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Corporate Finance
Management
Euro Currency System
Respectable Teacher:
Professor Osman Altay Students:
Fatemeh Hashemi 093014007
Fall 2010
official currency of the European Union.
Eleven member states have adopted it collectively known as
Eurozone.(Austria, Belgium, Cyprus, Finland, France, Germany,
Greece, Ireland, Italy, etc.)
Taking official estimates of 2007 GDP, the Eurozone is the 2nd
largest economy in the world.
The euro was introduced to world financial markets as an
currency in 1999 and launched coin and Banknote on 1st,
January 2002.
All nations that have joined the EU since the 1993
implementation of the Maastricht Treaty
The euro sign (€) is the currency sign used for the euro the
official currency of the European Union(EU).
The design was presented to the public by the European
Commission on 12th December , 1996.
The international three-letter code (according to ISO standard
ISO 4217) for the euro is EUR
Maastricht Treaty
Also known as Treaty on European union
Signed on 7 February 1992 between members
of European community
Led to the creation of EURO.
EUROPEAN MONETARY UNION
EMU is the agreement among the participating member
states of the European Union to adopt a single currency and
monetary system.
Eleven countries have been selected as the members of EMU.
As part of the EMU, these eleven countries now make up the
world's second-largest economy, after the United States
Greece and Sweden, failed to meet the convergence
requirements in time to join the EMU in the first round.
Sweden failed to satisfy two of the conditions:
laws governing Sweden's central bank were not compatible
with the Maastricht Treaty and the currency exchange rates in
Sweden were not sufficiently stable for the previous two years.
Greece failed to meet all of the requirements
European Monetary Institute
The European Monetary Institute
(EMI) was the forerunner of the
European Central Bank(ECB).
It encouraged cooperation between
the national banks of the member
states of the EU
Further budget constraints are
required in countries ( Italy and
Belgium) meet the requirements of
the pact.
CONVERGENCE CRITERIA
Price stability: Inflation rate should not exceed 1.5% that of three best performing member state.
Annual government deficit: the ratio of the annual government deficit to gross domestic product (GDP) must not exceed 3%
Government debt: the ratio of gross government debt to GDP must not exceed 60% at the end of the preceding financial year.
Long-term interest rates. In practice, the nominal long-term interest rate must not exceed by more than 2 percentage points that of, at most, the three best-performing Member States
• SWITCH TO THE EURO AT VARYING SPEEDS
• Banking for individuals will probably switch to Euros at a last stage
• Done largely in local currency up to final changeover
• Corporate banking may well start using earlier
• Adoption of Euro in corporate sector
• Plan of large companies to adopt euro as company currency
• Expected their customers and suppliers to use Euros in transactions
• Internationally oriented medium sized companies will probably also turn
quickly to new currency in many of their functions
• Smaller domestically oriented companies, self employed and households will
keep more or less to national currency until euro coins or notes and coins are
introduced
Public sector in Germany brings up rear
•German public sector didn‟t planned to switch to euro until end of
2001
•Possible to make non cash payments in Euro ex. tax
•Companies were particularly concerned to pay income and
corporation tax returns in DEM until 2001
•Preferred to use Euro right earlier
Shortening of cash changeover phase in
Germany
•In order to minimize the burden on the retail sector
•Banks and retailers continue to give out DEM coin they receive as
can be used for any vending machine
THE LEGAL FRAMEWORK FOR THE
CURRENCY CHANGEOVER
Based on two regulationsFirst regulation
•Based on article 235 of the EC treaty took effect on
June 20th ,1997 applied to all EU countries
•The existing contracts will remain in force with all
rights and obligations provided no other agreement has
been made after the advent of new currency
•Neither investors nor debtors holding long term
contracts will enjoy advantage or suffer disadvantage
through changeover of currency
Second regulation
•Based on article 109 of the treaty-on the introduction of the
euro was passed during the May 1998
•Established principle that who wants to use the euro can
but no one can be forced to (UK,Sweden,Denmark)
•Determines the legal status of euro vs. the national
currencies
•Euro EG opened company,stock exchange,
accounting¤cy law to the Euro
•Paved way for changeover on the financial markets &
exchanges
that lead companies to adjust their accounts,equity capital
structures
• EUROPEAN ECONOMIC AND MONETARY UNION (EMU):
• EMU consists three stages
• 1ST Stage(1 July 1990 to 31 December 1993):
The Treaty of Maastricht in 1992 establishes the completion of the EMU as a formal objective and sets a number of economic convergence criteria, concerning the inflation rate, public finances, interest rates and exchange rate stability.
