commercial paper market, the secondary market for Euro commercial paper is relatively
underdeveloped. If a client needs to sell paper before maturity he will almost always sell
it to the dealer who sold him the paper initially. Any trading usually occurs in the first
few days after the paper is issued. Trading is most frequent in the sovereign sector,
which accounts for about 20 percent of Euro commercial paper outstanding.
CREATION OF EURODOLLARS
Eurodollar markets are well organized, very efficient, and very large. They serve
a number of valuable purposes for multinational business operations. Eurodollars are a
convenient money market device for multinational firms to hold their excess liquidity.
Eurodollars are a major source of short-term loans to finance corporate working capital
needs and foreign trade. Many multinational companies and governments have learned
to employ the Eurodollar market as readily as they do the domestic or banking system.
The major sources of Eurodollars are (1) the growing dollar reserves of oil-exporting
countries, (2) foreign governments or businessmen who prefer to hold dollars outside the
United States, (3) foreign banks with dollars in excess of current needs, and (4)
multinational companies with excess cash balances. Since the 1974 oil crisis, oil-
exporting countries have had enough leverage on the worldwide oil supply to impose a
major price escalation. As a result, the Middle East, where more than half of the world’s
known oil reserves are located, has acquired enormous economic wealth and has become
the important source of Eurodollars. Once Eurodollars come into existence, they can
create themselves through the lending and investing activities of commercial banks. T-
accounts may be used to illustrate such Eurodollar creation.
Example – 1
Assume that the International Trading Company holds $1,000 on deposit in a
New York bank. If the reserve requirement is 20 percent, the $1,000 deposit will be
reflected in the books of the New York bank, the International Trading Company, and the
Federal Reserve Bank of New York as follows:
Cash flows in a commercial bank involve four major elements of information: (1)
currency, (2) institution and location, (3) maturity date, and (4) interest rate. To better
understand how bank transfers take place and how Eurodollars come into existence, let us
examine a few transactions.
Step 1. Assume that the International Trading Company decides to transfer its
$1,000 deposit from the New York bank to a London bank. Let us further assume that
the International Trading Company decides to maintain its dollars in a dollar-
denominated 90-day deposit account at the going rate with the London bank. This
situation will be reflected in the books of the New York bank, the London bank, the
London bank, and the International Trading Company as follows: