CHAPTER-03

International Financial Markets

Q: Why International Financial Markets has developed?
The existence of several barriers such as tax differentials, tariffs, quotas, labor
immobility, cultural differences, financial reporting differences, and significant
cost of communicating information across countries prevent the markets from
completely integrated. These barriers create unique opportunities for foreign
investors and creditors to invest in specific geographic markets. The existences
of imperfect markets lead to the internationalization of financial markets.
Q: Motives for Investing in Foreign Markets:
Investors invest in foreign markets for one or more of the following motives:
1) Economic conditions: investors may expect firms in a particular foreign
country to achieve more favorable performance than those in the investors
home country. For example: the loorening of restrictions in eastern European
countries created favorable economic conditions there, such conditions attracted
foreign investors and creditors.
2) Exchange rate expectations: some investors purchase financial securities
denominated in a currency that is expected to appreciate against their own. The
performance of such an investment is highly dependent on the currency
movement over the investment horizon.
3) International diversification: investors may achieve benefits from
internationally diversifying their asset portfolio. When an investors entire
portfolio does not depend solely on a single countrys economy, cross border
differences in economic conditions can allow for risk-reduction benefits. A
furthermore, access to foreign markets allow investors to spread their funds
across a more diverse group of industries than may be available domestically.
This is especially true for investors residing in countries where firms are
concentrated in a relatively small number of industries.

Q: Motives for Providing Credit in Foreign Markets:

1) High interest rates: Foreign creditors may attempt to capitalize on the
higher interest rates, thereby providing capital to overseas markets. Often,
however, relatively high interest rates are perceived to reflect relatively high
inflationary expectations in that country. To the extent that inflation can cause
depreciation of the local currency against others, high interest rates in the
country may be somewhat offset by a weakening of the local currency over the
time period of concern the relation between a countrys expected inflation and
its local currency movements is not precise, however because several other
factors can influence currency movement as well.
2) Exchange rate expectations: creditors may consider supplying capital to
countries whose currencies are expected to appreciate against their own.
Whether the form of the transaction is a bond or a loan, the creditor benefits
when the currency of denomination appreciates against the creditors home
currency.
3) International diversification: creditors can benefit from international
diversification, which may reduce the probability of simultaneous bankruptcy
across borrowers.
Q: Motives for Borrowings in Foreign Markets:
1) Low interest rates: borrowers may attempt to borrow funds from creditors
in the countries where there is a large supply of funds available because the
interest rate charged is lower. A country with relatively low interest rate is often
expected to have a relatively low rate of inflation, which can place upward
pressure on the foreign currencys value & offset any advantage of lower
interest rates. The relation between expected inflation differentials and currency
movements is not precise.
2) Exchange rate expectations: borrowers attempt to borrow from the foreign
market if the foreign currency is expected to depreciate against their home
currency. If the foreign currency depreciates then the borrower repurchase the
foreign currency by giving small amount of their home currency to repay the
loan.

Q: Foreign Exchange Market:

The market where we can easily buy or sell currency is called Foreign Exchange
Market.
Q: Why we need foreign exchange market?
Borrowing or investing internationally requires foreign currency. Foreign
exchange market allows currency to be exchanged that facilitates international
trade and financial transactions. Foreign investors rely on the foreign exchange
market to exchange their home currency for a foreign currency that they need to
purchase imports or to use for foreign direct investment. Alternatively, they
may need the foreign exchange market to exchange a foreign currency that they
receive into their home currency.
Q: Eurocurrency Market:
U.S. dollar was widely used as medium of international trade in Europe and
elsewhere. To conduct international trade with European countries, corporation
in the United States deposited U.S. dollars in European banks. The banks were
willing to accept the deposits because they could lend the dollars to corporate
customers based in Europe. These dollars deposited in banks in Europe (and on
other countries as well) came to be known as Eurodollars and the market for
Eurodollars came to be known as the Eurocurrency market.
Q: Petrodollars
OPEC generally requires payment for oil in dollars; the OPEC countries began
to use the Eurocurrency market to deposit a portion of their oil reserves. These
dollar denominated deposits are known as petrodollars. Oil revenues deposited
in the banks have sometimes been lent to oil-importing countries that are short
of cash. As these countries purchase more oil, funds are again transferred to the
oil-exporting countries, which in turn create new deposits. This recycling
process has been an important source of funds for some countries.
Q: Euro Credit Market:
Multinational corporations and domestics firms sometimes obtain medium term
funds through term loans from local financial institutions or through the
issuance of notes in the local markets. However, MNCs also have access to

medium-term funds through banks located in foreign markets. Loans of one

year or longer extended by banks to MNCs or government agencies in Europe
are commonly called Euro credits or Euro credit loans. These loans are provided
in the so-called Euro credit market. The loan can be denominated in dollars or
many other currencies and commonly have a maturity of five years.

