Siam University Postgraduate College MBA DepartmentGroup 2 Assignment ByDenis Hour Vino Njambe ID: 5617190008

504-223 International Finance and Banking(term3/2014) as at June 26, 2015

Term Project: Euro Exchange Market.

Purpose: To Report and Study significant areas in The Eurozone Exchange Market

I. Table of Content

II. Introduction

III. History and Summary

IV. Why The Euro Exchange Market Is Unique?

V. Advantages and Disadvantages of Euro Exchange Market

VI. Characteristic of Euro Exchange Market

VII. Factors Affecting Movement of Euro Exchange rates

VIII. Euro Exchange Risk

IX. Conclusion.

I INTRODUCTION

Euro Currency

DEFINITION The official currency of the Eurozone is the euro( sign: ; code: EUR) and the countries consists of 19 of the 28 member states of the European Union: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain. The currency is also officially used by the institutions of the European Union and four other European countries, as well as unilaterally by two others, and is consequently used daily by some 337 million Europeans as of 2015. A number of overseas territories of EU members also use the euro as their currency.

Eurozone Exchange Market

DEFINITION EEM is the money market for borrowing and lending euro currencies that are held in the form of deposits in banks located outside the Eurozone where the currencies are issued as legal tender. The Eurozone, officially called the Euro Area, is a monetary union of 19 of the 28 European Union (EU) member states which have adopted the euro () as their common currency and sole legal tender. The other 9 members of the European Union continue to use their own national currencies. The money market is the Eurocurrency, held in banks outside of the European Union where it is legal tender and is borrowed and lent by banks in Europe. Large firms and extremely wealthy individuals benefit from the Eurocurrency Market who wish to avoid regulatory requirements, tax laws and interest rate caps that are often exist in domestic banking, particularly in the US. The concept, which originated in the region and represents any deposit of foreign currency, does not have anything to do with the European Union or the banks associated with the member countries. Instead, it represents any deposit of foreign currencies into a domestic bank. For example, if the Japanese yen is deposited into a bank in the United States, it is considered to be operating under the auspices of the Eurocurrency market.

II History and Summary

The World War II era created an environment in which a base for this market was formed. Political challenges caused by the Axis Powers meant that there was a limited marketplace for trading in foreign currency. No friendly government operations within the European market place meant the traditional economies of the nations were displaced, along with the currencies. To combat this, and realizing that many American companies were tied to the maintenance of business behind enemy lines, banks around the world began to inject large sums of foreign currency and a new money market was created. On January1, 1999 the Eurozone commenced with 11 Member States. On January1, 2001, one year before the euro had physically entered into circulation Greece was added. In 2004, on January1, Slovenia (2007), Cyprus (2008), Malta (2008), Slovakia (2009), Estonia (2011), Latvia (2014), and Lithuania (2015) joined the Eurozone.After signing the Maastricht treaty in 1992, the new Euro members were obliged to adopt the euro under the terms of their accession treaties. However, the last of the five economic convergence criteria is the exchange rate stability criterion, which requires an ERM-member (European Exchange Rate Mechanism) to be member for a minimum of two years without the presence of "severe tensions". The euro adoption preparation talks in September 2011 between the seven remaining new Member States who had yet to adopt the euro (Bulgaria, Czech Republic, Hungary, Latvia, Lithuania, Poland and Romania), announced that the monetary union (Eurozone) they had thought they joining upon their signing of the accession treaty may in fact end up being a very different union entailing much closer fiscal, economic and political demands. The legal status of the Eurozone changed potentially causing them to conclude that the conditions for their promise to join were no longer valid, which "could force them to stage new referendums regarding euro adoption.

