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London Interbank Market. Some large London banks act as brokers in the interbank Eurodollar market. Recall that fed funds are used by banks to make up temporary shortfalls in their reserves. Eurodollars are an alternative to fed funds. Banks from around the world buy and sell overnight funds in this market. The rate paid by banks buying funds is the London interbank bid rate (LIBID). Funds are offered for sale in this market at the London interbank offer rate (LIBOR). Because many banks participate in this market, it is extremely competitive. The spread between the bid and the offer rate seldom exceeds 0.125%. Eurodollar deposits are time deposits, which means that they cannot be withdrawn for a specified period of time. Although the most common time period is overnight, different maturities are available. Each maturity has a different rate. The overnight LIBOR and the fed funds rate tend to be very close to each other. This is because they are near-perfect substitutes. Suppose that the fed funds rate exceeded the overnight LIBOR. Banks that need to borrow funds will borrow overnight Eurodollars, thus tending to raise rates, and banks with funds to lend will lend fed funds, thus tending to lower rates. The demand and supply pressure will cause a rapid adjustment that will drive the two rates together. At one time, most short-term loans with adjustable interest rates were tied to the Treasury bill rate. However, the market for Eurodollars is so broad and deep that it has recently become the standard rate against which others are compared. For example, the U.S. commercial paper market now quotes rates as a spread over LIBOR, rather than over the T-bill rate. The Eurodollar market is not limited to London banks anymore. The primary brokers in this market maintain offices in all of the major financial centers worldwide.

Eurodollar Certificates of Deposit. Because Eurodollars are time deposits with fixed maturities, they are to a certain extent illiquid. As usual, the financial markets created new types of securities to combat this problem. These new securities were transferable negotiable certificates of deposit (negotiable CDs). Because most Eurodollar deposits have a relatively short term to begin with, the market for Eurodollar negotiable CDs is relatively limited, comprising less than 10% of the amount of regular Eurodollar deposits. The market for the negotiable CDs is still thin.

Other Eurocurrencies. The Eurodollar market is by far the largest short-term security market in the world. This is due to the international popularity of the U.S. dollar for trade. However, the market is not limited to dollars. It is possible to have an account denominated in Japanese yen held in a London or New York bank. Such an account would be termed a Euroyen account. Similarly, you may also have Euromark or Europeso accounts denominated in marks and pesos, respectively, and held in various banks around the world. Keep in mind that if market participants have a need for a particular security and are willing to pay for it, the financial markets stand ready and willing to create it.

Date: 2015-12-24; view: 975