Markets

One way for U.S. citizens to invest in world markets is to buy the stocks of U.S. multinational corporations that invest directly in foreign countries. Another way is to purchase foreign securities stocks, bonds. or money market instruments issued by foreign security investments are know as portfolio investments and they are distinguished from direct investments in physical assets by U.S. corporations.

From world war II through the 1960s. The U.S. capital markets dominated world markets. Today however the value of U.S. securities represents less than one fourth the value of all securities. Given this situation it is important for both corporate managers and investors to have an understanding of international markets. Moreover, these markets often offer better opportunities for raising or investing capital than are available domestically.

Eurodollar Market

A Eurodollar is a U.S. dollar deposited in a bank outside the United States. (Al-though they are called Eurodollars because they originated in Europe, Eurodollars are really any dollars deposited in any part of the world then than the United State.) The bank in which the deposit is made may be a non-U.S. bank, such as Barclay’s bank in London; the foreign branch of a U.S. bank, such as Citibank’s Paris branch; or even a foreign branch of a third-country bank, such as Barclay’s Munich branch. Most Eurodollar deposits are for $500,000 or more, and they have maturities ranging from overnight to about one year.

The major difference between Eurodollar deposits and regular U.S. time deposits is their geographic locations. The two types of deposits do not involve different currencies-in both cases, dollars are on deposit. However, Eurodollars are outside the direct control of the U.S. monetary authorities, so U.S. banking regulations, including reserve requirements and FDIC insurance premiums, do not apply. The absence of these costs means that the interest rate paid on Eurodollar deposits can be higher than domestic U.S. rates on equivalent instruments.

Although the dollar is the leading international currency. British pounds, German marks, Swiss francs, Japanese yen, and other currencies are also deposited outside their home countries; these Eurocurrencies are handled in exactly the same very as Eurodollars.

Eurodollars are borrowed by U.S. and foreign corporations for various purposes. But especially to pay for goods exported from the United States and to invest in U.S. security markets. Also U.S. dollars are used as an international currency or international medium of exchange and many Eurodollars are used for this purpose. It is interesting to note that Eurodollars were actually invented by the soviets in 1946. International merchants did not trust the soviets or their rubles. So the soviets bought some dollars (for gold), deposited them in a Paris bank and then used these dollars to buy goods in the world markets. Others found it convenient to use dollars this same way and soon the Eurodollar market was in full swing.

Eurodollars are usually held in interest-bearing accounts. The interest rate paid on these deposits depends (1) on the bank’s lending rate, as the interest a bank earns on loans determines its willingness and ability to pay interest on deposits and (2) on rates of return available on U.S. money market instruments. If money market rates in the United State were above Eurodollar deposit rates these dollars would be sent back and invested in the United States. Whereas if Eurodollar deposit rates were significantly above U.S. rated which is more often the case more dollars would be sent out of the United States to become Eurodollars. Given the existence of the Eurodollar market and the electronic flow of dollars to and from the United States, it is easy to see why interest rate in the United States cannot be insulated from those in other parts of the world.

Interest rates on Eurodollar deposits (and loans) are tied to a standard rate know by the acronym LIBOR, which stands for London Inter Bank Offer Rate. LIBOR is the rate of interest offered by the largest and strongest London banks on dollar deposits of significant size. In December 1996, LIBOR rates were over half a percentage point above domestic U.S. bank rates on time deposits of the same maturity–4.94 percent for three-month CDs versus 5.63 percent for LIBOR CDs. The Eurodollar market is essentially a short-term market; most loans and deposits are for less than one year.