III The Unique Qualities of the Euro Exchange Market

Characteristics of the Eurocurrency Market:

1. As a wholesale rather than retail market means 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 tend to be very short term leading to concerns about risks, 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 and most are traded in multiples of $1 million or more resulting in the CDs being quoted at a discount and at a fixed interest rate but also being quoted at floating interest rates. The Eurocurrency market has short- and medium-term characteristics. Short-term Eurocurrency borrowing has a maturity of less than one year however, it is also possible to borrow 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 slightly cheaper than in domestic markets. Traditionally, loans are made at a certain 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 is characterized in Fig. 9.3 as the Eurocurrency borrowing rate, depends on the credit status of the customer and must be able 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.The LIBID is the bid rate that corresponds to the LIBOR, and the difference between the LIBOR and the LIBID is usually about one eighth of a percentage point. The rate one earns on deposits in the Eurocurrency is usually less than the LIBID, but it is often more than can be earned in the domestic market.

Since the banks deal with a variety of currencies issued by foreign entities, it is difficult for domestic governments to act, particularly in the U.S.The flexible exchange rate system in 1973 was established, however, the U.S. Federal Reserve System was given powers to stabilize lending currencies in the event of a crisis situation. One problem that arises is that these crises are not defined by the regulations, but 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 thus adding to the volatility of the market.

The Eurocurrency market is primarily influenced by the value of the American dollar, since 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.

IV Eurozone Enlargements and Exchange-Rate Regimes for EU Members

The chart below provides a full summary of all applying exchange-rate regimes for EU members, since the European Monetary System with its Exchange Rate Mechanism and the related new common currency ECU was born on March 13, 1979. The euro replaced the ECU 1:1 at the exchange rate markets, on January 1, 1999. During 1979-1999, the D-Mark (Deutsche Mark was the official currency of West Germany 19481990 and unified Germany 19902002 until the adoption of the euro in 2002) functioned as a de facto anchor for the ECU, meaning there was only a minor difference between securing your currency against ECU and securing it against the D-mark.

Bailout provisions

The 20072008 financial crisis prompted a number of reforms in The Eurozone. One was a turn -around of the Eurozone's bailout policy leading to the creation of a specific fund to assist troubled Eurozone states. The European Financial Stability Facility (EFSF) and the European Financial Stability Mechanism (EFSM) were created in 2010 to provide, alongside the International Monetary Fund (IMF), a system and fund to bail out members. Being small and temporary the EFSF and EFSM lacked a basis in the EU treaties. Therefore, it was agreed in 2011 to establish a European Stability Mechanism (ESM) which would be much larger, funded only by Eurozone states (not the EU as a whole as the EFSF/EFSM were) and would have a permanent treaty basis. This creation involved agreeing to an amendment to TEFU Article 136 allowing for the ESM and a new ESM treaty to explain their operations. Successful ratification according to schedule would mean that the ESM would be operational by the time the EFSF/EFSM expired in mid-2013.

V Advantages and Disadvantages of Euro Exchange Market

Global currencies are subjected to identical market laws and values change according to the same factors that influence all other currencies. All countries within the Eurozone share the same currency which is the euro, and are less affected by changes in the euro exchange rate.Advantages out- weigh disadvantages of countries adopting the euro in the Eurozone.

However disadvantages remain. 1 The obliteration of the existing exchange rate fluctuations between a number of currencies and reduction of transaction costs (no other currency is necessary when conducting business or traveling in the Eurozone). The single European currency also stimulates trade activities and free movement of capital, goods and people but these effects should be subject to a profound academic research.

2 Previously, the national economies of the European Union member states sometimes suffered from fluctuations of the local currencies within a common market. The euro exchange rate does not protect countries from currency fluctuations in general but are able to predict and unify the means of exchange in all countries in the Eurozone. 12 countries in the EU witnessed their national currency disappear with more new member states entering the Eurozone gradually and other waiting at the door following the adoption of the euro.

All current members of the Eurozone take advantage of the single currency but they share the disadvantages as well. When the U.S. Federal Reserve releases data showing increasing unemployment rate, falling number of new mortgages and growing number of businesses going bankrupt the consequence will be a falling exchange rate of the U.S. dollar. The same applies to the single European currency, and data released by the European Central Bank also applies to Forex traders around the globe and influences their decisions whether to buy or not to buy the euro on data about the national economies of the countries participating in the Eurozone. So negative signals reported by the French or German economy may result in lowering of the euro exchange rate as a whole despite the fact that economies of all other Eurozone member states are running smoothly.

