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CHAPTER IX

INTERNATIONAL FINANCIAL MARKETS

The International Financial System

INTERNATIONAL BUSINESS

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Learning ObjectivesDiscuss the purposes, development, and financial centers of the international capital market.

Describe the international bond, international equity, and Eurocurrency markets.

Discuss the four primary functions of the foreign exchange market

Explain how currencies are quoted and the different rates given

Identify the main instruments and institutions of the foreign exchange market

Explain why and how government restrict currency convertibility

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INTERNATIONAL CAPITAL MARKET

Capital Market

System that allocates financial

resources in the form of debt and

equity according to their most

efficient uses.

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INTERNATIONAL CAPITAL MARKET

Purposes of National Capital Markets

Purpose of the International Capital

Market

Forces Expanding the International

Capital Market

World Financial Centers

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Purposes of National Capital Markets

National Capital Markets help individuals

and

institutions borrow the money that other

individuals and institutions want to lend.

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Purposes of National Capital Markets

The most common Capital-Market

Intermediaries:

Commercial Banks Lend borrowers their

investors’ deposits at a specific rate of

interest

Investment Banks Help clients to invest

excess capital and to borrow need capital.

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Purposes of National Capital Markets

Role of Debt Role of Equity

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Role of Debt

Debt: Loans in which the borrowers

promises to repay the borrowed amount

plus a predetermined rate of interest.

Bond: Debt instrument that specifies

the timing of principal and interest

payments.

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Role of Equity

Equity: Part-ownership of a company in which the equity holder participates with other part owners in the company’s financial gains and losses

Stock: Shares of ownership in a company’s assets that give shareholders a claim on the company’s future cash flows

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Role of Equity

Liquidity: Ease with which

bondholders and shareholders may

convert their investments into cash.

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Purposes of National Capital Markets

Share

Equity

Stock

Bond

Debt

Company

Assets

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Purposes of the International Capital Markets

International Capital Market :

Network of individuals, companies

financial institutions, and

governments that invest and borrow

across national boundaries.

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Purposes of the International Capital Markets

Expanding the Money Supply for

Borrowers

Reducing the Cost of Money for

Borrowers

Reducing Risk for Lenders

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Reducing Risk for Lenders

Two Ways:

Investors enjoy a greater set of

opportunities from which to choose.

Investing in international securities benefits

investors because some economies are

growing while others are in decline.

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Forces Expanding the International Capital Market

Information Technology

Deregulation

Financial Instruments.

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Forces Expanding the International Capital Market

Securitization : Unbundling and

repacking of hard-to-trade financial

assets into more liquid, negotiable,

and marketable financial

instruments( or securities)

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World Financial Centers

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World Financial Centers

Offshore financial center: Country

or

territory whose financial sector

features

very few regulations and few, if any,

taxes.

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MAIN COMPONENTS OF THE INTERNATIONAL CAPITAL MARKET

International Bond Market

International Equity Market

Eurocurrency Market

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International Bond Market

International Bond Market

Market consisting of all bonds sold by

issuing

companies, government, or other

organizations outside their own

countries .

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International Bond Market

Types of International Bonds

Interest Rates

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Types of International Bonds

Eurobond

Foreign Bond.

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Eurobond

Eurobond

Bond issued outside the country in

whose

currency it is denominated.

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Foreign bond

Foreign bond

Bond sold outside the borrower’s

country and denominated in the

currency of the country in which it is

sold .

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Interest Rates A Driving Force

How can investors who are seeking higher returns and borrowers who are seeking to pay lower interest rates both come out ahead?

By using bonds in the international bond market, borrowers from newly industrialized and developing countries can borrow money from other nations where interest rates are lower.

Investors in developed countries buy bonds in newly industrialized and developing nations in order to obtain higher returns on their investments.

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International Equity Market

International equity market

Market consisting of all stocks bought

and sold outside the issuer’s home

country.

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International Equity Market

Spread of Privatization

Economic Growth in Developing

Countries.

Activity of Investment Banks

Advent of Cybermarkets

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Eurocurrency Market

Eurocurrency market

Market consisting of all the world’s

currencies ( referred to as

“Eurocurrency” ) that are banked

outside their countries of origin.

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Eurocurrency Market

Deposits Originate Primarily from Four Sources:

• Governments with excess funds generated by a

prolonged trade surplus

• Commercial Banks with large deposits of excess

currency

• International companies with large amounts of excess

cash

• Extremely wealthy individuals.

