Misplaced Pages

#553446

56-601: Eurodollars are U.S. dollars held in time deposit accounts in banks outside the United States . The term was originally applied to U.S. dollar accounts held in banks situated in Europe, but it expanded over the years to cover US dollar accounts held anywhere outside the U.S. Thus, a U.S. dollar-denominated deposit in Tokyo or Beijing would likewise be deemed a Eurodollar deposit (sometimes an Asiadollar ). More generally,

112-424: A balance sheet hedge, since translation exposure arises from discrepancies between net assets and net liabilities solely from exchange rate differences. Following this logic, a firm could acquire an appropriate amount of exposed assets or liabilities to balance any outstanding discrepancy. Foreign exchange derivatives may also be used to hedge against translation exposure. A common technique to hedge translation risk

168-429: A central bank in a foreign country raises interest rates or the legislature increases taxes, the return on investment will be significantly impacted. As a result, economic risk can be reduced by utilizing various analytical and predictive tools that consider the diversification of time, exchange rates, and economic development in multiple countries, which offer different currencies, instruments, and industries. When making

224-455: A comprehensive economic forecast, several risk factors should be noted. One of the most effective strategies is to develop a set of positive and negative risks that associate with the standard economic metrics of an investment. In a macroeconomic model, major risks include changes in GDP , exchange-rate fluctuations, and commodity-price and stock-market fluctuations. It is equally critical to identify

280-435: A corporation's checking account into an overnight investment option to effectively earn interest on those funds. Banks usually allow these funds to be swept either into money market funds , or alternately they may be used for bank funding by transferring to an offshore branch of a bank. Today, commercial banks continue to offer many forms of sweep services which tend to give a higher rate of return whilst smaller entities may use

336-595: A dominant world currency began when the Soviet Union wanted better interest rates on their Eurodollars and convinced an Italian banking cartel to give them more interest than could have been earned if the dollars were deposited in the U.S. The Italian bankers then had to find customers ready to borrow the Soviet dollars and pay above the U.S. legal interest-rate caps for their use, and were able to do so; thus, Eurodollars began to be used increasingly in global finance. By

392-457: A financial risk management technique called value at risk (VaR), which examines the tail end of a distribution of returns for changes in exchange rates, to highlight the outcomes with the worst returns. Banks in Europe have been authorized by the Bank for International Settlements to employ VaR models of their own design in establishing capital requirements for given levels of market risk . Using

448-429: A firm maintains financial statements in a currency other than the domestic currency of the consolidated entity. Investors and businesses exporting or importing goods and services, or making foreign investments, have an exchange-rate risk but can take steps to manage (i.e. reduce) the risk. Many businesses were unconcerned with, and did not manage, foreign exchange risk under the international Bretton Woods system . It

504-514: A firm's reported earnings and therefore its stock price. Translation risk deals with the risk to a company's equities, assets, liabilities, or income, any of which can change in value due to fluctuating foreign exchange rates when a portion is denominated in a foreign currency. A company doing business in a foreign country will eventually have to exchange its host country's currency back into their domestic currency. When exchange rates appreciate or depreciate, significant, difficult-to-predict changes in

560-443: A foreign currency. To realize the domestic value of its foreign-denominated cash flows, the firm must exchange, or translate, the foreign currency for domestic. When firms negotiate contracts with set prices and delivery dates in the face of a volatile foreign exchange market, with rates constantly fluctuating between initiating a transaction and its settlement, or payment, those firms face the risk of significant loss. Businesses have

616-547: A higher interest rate. The use of Eurodollars has been on a consistent decline. There is no connection with the euro currency of the European Union . After World War II , the quantity of physical U.S. dollar banknotes outside the United States increased significantly, as a result of both the dollar funding of the Marshall Plan and from dollar proceeds of European exports to the U.S., which had become

SECTION 10

#1732765555554

672-407: A mind for lowering costs, using a policy of flexible sourcing in its supply chain management, diversifying its export market across a greater number of countries, or by implementing strong research and development activities and differentiating its products in pursuit of less foreign-exchange risk exposure. By putting more effort into researching alternative methods for production and development, it

