Eurodollars assignment help

“Eurodollars” was a term that originally related to US dollars that existed outside the American banking system. Today, this term or its equivalent, Eurocurrency, includes more than twenty currencies which are dealt with outside their original banking systems. The concept of the Eurodollar started in Europe following World War II when the United States funded the reconstruction of Europe. Millions of dollars left the American banking system and were circulated and recycled in Europe.

At the same period, moreover, Communist countries did their trading with Europe in American dollars and did not want to have their moneys directly supervised or held by American banks because they feared that the US might confiscate these moneys. As a result, most of the dollars used bc Communist countries for trading remained in Europe and were thus recycled as Eurocurrency.

In many cases, Eurodollars do not even leave the American banking system. For example, if two American banks are doing business between their US-based and Europe-based branches, millions of dollars are transferred from one branch in the US to another in Europe, thus creating a pool of Eurodollars, whereas in reality the money never left the US but was rather transferred from the Reserve Accounts of one bank to those of another. As many large banks all over the world are growing in size and in the number of branches, this in turn has contributed to the expansion of the Eurodollar market.

When the Eurodollar market started, it was focused in London. The original reason for choosing London was the 1957 crisis of the Sterling following Britain’s involvement in the Suez Canal conflict. As a result of the crisis, Britain needed hard currency in considerable amounts. At the same time, the British government was interested in turning London into a European banking center, mainly by loosening its banking and financial regulations, and by facilitating the operations of organizations operating in the field of banking and finance. Eventually, however, other countries in Europe and even outside Europe wanted a piece of the market, and so, soon Amesterdam, Paris, Frankfurt, Hong Kong and Bahrain became important global centers for the Eurodollar market.

One of the most important characteristics of the Eurodollar market is that it is very loose. Regulations related to lending are much looser than those existing in state banking systems. In addition to this, the lack of regulations makes it easier and cheaper to run the operations, and hence, this makes the spread between the Eurocurrency deposit rate and the Eurocurrency lending rate much less than the spread between the domestic deposit rate and the domestic lending rate. This of course makes it more appealing and attractive to borrow from the Eurodollar market or to deposit in its accounts.

Another important advantage of the Eurodollar market is that it is very speedy and fast. In comparison to regular banking systems, getting a loan from the Eurodollar market is very fast and easy. The reason is that most individuals, companies and institutions in the Eurodollar market know each other very well and they also know a lot about each other, and hence, there is no need for a waiting period during which a check is made on the credit history of the borrower.

The Eurodollar market has many advantages. First of all, it offers large institutions, governments and rich individuals an opportunity to make their surplus funds and cash available for international use by other parties. Secondly, it is a fast and effective credit and loan facility for these individuals, institutions and governments. Thirdly, there exists a continuous strong competition among Eurobanks to lend money and this in turn keeps the interest rates lower than they are in domestic banking systems. Furthermore, there are no reserve requirements for Eurobank assets and hence, more assets are lent out than is the case in domestic systems where banks have to put up reserve requirements.

This is not to mention that the cost of coping with regulations and laws is much lower than the case is with domestic banking systems. Another important advantage is that taxes on Eurobanks are generally lower than those levied on domestic banks, nor are depositors subject to withholding taxes as they are on interest earned on funds deposited domestically. With all these advantages and attractive characteristics, the Eurodollar has grown very extensively over the past decades, from the size of a few-million-dollar market into a market that ranges between $1.5 and $5 trillion today.

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The interest rate for the Eurodollar market is calculated by adding the LIBOR (the London InterBank Offer Rate) to the Spread rate, the spread rate being the cover for administration costs, gross profits, in addition of the risk of both the lender and the borrower. The interest rate is almost completely set by the market forces and not by governments, and this explains why it is usually lower than that of domestic banking systems.

Still, the Eurodollar is not a fool-free system. There are several disadvantages involved, some of which are very risky. To start with, there is the problem of currency fluctuation, a problem that is not usually faced in domestic banking systems, at least not in the short term. This problem can be very costly for borrowers and lenders alike, depending on the situation. For example, if an institution borrows $100 million today at a certain rate of exchange and this rate suddenly rises before the due date for payment, the borrower will actually be paying more money because of the difference with his own currency. To avoid this solution, various kinds of money swaps and other derivatives have been developed and innovated. Still however, the fluctuation risks remain quite high and common, thus discouraging many investors or borrowers from seeking the Eurodollar market. Risk seekers, on the other hand, prefer to seek the Eurodollar market for help, especially if they are looking for better solvency, faster transactions, and better interest rates.

While the Eurodollar market has created a very important facility for improving financial transactions and the operations of financial institutions worldwide, it has also created outlets for criminal institutions that deal in various kinds of criminal activities such as money laundring, drugs, smuggling, arms trade, and even slavery. These criminal activities are usually hidden behind the transactions of large institutions or rich individuals or even commercial banks and once the moneys that are generated as revenues from these illegal operations find their way to the Eurodollar market, it becomes very difficult if not impossible to follow their tracks and determine where exactly they came from. Switzerland, for example, depends on the Eurodollar market in order to circulate its excessive anonymous accounts, and similarly, many rich individuals who may fear that their moneys may be confiscated in American or other banks, seek and prefer the Eurodollar market as an alternative.

The Eurodollar market is not an alternative to domestic banking sytems. While it has its many advantages, it has very serious disadvantages such as currency value fluctuations and the higher risks of bankruptcy. Regardless of these risks, the Eurodollar market has been flourishing for many years, probably more due to political and legal factors than for economic factors. This system has increased in size and breadth to include more than 20 currencies today, and involving trillions of dollars worth of money from all over the world.

References

“What is the Eurodollar market and how did it evolve?” www.valhalla.vossnet.co.uk/cmmahon/edollar/html, December 28, 2000.

“International Capital Market”www.iso.gmu.edu/~jvolpe.htm, December 28, 2000.

“What exactly is offshore?” www.viable.com/offshore/osinfo2.htm, December 27, 2000.