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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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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 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
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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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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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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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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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.