728-593: A project, a company's operating costs, debt obligations, and the ability to predict economically unsustainable circumstances should be thoroughly calculated in order to produce adequate revenues in covering those economic risks. For instance, when an American company invests money in a manufacturing plant in Spain, the Spanish government might institute changes that negatively impact the American company's ability to operate

784-491: A risk arises from the potential of a firm to suddenly face a transnational or economic foreign-exchange risk contingent on the outcome of some contract or negotiation. For example, a firm could be waiting for a project bid to be accepted by a foreign business or government that, if accepted, would result in an immediate receivable. While waiting, the firm faces a contingent risk from the uncertainty as to whether or not that receivable will accrue. Companies will often participate in

840-411: A self-sustaining foreign entity. An integrated foreign entity operates as an extension of the parent company, with cash flows and business operations that are highly interrelated with those of the parent. A self-sustaining foreign entity operates in its local economic environment, independent of the parent company. Both integrated and self-sustaining foreign entities operate use functional currency , which

896-437: A sweep account simply out of convenience. Time deposit Unlike a certificate of deposit and bonds , a time deposit is generally not negotiable ; it is not transferable by the depositor, so that depositors need to deal with the financial institution when they need to prematurely cash out of the deposit. Time deposits enable the bank to invest the funds in higher-earning financial products. In some countries, including

952-424: A transaction involving more than one currency. In order to meet the legal and accounting standards of processing these transactions, companies have to translate foreign currencies involved into their domestic currency. A firm has transaction risk whenever it has contractual cash flows (receivables and payables) whose values are subject to unanticipated changes in exchange rates due to a contract being denominated in

1008-412: Is a financial risk that exists when a financial transaction is denominated in a currency other than the domestic currency of the company. The exchange risk arises when there is a risk of an unfavourable change in exchange rate between the domestic currency and the denominated currency before the date when the transaction is completed. Foreign exchange risk also exists when the foreign subsidiary of

1064-419: Is able to set a rate that is "at-worst" for the transaction. If the option expires and it's out-of-the-money, the company is able to execute the transaction in the open market at a favorable rate. If a company decides to take out a forward contract, it will set a specific currency rate for a set date in the future. Currency invoicing refers to the practice of invoicing transactions in the currency that benefits

1120-415: Is affected by exchange-rate movements. As all firms generally must prepare consolidated financial statements for reporting purposes, the consolidation process for multinationals entails translating foreign assets and liabilities, or the financial statements of foreign subsidiaries, from foreign to domestic currency. While translation risk may not affect a firm's cash flows, it could have a significant impact on

1176-426: Is also set to receive a similar amount from another order, it might move the date of receipt of the sum to coincide with the payment. This delay would be termed lagging. If the receipt date were moved sooner, this would be termed leading the payment. Another method to reduce exposure transaction risk is natural hedging (or netting foreign-exchange exposures), which is an efficient form of hedging because it will reduce

SECTION 20

#1732765555554

1232-400: Is always the chance that exchange rates will move in your favor. However, the standardization of futures can be a part of what makes them attractive to some: they are well-regulated and are traded only on exchanges. Two popular and inexpensive methods companies can use to minimize potential losses is hedging with options and forward contracts . If a company decides to purchase an option, it

1288-427: Is called balance-sheet hedging, which involves speculating on the forward market in hopes that a cash profit will be realized to offset a non-cash loss from translation. This requires an equal amount of exposed foreign currency assets and liabilities on the firm's consolidated balance sheet. If this is achieved for each foreign currency, the net translation exposure will be zero. A change in the exchange rates will change

1344-409: Is possible that a firm may discover more ways to produce their outputs locally rather than relying on export sources that would expose them to the foreign exchange risk. By paying attention to currency fluctuations around the world, firms can advantageously relocate their production to other countries. For this strategy to be effective, the new site must have lower production costs. There are many factors

