Lecture Notes for 15.436

International Financial Markets

Chapter 10

The international money and bond market

Fall 1999

Raman Uppal

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International Finance: Chapter 10 – International bond market

Fall 1999

Road Map
1 Part A Part B Part C 10 11 Part D Part E Preliminaries: Conventions, notation, and basic concepts Currency markets and the behavior of the exchange rate Markets for exchange-rate derivatives and the hedging decision Markets for fixed income securities and the financing decision International money and bond markets Swap markets Markets for equities and the portfolio investment decision Foreign direct investment

Fall 1999

International Finance: Chapter 10 – International bond market

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2. After the second world war, the gbp was chronically overvalued, and the UK had serious balance of payments problems. So the UK government limited foreign borrowing in GBP. As a result, UK banks borrowed usd (that is accepted usd deposits), which were then used to extend usd loans instead of gbp loans. 3. Several regulations imposed by the US government imposed interest ceilings on domestic usd deposits; thus, US corporations and investors preferred to place usd deposits in Europe (where they obtained better rates); and these dollars were then re-lent to non-US borrowers, who were not allowed to borrow usd in the US. 4. Nixon’s “voluntary” (and, later on, mandatory) curbs on capital exports had the unexpected result that US multinationals stopped depositing their funds in the US, fearing that they would be blocked there. Instead, these funds were deposited in euro-markets.

Fall 1999

International Finance: Chapter 10 – International bond market

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• The explanation for the long-term success of these offshore markets is their lower bid-offer spread (that is, the difference between interest rates on loans and deposits), which in turn reflect the lower costs of off-shore banking as compared to domestic banking. There reasons for the low operating costs are:

1. The offshore market is essentially a wholesale market, where large volumes of