Some advantages include:

1 The single euro exchange rate is a good thing from a customers point of view. There is no need to exchange your money into a new currency every time you cross a border within the Eurozone.

2 The euro aids currency transfers within and outside the EU and reduces the costs of such transfers.

3The risks of a currency collapse cannot be eliminated but the safety provided by the euro is good enough to reduce such risks to a minimum and to maintain largely predictable euro exchange rate.

4 The main factor that makes the Eurocurrency market so attractive to both depositors and borrowers is its lack of government regulation. This allows banks to offer higher interest rates on Eurocurrency deposits than on deposits made in the home currency, making Eurocurrency deposits attractive to those who have cash to deposit. The lack of regulation also allows banks to charge borrowers a lower interest rate for Eurocurrency borrowings than for borrowings in the home currency, making Eurocurrency loans attractive for those who want to borrow money. In other words, the spread between the Eurocurrency deposit rate and the Eurocurrency lending rate is less than the spread between the domestic deposit and lending rates. Examination of how government regulations raise the costs of domestic banking needs to be understood

Characteristics of the Euro Exchange Market

Compared with its individual member countries, the euro area is a large and much more closed economy. In terms of its share of global GDP, it is the worlds third-largest economy, after the United States and China.As in other highly developed economies, the service sector has the largest share of total output, followed by the industrial sector, while the share of agriculture, fishing and forestry is relatively small. The euro area is also one of the worlds largest economies in terms of population, with almost 340 million people.

Key real economy characteristics of the euro area and other major economic areas in 2014

Sources: For the euro area: ECB, Eurostat, national data and ECB calculations; for the Unites States, Japan and China: BIS, IMF, OECD, Reuters and national sources.*)2013 figures Notes: (1)Euro data, US and Japan: annual average; China: end of the year data.(2)Data for US, Japan and China are converted into euro at OECD purchasing power parities (PPPs).(3)Ratio of the labor force to the working age population (aged 15 to 64). US: the proportion of the civilian non-institutional population (aged 16 to 64) either at work or actively seeking work. Annual average.(4)Ratio of persons employed to the working age population (aged 15 to 64). US: the proportion of the civilian non-institutional population (aged 16 to 64) at work. Annual average.(5)General government data for China are not directly comparable with the other major economic areas.(6)General government debt consists of deposits, debt securities and loans outstanding at nominal value and is consolidated within the general government sector. Chinese data follow a different methodology and are not directly comparable. Year-end.(7)European definition also for US and JP.(8)Euro area: based on extra-euro area transactions.

UnitEuro area(9)United StatesJapanChina

Population(1)millions339.4319.2127.11,360.7*)

GDP (share of world GDP in PPP)%12.216.14.416.3

GDP per capita (2) thousands 29.3*)41.2*)28.2*)9.2*)

Value added by economic activity

Agriculture, fishing, forestry% of total 1.61.21.2*)10.0*)

Industry (including constructions)% of total24.518.424.5*)43.9*)

Services (including non-market services)% of total73.880.474.3*)46.1*)

Unemployment rate (share of the labour force)%11.66.23.64.1*)

Labour force participation rate (3)%72.372.775.5-

Employment rate(4)%63.868.172.8-

General government(5)

Surplus (+) or deficit (-)% of GDP-2.4-5.6*)-8.5*)-1.1

Gross debt (6)% of GDP92.096.3223.341.1

Revenue% of GDP46.533.1*)33.9*)28.5

of which direct taxes% of GDP12.512.6*)8.7*)5.0

of which indirect taxes% of GDP13.36.9*)8.6*)13.7

of which social contributions% of GDP15.56.6*)13.0*)-

Expenditure(7)% of GDP48.738.7*)42.3*)29.6

of which final consumption% of GDP21.115.2*)20.6*)-

of which social payments% of GDP24.014.3*)22.8*)-

External(8)