1400-452: Is the currency of the primary economic environment in which the subsidiary operates and in which day-to-day operations are transacted. Management must evaluate the nature of its foreign subsidiaries to determine the appropriate functional currency for each. There are three translation methods: current-rate method, temporal method, and U.S. translation procedures. Under the current-rate method, all financial statement line items are translated at

1456-483: The Argentine peso crisis , led to substantial losses from foreign exchange and led firms to pay closer attention to their foreign exchange risk. A firm has economic risk (also known as forecast risk ) to the degree that its market value is influenced by unexpected exchange-rate fluctuations, which can severely affect the firm's market share with regard to its competitors, the firm's future cash flows, and ultimately

1512-407: The euro- prefix can be used to indicate any currency held in a country where it is not the official currency, broadly termed " eurocurrency ", for example, Euroyen or even Euroeuro . Eurodollars have different regulatory requirements that dollars held in U.S. banks. Eurodollars can be riskier than assets held in U.S. banks, which include at least partial deposit insurance, and as a result, demand

1568-440: The "current" exchange rate. Under the temporal method, specific assets and liabilities are translated at exchange rates consistent with the timing of the item's creation. The U.S. translation procedures differentiate foreign subsidiaries by functional currency , not subsidiary characterization. If a firm translates by the temporal method, a zero net exposed position is called fiscal balance. The temporal method cannot be achieved by

1624-642: The Soviet Union during the Cold War , following the invasion of Hungary in 1956 , as the Soviet Union feared that its deposits in North American banks would be frozen as a sanction. It therefore decided to move some of its U.S. dollars held directly in North American banks to the Moscow Narodny Bank , an English limited liability company registered in London in 1919, whose shares were owned by

1680-515: The Soviet Union. The English bank would then re-deposit the dollars into U.S. banks. Thus although in reality the dollars never left North America, there would be no chance of the U.S. confiscating that money, because now it belonged legally to the British bank and not directly to the Soviets, the beneficial owners . Accordingly, on 28 February 1957, the sum of $ 800,000 was duly transferred, creating

1736-483: The United States, time deposits are not subject to the banks’ reserve requirements , on the basis that the funds cannot be withdrawn at short notice. In some countries, time deposits are guaranteed by the government or protected by deposit insurance . Time deposits normally earn interest , which is normally fixed for the duration of the term and payable upon maturity, though some may be paid periodically during

Eurodollar - Misplaced Pages Continue

1792-755: The VaR model helps risk managers determine the amount that could be lost on an investment portfolio over a certain period of time with a given probability of changes in exchange rates. Firms with exposure to foreign-exchange risk may use a number of hedging strategies to reduce that risk. Transaction exposure can be reduced either with the use of money markets , foreign exchange derivatives —such as forward contracts , options , futures contracts , and swaps —or with operational techniques such as currency invoicing, leading and lagging of receipts and payments, and exposure netting . Each hedging strategy comes with its own benefits that may make it more suitable than another, based on

1848-541: The amount exchange rates deviate, on average, from the mean exchange rate in a probabilistic distribution . A higher standard deviation would signal a greater currency risk. Because of its uniform treatment of deviations and for the automatically squaring of deviation values, economists have criticized the accuracy of standard deviation as a risk indicator. Alternatives such as average absolute deviation and semivariance have been advanced for measuring financial risk. Practitioners have advanced, and regulators have accepted,

1904-448: The current-rate method because total assets will have to be matched by an equal amount of debt, but the equity section of the balance sheet must be translated at historical exchange rates. If foreign-exchange markets are efficient —such that purchasing power parity , interest rate parity , and the international Fisher effect hold true—a firm or investor need not concern itself with foreign exchange risk. A deviation from one or more of

1960-497: The end of 1970, 385 billion eurodollars were held in offshore bank accounts. These deposits were lent on as U.S. dollar loans to businesses in other countries where interest rates on loans were perhaps much higher in the local currency, and where the businesses were exporting to the U.S. and receiving payment in dollars, thereby avoiding foreign exchange risk on their funding arrangements. Several factors led eurodollars to overtake certificates of deposit (CDs) issued by U.S. banks as

