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&currency 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