Exports of goods% of GDP19.49.5*)15.222.5*)

Exports of goods and services% of GDP26.313.6*)18.724.8*)

Import of goods% of GDP17.013.7*)17.318.8*)

Import of goods and services% of GDP23.216.4*)21.522.3*)

Exports (share of world exports, including intra-euro area trade)%24.88.83.712.7

Exports (share of world exports, excluding intra-euro area trade)%15.910.04.314.4

Current account balance% of GDP2.0-2.4*)0.51.9*)

Main Factors that Influence Exchange Rates of Euro 1. InflationIf inflation in the Euro Zone is relatively lower than elsewhere, then Euro exports will become more competitive and there will be an increase in demand for Pound Sterling to buy Euro goods. Also foreign goods will be less competitive and so Euro citizens will buy less imports.Therefore countries withlower inflation ratestend to see anappreciationin the value of their currency.2. Interest RatesIf Euro interest rates rise relative to elsewhere, it will become more attractive to deposit money in the Euro. You will get a better rate of return from saving in Euro banks, therefore demand for Sterling will rise. This is known as hot money flows and is an important short run factor in determining the value of a currency.Higher interest ratescause anappreciation.3. SpeculationIf speculators believe the sterling will rise in the future, they will demand more now to be able to make a profit. This increase in demand will cause the value to rise. Therefore movements in the exchange rate do not always reflect economic fundamentals, but are often driven by the sentiments of the financial markets. For example, if markets see news which makes an interest rate increase more likely, the value of the pound will probably rise in anticipation.4. Change in CompetitivenessIf British goods become more attractive and competitive this will also cause the value of the Exchange Rate to rise. This is important for determining the long run value of the Pound. This is similar factor to low inflation.5. Relative strength of other currencies.In 2010 and 2011, the value of the Japanese Yen and Swiss Franc rose because markets were worried about all the other major economies US and EU. Therefore, despite low interest rates and low growth in Japan, the Yen kept appreciating.6. Balance of PaymentsA deficit on the current account means that the value of imports (of goods and services) is greater than the value of exports. If this is financed by a surplus on the financial / capital account then this is OK. But a country who struggles to attract enough capital inflows to finance a current account deficit, will see a depreciation in the currency. (For example current account deficit in US of 7% of GDP was one reason for depreciation of dollar in 2006-07)7. Government Debt.Under some circumstances, the value of government debt can influence the exchange rate. If markets fear a government may default on its debt, then investors will sell their bonds causing a fall in the value of the exchange rate. For example, Iceland debt problems in 2008, caused a rapid fall in the value of the Icelandic currency.For example, if markets feared the US would default on its debt, foreign investors would sell their holdings of US bonds. This would cause a fall in the value of the dollar. See:US dollar and debt8. Government InterventionSome governments attempt to influence the value of their currency. For example, China has sought to keep its currency undervalued to make Chinese exports more competitive. They can do this by buying US dollar assets which increases the value of the US dollar to Chinese Yuan. see also:Chinese Currency|Swiss Franc pegged against Euro9. Economic growth / recessionA recession may cause a depreciation in the exchange rate because during a recession interest rates usually fall. However, there is no hard and fast rule. It depends on several factors. See:Impact of recession on currency.Example Fall in Value of Sterling 2007 Jan 2009

During this period, the value of Sterling fell over 20%. This was due to: Restoring Euros lost competitiveness. Euros had large current account deficit in 2007 Bank of England cut interest rates to 0.5% in 2008. Recession hit Euro economy hard. Markets expected interest rates in Euro to stay low for a considerable time. Bank of England pursued quantitative easing (increasing money supply). This raised prospect of future inflation, making Euro bonds less attractive.

References

https://en.wikipedia.org/wiki/Eurocurrency

http://www.reuters.com/finance/markets/europe

http://www.nasdaq.com/earnings/earnings-calendar.aspx