2016-484: The firm's value. Economic risk can affect the present value of future cash flows. An example of an economic risk would be a shift in exchange rates that influences the demand for a good sold in a foreign country. Another example of an economic risk is the possibility that macroeconomic conditions will influence an investment in a foreign country. Macroeconomic conditions include exchange rates, government regulations, and political stability. When financing an investment or

2072-447: The firm. This does not necessarily eliminate foreign exchange risk, but rather moves its burden from one party to another. A firm can invoice its imports from another country in its home currency, which would move the risk to the exporter and away from itself. This technique may not be as simple as it sounds; if the exporter's currency is more volatile than that of the importer, the firm would want to avoid invoicing in that currency. If both

2128-659: The first eurodollar account was created in France in favour of Communist China , which in 1949 managed to move almost all of its U.S. dollar banknotes to the Soviet-owned Banque Commerciale pour l'Europe du Nord in Paris before the United States froze its remaining U.S. situated assets during the Korean War. In another version, the first eurodollar account was created by an English bank in favour of

2184-453: The first eurodollars. Initially dubbed "Eurobank dollars" after the bank's telex address, they eventually became known as "eurodollars" as such deposits were at first held mostly by European banks and financial institutions . City of London banks, such as Midland Bank , now part of HSBC , and their offshore holding companies also played a major role in holding the deposits. In the mid-1950s, Eurodollar trading and its development into

2240-408: The goal of making all monetary transactions profitable ones, and the currency markets must thus be carefully observed. Applying public accounting rules causes firms with transnational risks to be impacted by a process known as "re-measurement". The current value of contractual cash flows are remeasured on each balance sheet. A firm's translation risk is the extent to which its financial reporting

2296-411: The importer and exporter want to avoid using their own currencies, it is also fairly common to conduct the exchange using a third, more stable currency. If a firm looks to leading and lagging as a hedge, it must exercise extreme caution. Leading and lagging refer to the movement of cash inflows or outflows either forward or backward in time. For example, if a firm must pay a large sum in three months but

Eurodollar - Misplaced Pages Continue

2352-525: The largest consumer market. As a result, large amounts of U.S. dollar banknotes were in the custody of foreign banks outside the United States. Some foreign countries, including the Soviet Union , also had deposits in U.S. dollars in American banks, evidenced by certificates of deposit. Various narrations are given of the creation of the first eurodollar account, but most trace back to Communist governments keeping dollar deposits abroad. In one version,

2408-523: The margin that is taken by banks when businesses exchange currencies; and it is a form of hedging that is easy to understand. To enforce the netting, there will be a systematic-approach requirement, as well as a real-time look at exposure and a platform for initiating the process, which, along with the foreign cash flow uncertainty, can make the procedure seem more difficult. Having a back-up plan, such as foreign-currency accounts, will be helpful in this process. The companies that deal with inflows and outflows in

2464-617: The nature of the business and risks it may encounter. Forward and futures contracts serve similar purposes: they both allow transactions that take place in the future—for a specified price at a specified rate—that offset otherwise adverse exchange fluctuations. Forward contracts are more flexible, to an extent, because they can be customized to specific transactions, whereas futures come in standard amounts and are based on certain commodities or assets, such as other currencies. Because futures are only available for certain currencies and time periods, they cannot entirely mitigate risk, because there

2520-716: The plant, such as changing laws or even seizing the plant, or to otherwise make it difficult for the American company to move its profits out of Spain. As a result, all possible risks that outweigh an investment's profits and outcomes need to be closely scrutinized and strategically planned before initiating the investment. Other examples of potential economic risk are steep market downturns, unexpected cost overruns, and low demand for goods. International investments are associated with significantly higher economic risk levels as compared to domestic investments. In international firms, economic risk heavily affects not only investors but also bondholders and shareholders, especially when dealing with

2576-481: The primary private short-term money market instruments by the 1980s, including: In 1997, nearly 90% of all international loans were made this way. In December 1985, the Eurodollar market was estimated by J.P. Morgan & Co. Guaranty bank to have a net size of 1.668 trillion. In 2016, the Eurodollar market size was estimated at around 13.833 trillion. The Eurodollar futures contract was launched in 1981. It