The treaty enters into force on the 1 November 1993.
• 2nd stage(1 January 1994 to 31 December 1998):
The European Monetary Institute is established as the forerunner of the European Central Bank
THE EUROPEAN CENTRAL BANK
On 16 December 1995, details such as the name of the new currency (the euro) as well as the duration of the transition periods are decided.
New exchange rate mechanism (ERM II) is set up to provide stability between the euro and the national currencies of countries that haven't yet entered the euro zone
The 11 initial countries that will participate in the third stage from 1 January 1999 are selected.
On 1 June 1998, the European Central Bank(ECB) is created
3rd Stage(1 January 1999 and continuing)
From the start of 1999, the euro is now a real currency, and a single monetary policy is introduced under the authority of the ECB.
THE EUROPEAN CENTRAL BANK
ECB FUNCTIONING MECHANISM
• ECB working procedures are segregated into three parts:
• 1. GOVERNMENTAL
• 2. EXECUTIVE SECTION
• 3. GENERAL BODY
FUNCTIONS OF EUROPEAN CENTRAL BANK (ECB)
To maintain Price stability
Implement the Monetary policy
Issuance of euro banknotes
ECB’S MINIMUM RESERVE SYSTEM
The main features of the minimum reserve system, which was specified in November 1998 are:
The reserve base will comprise bank deposits, debt securities issued and money market paper. Repos, deposits and debt securities with a maturity of more than two years will not be subject to minimum reserve requirements.
The reserve ratios will be in the range of between 1.5% and 2.5%.
IMPLICATION OF FINANCIAL MARKETS
Consequences for the bond markets
• Outstanding bonds denominated in currencies of participating
countries, in ECU.
• Bonds issued by governments, banks, company and other issuers.
• It will be equivalent to 50% of the dollar bond market and 130%
of
yen bond market
• Scope for financing and investment provide new opportunities
for
market participants
• The three largest country make up more than three-quarters of
the
aggregate bond market
• Growth of overall market being neglected as the countries
continue
to consolidate the government finances.
Yields not uniform
• Highly liquid segment maintained by a single borrower
compared to the U.S bill market
• Yields determined by monetary and fiscal policy
• The development of economy and international capital flows
due to inflation expectations
• Yields differential between sovereign issuers will small
• Countries were expected to revalue were rewarded with lower
yields
• EMU having no currency risk and credit standing will be the
main risk factor
• Individual countries have no longer control on their own
money supply
Benchmark bonds• Highly liquid at the lowest possible yields
• Appropriate yield premium
• Existence of highly developed future market
• Issue of trading bonds and coupons separately
• Pre-announcement of issues in a regular calendar and low tax rates
New issuers and market segments• Debt Issuance by states government
• Public Sector issuers
• Supranational institutions and foreign issuers
• Sovereign borrowers from emerging economies
Corporate bonds• France is only which has corporate bonds
• There is no difficulties for European investors
• Increased Demand from Institutional investors
Currency changeover in the bond markets
• ECU claims and liabilities will be converted to euros at
the rate of
1 ECU= 1 euro
New reference interest rates
• EURIBOR is replaced by FIBOR, PIBOR and EONIA
• ECB calculates overnight rate(EONIA) charged by
references bank
Consequences for the equity markets
• Second largest equity market all over the world
• Japan is leading country
• Pronounced differences in accounting, legal and tax
regulation
A “big bang” in asset allocation
• Households, institutional investors and public institutions
have
already begun to change
• Rising of capital and increase in occupational pension
funds
The changeover in the equity markets• Share capital and the par value of share redenominated in Euros
• Public company‟s should have share capital of at least 50000
Euros
• Convert par value share into Euros
Consequences for the futures and options markets• Existing will modernized and new ones will be launched
• Products become more standardized and transparent
• Liquid and trading volume increase and costs will fall
• Electronic trading is the another benchmark
Competition between the financial centers • “Home” currency will disappear and national regulatory system
come under pressure
• London Stock Exchange and Deutsche Borse AG announced an
alliance which will allow customers to trade on both exchanges
OPPORTUNITIES OF MONETARY UNION
Broader Investment & Financing Opportunities
Greater Role in International Currency System
Doesn‟t Affect Purchasing Power
No Bail-Out of Member States
Boost Growth & Employment in the Long Term
Easier Travel & Money Transfer in EU
Companies to Benefit in Multiple Ways
Political Stability
EURO’s INTERNATIONAL ROLE
No Hedging Costs within EU
Euro v/s USD
Investment & Reserve Currency
WHERE DID EUROPE COME FROM?