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Eurocurrency Market

Interbank Interest Rates

Interest rates that the world’s largest

banks charge one another for loans.

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FOREIGN EXCHANGE MARKET

Foreign Exchange Market

Market in which currencies are

bought

and sold and their prices

determined .

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FOREIGN EXCHANGE MARKET

Exchange rate

Rate at which one currency is

exchange

for another .

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Functions of the Foreign Exchange Market

Currency Conversion

Currency Hedging

Currency Arbitrage

Currency Speculation

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Functions of the Foreign Exchange Market

Currency Hedging

Practice of insuring against potential

losses that result from adverse

changes in exchange rates .

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Functions of the Foreign Exchange Market

Currency Arbitrage

Instantaneous purchase and sale of a

currency in different markets for profit.

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Functions of the Foreign Exchange Market

Interest arbitrage

Profit-motivated purchase and sale of

interest-paying securities denominated in

different currencies.

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Functions of the Foreign Exchange Market

Currency speculation

Purchase or sale of a currency with the

expectation that its value will change and

generate a profit .

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HOW THE FOREIGN EXCHANGE MARKET WORKS

Quoting Currencies

Spot Rates

Forward Rates

Swaps, Options, and Futures.

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Quoting Currencies

Quoted Currency: In a quoted

exchange rate ,the currency with

which another currency is to be

purchased.

Base Currency: In a quoted

exchange rate, the currency that is to

be purchased with another currency.

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Quoting Currencies

Direct and Indirect Rate Quotes

Calculating Percent Change

Cross Rates

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Spot Rates

Spot Rate: Exchange rate requiring

delivery of the traded currency within

2 business days.

Spot Market: Market for currency

transactions at spot rates.

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Forward Rates

Forward Rate: Exchange rate a

which two parties agree to exchange

currencies on a specified future date.

Forward Market: Market for

currency transactions at forward rates

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Forward Rates

Forward contract: Contract that

requires the exchange of an agreed-upon

amount of a currency on an agreed-upon

date at a specific exchange rate .

Derivative: Financial instrument whose

value derives from other commodities or

financial instruments

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Swaps, Options, and Futures

Currency Swap: Simultaneous

purchase and sale of foreign exchange

for two different dates.

Currency Option: Right, or option ,to

exchange a specific amount of a

currency on a specific date at a specific

rate.

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Swaps, Options, and Futures

Currency Futures Contract:

Contract requiring the exchange of a

specific amount of currency on a

specific date at a specific exchange

rate, with all conditions fixed and not

adjustable.

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FOREIGN EXCHANGE MARKET TODAY

Trading Centers

Important currencies

Institutions of the Foreign

Exchange

Market

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Trading Centers

Most of world’s mayor cities participate in

trading on the foreign exchange market.

Three mayor cities:

•The United Kingdom

•The United States

• Japan

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Important Currencies

Vehicle currencies: Currency used

as an intermediary to convert funds

between two other currencies.

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Institutions of the Foreign Exchange Market

Interbank Market

Securities Exchanges

Over-the-Counter Market

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Interbank Market

Interbank Market: Market in which

the world’s largest banks exchange

currencies at spot and forward rates.

Clearing: Process of aggregating the

currencies that one bank owes another

and them carrying out the transaction.

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Securities Exchange

Securities Exchange: Exchange

specializing in currency futures and

options transactions.

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Over-the- Counter Market

Over-the- counter (OTC) market:

Exchange consisting of a global

computer network of foreign exchange

traders and other market participants.

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CURRENCY CONVERTIBILITY

Convertible (hard) Currency:

Currency that trades freely in the

foreign exchange market, with its price

determined by the forces of supply and

demand.

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CURRENCY CONVERTIBILITY

Goals of Currency Restriction Policies for Restricting Currencies

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Goals of Currency Restriction

To preserve a country reserve of hard

currencies.

To preserve hard currencies to pay for

imports and to finance trade deficits.

To protect a currency from speculators.

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Policies for Restricting Currencies

Restrict currencies convertibility

Government’s requires:

• Foreign exchange transactions be performed at

or approved by the country’s central banks.

• Import licenses for some or all import

transactions.

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Policies for Restricting Currencies

Countertrade: Practice of selling

goods or services that are paid for ,

in whole or part ,with other goods or

services.

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THE END