2632-538: The principal can be either paid back to the depositor (usually by a deposit into a bank account designated by the depositor) or rolled over for another term. Interest may be paid into the same account as the principal or to another bank account or rolled over with the principal to the next term. The money deposited normally can be withdrawn before maturity, but a significant penalty will normally be payable. Foreign exchange risk Foreign exchange risk (also known as FX risk , exchange rate risk or currency risk )

2688-572: The sale and purchase of foreign government bonds. However, economic risk can also create opportunities and profits for investors globally. When investing in foreign bonds, investors can profit from the fluctuation of the foreign-exchange markets and interest rates in different countries. Investors should always be aware of possible changes by the foreign regulatory authorities. Changing laws and regulations regarding sizes, types, timing, credit quality, and disclosures of bonds will immediately and directly affect investments in foreign countries. For example, if

2744-625: The same currency will experience efficiencies and a reduction in risk by calculating the net of the inflows and outflows, and using foreign-currency account balances that will pay in part for some or all of the exposure. Translation exposure is largely dependent on the translation methods required by accounting standards of the home country. For example, the United States Federal Accounting Standards Board specifies when and where to use certain methods. Firms can manage translation exposure by performing

2800-451: The stability of the economic system. Before initiating an investment, a firm should consider the stability of the investing sector that influences the exchange-rate changes. For instance, a service sector is less likely to have inventory swings and exchange-rate changes as compared to a large consumer sector. A firm has contingent risk when bidding for foreign projects, negotiating other contracts, or handling direct foreign investments. Such

2856-473: The term, especially with longer-term deposits. Generally, the longer the term and the larger the deposit amount the higher the interest rate that will be offered. The interest paid on a time deposit tends to be higher than on an at-call savings account, but tends to be lower than that of riskier products such as stocks or bonds. Some banks offer market-linked time deposit accounts which offer potentially higher returns while guaranteeing principal. At maturity,

SECTION 50

#1732765555554

2912-526: The three international parity conditions generally needs to occur for there to be a significant exposure to foreign-exchange risk. Financial risk is most commonly measured in terms of the variance or standard deviation of a quantity such as percentage returns or rates of change. In foreign exchange, a relevant factor would be the rate of change of the foreign currency spot exchange rate. A variance, or spread, in exchange rates indicates enhanced risk, whereas standard deviation represents exchange-rate risk by

2968-495: The value of exposed liabilities to an equal degree but opposite to the change in the value of exposed assets. Companies can also attempt to hedge translation risk by purchasing currency swaps or futures contracts. Companies can also request clients to pay in the company's domestic currency, whereby the risk is transferred to the client. Firms may adopt strategies other than financial hedging for managing their economic or operating exposure, by carefully selecting production sites with

3024-497: The value of the foreign currency can occur. For example, U.S. companies must translate Euro, Pound, Yen, etc., statements into U.S. dollars. A foreign subsidiary's income statement and balance sheet are the two financial statements that must be translated. A subsidiary doing business in the host country usually follows that country's prescribed translation method, which may vary, depending on the subsidiary's business operations. Subsidiaries can be characterized as either an integrated or

3080-557: Was not until the switch to floating exchange rates , following the collapse of the Bretton Woods system , that firms became exposed to an increased risk from exchange rate fluctuations and began trading an increasing volume of financial derivatives in an effort to hedge their exposure. The currency crises of the 1990s and early 2000s, such as the Mexican peso crisis , Asian currency crisis , 1998 Russian financial crisis , and

3136-738: Was the first cash-settled futures contract. It traded on the Chicago Mercantile Exchange . Eurodollar futures were an instrument used to wager on Federal Reserve policy or to hedge the direction of short-term interest rates. In April 2023, after the Libor scandal , they were eliminated and transitioned to SOFR -based contracts. In United States banking , Eurodollars are used for what are known as " sweeps ". Until 21 July 2011, banks were not allowed to pay interest on corporate transactional accounts . To accommodate larger businesses, banks may automatically transfer, or sweep, funds from

#553446