IS EURO SYSTEM A HEALTHY ONE?
10/31/07 - Euro climbs
above $1.45, for first
time. U.S. Fed announces
a 25 basis point cut in its
key interest rate to 4.5%.
7/15/08 - Euro sets
record high of
$1.6038 after U.S.
government support
for Fannie Mae &
Freddie Mac fails to
quell concerns about
wider U.S. financial
stability.
Oct 2009-
US headlines
discuss
„demise of
the US
Dollar‟ as a
world
currency
April 2009-
Greek debt
crisis turns
speculation to
Euro decline
and break-upOct 2008- „Flight to safety:‟
US dollar rallies as financial
crisis goes global
Dec 2008- ECB
Expected to lower
interest rates by 50
bhp
A Bumpy ride… euro’s limitations are stressed, but the euro
survived.
April 2009 Greek crisis pushes the euro to a breaking point.
7
THE TURNING POINT:SEPTEMBER, 2008
2008 EUROPE STARTED FACING THE BIGGEST
GDP DECLINE SINCE THE GREAT DEPRESSION
EURO GOVERNMENTS STEP IN TO STABILIZE
THE FINANCIAL SECTOR, INCREASING DEBT
Source: European Central Bank, OCP N109, April 2010
RESULTING IN DEBT AND DEFICITS ACROSS
THE EURO ZONE
Euro deficit limit: 3% ● Euro debt to GDP limit: 60%
PIGS* IN DEBT:
A TANGLED WEB THAT TRAPS ALL OF EUROPE
Source: New York Times, May 1, 2010
* Portugal, Spain, Italy, Ireland, Greece
FRANCE, GERMANY & THE UKCARRY THE LOAD
Debtor
Country
$ billions
Total
Foreign
Debt
Germany UK France
Greece $256 $45 $15 $75
Portugal $286 $47 $24 $45
Spain $1,100 $238 $114 $220
Ireland $867 $184 $114 $60
Italy $1,400 $190 $77 $511
Total $3,645 $704 $344 $911
Percentage 19.3% 9.4% 25%
ACTIONS SPEAK LOUDER THAN WORDS
Country Past breach periods for
deficit
Past breach periods for
debt
Austria 2003-09
Germany 2003-06 2003-09
France 2003-04 2003-09
Italy 2003-09 2003-09
Luxembourg
Netherlands 2004-05
Belgium 2003-09
Spain 2008
Portugal 2002; 2005-06 2005-09
Finland 2005-2007
Ireland 2008
Greece 2003-08 2003-09
Will the debt crisis lead to the collapse of the euro?
THE EURO CRISIS
SJANUARY 1, 1999: BIRTH OF THE EURO AND EMU
Fundamental structural issues with the euro set the stage for
today’s crisis
ConflictsMonetary vs. Fiscal Policy
European Central Bank (ECB) has responsibility for
monetary policy;
individual central banks retained fiscal policy
responsibilities
ProblemNo authority to:
• Tax
• Spend
• Enforce actions/impose penalties for non-
compliance
KEY THEMES
ECB has no authority
EU Members have different agendas
European? Yes. Union? No.
No common
Purpose/Identity/Language/Culture
Increasing debt becomes a vicious
cycle
A VICIOUS CYCLE OF GROWING DEBT
AND DECLINING GDP, EXACERBATED
BY GROWING LIABILITIES
what the Greece debt problem means for the euro and European unity?
• French banks have the biggest exposure to Greece among European lenders, accounting for $75billion.
Contagion from the Greek crisis is “threatening the stability of the financial system” like the Ebola virus
. Organization for Economic Cooperation and Development
Angel Gurria, Secretary General
GREEK’S DEFICIT AND DEBT FORCE THE
EUROZONE TO TAKE ACTION
Source: Association for Finance Professionals, March-April 2009
“The euro zone deficit will climb to 7%
in 2010”
“…by then, all euro countries will
exceed the 3% deficit limit”
EVEN THE ECB SEES IT
GETTING WORSE
Source: European Central Bank, OCP N109, April 2010
"..the real story behind the euro mess lies not in the profligacy of politicians but in the arrogance of elites —specifically, the policy elites who pushed Europe into adopting a single currency well before the continent was ready for such an experiment."
PAUL KRUGMANNew York Times Op-ed February 14, 2010