Q; How bank Interest Rates are Determined?

LIBOR+ 3 Percent:
Libor is the rate which is commonly for loans between banks, Bank rate. Banks
commonly we floating rate loans to avoid the risk. The loan rate floats in
accordance with movement of some market interest rate, such as the London
interbank offer rate (Libor); it is the rate which is commonly for loans between
banks. Example: a euro credit loan may have a loan rate that adjusts every six
months and is set at LIBOR+ 3 Percent.
+ Percent depends on credit risk:
The premium paid above LIBOR will depend on the credit risk of the borrower.
The LIBOR varies among currencies because the market supply of and demand
for funds vary among currencies.
Q-Syndicated Loans:
Sometimes a single bank is unwilling or unable to lend the amount needed by a
particular corporation or government agency. In this case, a syndicate of banks
may be organized. Each bank within the syndicate participates in the lending. A
lead bank is responsible for negotiating terms with the borrower. Then the lead
bank organizes a group of banks to underwrite the loans. Borrowers that receive
a syndicated loan incur various fees besides the interest on the loan. Front-end
management fees are paid to cover the costs of organizing the syndicate and
underwriting the loan. In addition, a commitment fee of about .25 or .50 percent
is charged annually on the unused portion of the available credit extended by the
syndicate. Syndicated loans can be denominated in a variety of currencies. The
interest rate depends on the currency denominating the loan, the maturity of the
loan, and the creditworthiness of the borrower. Interest rates on syndicated

loans are commonly adjustable according to movements in an interbank lending

rate, and the adjustment may occur every 6 months or every year.
Advantage: 1) Helps reduce the default risk of a large loan. 2) It can add an
extra incentive for the borrower to repay the loan.
Q-Eurobond Market:
Eurobonds are bonds that are sold in countries other than the country of the
currency denominating the bonds. Eurobonds have become very popular as a
means of attracting funds, perhaps in part because they circumvent registration
requirements.
Features of Eurobonds: Eurobonds have several distinctive features:
1) Bearer form: Eurobonds are usually issued in bearer form, which means
that there are no records kept regarding ownership.
2) Yearly coupon payments: In Eurobonds Coupon payments are made
yearly.
3) Convertibility: Some Eurobonds carry a convertibility clause allowing them
to be converted into a specified number of shares of common stock.
4) Call provision: Eurobonds include Call provision which gives right to
bondholder to retire before the maturity period.
5) Adjustable interest rate: Eurobonds have a variable rate provision that
adjusts the coupon rate over time according to prevailing market rates.

Q-Underwriting Process:
Eurobonds are underwritten by a multinational syndicate of investment banks
and simultaneously placed in many countries, providing a wide spectrum of
fund sources to tap. The underwriting process takes place in a sequence of steps.
The multinational managing syndicate sells the bonds to a large underwriting
crew. Bonds are often distributed in higher volume to underwriters that have
fulfilled their commitments in the past which reduce the digestion problem
and also reduce the distribution cost. This has helped the Eurobond market
maintain its desirability as a bond placement center.

Q-Secondary Market:
Eurobonds also have a secondary market. The market makers are in many cases
the same underwriters who sell the primary issues. A technological advance
called Euro-clear helps to inform all traders about outstanding issues for sale,
thus allowing a more active secondary market. United Kingdom dominating the
action in the secondary market can act as brokers as well as dealers that hold
inventories of Eurobonds. MNCs from many different countries can issue bonds
denominated in Euros, which allows for a much larger and more liquid market.
MNCs have benefited because they can more easily obtain debt by issuing
bonds, as investors know that there will be adequate liquidity in the secondary
market.