International Business

8e
By Charles W.L. Hill

Chapter 11

The Global Capital Market

McGraw-Hill/Irwin Copyright 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

Why Do We Have Capital Markets?

Capital markets bring together investors and borrowers
investors - corporations with surplus cash, individuals, and non-bank financial institutions borrowers - individuals, companies, and governments markets makers - the financial service companies that connect investors and borrowers, either directly (investment banks) or indirectly (commercial banks) capital market loans can be equity or debt

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Who Are The Main Players in Capital Markets?

The Main Players in a Generic Capital Market

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What Makes The Global Capital Market Attractive?

Todays capital markets are highly interconnected and facilitate the free flow of money around the world Borrowers benefit from
the additional supply of funds global capital markets provide the associated lower cost of capital - the price of borrowing money or the rate of return that borrowers pay investors

Investors benefit from the wider range of investment opportunities

diversify portfolios and lower risk

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What Makes The Global Capital Market Attractive?

Market Liquidity and the Cost of Capital

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What Makes The Global Capital Market Attractive?

Risk Reduction through Portfolio Diversification

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How Have Global Capital Markets Changed Since 1990?

Global capital markets have grown rapidly
the stock of cross-border bank loans was just $3,600 billion in 1990, but $24,566 in 2008 the international bond market has grown from $3,515 billion in 1997 to $22,734 in 2008 international equity offerings were $18 billion in 1997 and $387 billion in 2008

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Why Is The Global Capital Market Growing?

Two factors are responsible for the growth of capital markets 1. Advances in information technology the growth of international communications technology and advances in data processing capabilities
24-hour-day trading so, shocks that occur in one financial market spread around the globe very quickly

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Why Is The Global Capital Market Growing?

2. Deregulation by governments has facilitated growth in international capital markets
governments have traditionally limited foreign investment in domestic companies, and the amount of foreign investment citizens could make since the 1980s, these restrictions have been falling deregulation began in the United States, then moved to other countries - Great Britain, Japan, and France many countries have dismantled capital controls making it easier for both inward and outward investment to occur
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What Are The Risks Of The Global Capital Markets?

Could deregulation of capital markets and fewer controls on cross-border capital flows make nations more vulnerable to the effects of speculative capital flows? Speculative capital flows may be the result of inaccurate information about investment opportunities If global capital markets continue to grow, better quality information is likely to be available from financial intermediaries

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What Is A Eurocurrency?
A eurocurrency is any currency banked outside its country of origin About two-thirds of all eurocurrencies are Eurodollars - dollars banked outside the United States
Other important eurocurrencies are the euroyen, the euro-pound, and the euro-euro

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Why Has The Eurocurrency Market Grown?

The eurocurrency market began in the 1950s when the Eastern bloc countries feared that the United States might seize their dollars
so, they deposited them in Europe additional dollar deposits came from Western European central banks and companies that exported to the United States

In 1957, the market surged again after changes in British laws

London continues to be the leading center of the eurocurrency market

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Why Has The Eurocurrency Market Grown?

In the 1960s, the market grew once again when, after changes in U.S. regulations discouraged U.S. banks from lending to non-U.S. residents, wouldbe borrowers of dollars outside the United States turned to the euromarket as a source of dollars The next big increase came after the 1973-74 and 1979-80 oil price increases
OPEC members avoided potential confiscation of their dollars by depositing them in banks in London

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What Makes The Eurocurrency Market Attractive?

The eurocurrency market is attractive because it is not regulated by the government
banks can offer higher interest rates on eurocurrency deposits than on deposits made in the home currency banks can charge lower interest rates to eurocurrency borrowers than to those who borrow the home currency

The spread between the eurocurrency deposit and lending rates is less than the spread between the domestic deposit and lending rates giving eurocurrency banks a competitive edge over domestic banks
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What Makes The Eurocurrency Market Attractive?

Interest Rate Spreads in Domestic and Eurocurrency Markets

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What Makes The Eurocurrency Market Unattractive?

The eurocurrency market has two significant drawbacks 1. Because the eurocurrency market is unregulated, there is a higher risk of bank failure 2. Companies borrowing eurocurrencies can be exposed to foreign exchange risk

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What Is The Global Bond Market?

Bonds are an important means of financing for many companies The most common kind is a fixed rate bond which gives investors fixed cash payoffs The global bond market grew rapidly during the 1980s and 1990s There are two types of international bonds 1. Foreign bonds are sold outside the borrowers country and are denominated in the currency of the country in which they are issued 2. Eurobonds are underwritten by a syndicate of banks and placed in countries other than the one in whose currency the bond is denominated

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What Makes The Eurobond Market Attractive?

The eurobond market is attractive because 1. It lacks regulatory interference since companies do not have to adhere to strict regulations, the cost of issuing bonds is lower 2. It has less stringent disclosure requirements than domestic bond markets it can be cheaper and less time consuming to offer eurobonds than dollar-denominated bonds 3. It is more favorable from a tax perspective eurobonds can be sold directly to foreign investors

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What Is The Global Equity Market?

The global equity market allows firms to 1. Attract capital from international investors
many investors invest in foreign equities to diversify their portfolios

2. List their stock on multiple exchanges

this type of trend may result in an internationalization of corporate ownership

3. Raise funds by issuing debt or equity around the world

by issuing stock in other countries, firms open the door to raising capital in the foreign market, and give the firm the option of compensating local managers and employees with stock

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How Do Exchange Rates Affect The Cost Of Capital?

Adverse exchange rates can increase the cost of foreign currency loans While it may initially seem attractive to borrow foreign currencies, when exchange rate risk is factored in, that can change Firms can hedge their risk by entering into forward contracts to purchase the necessary currency and lock in the exchange rate, but this will also raise costs Firms must weigh the benefits of a lower interest rate against the risk of an increase in the real cost of capital due to adverse exchange rate movements

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What Do Global Capital Markets Mean For Managers?

Growth in global capital markets has created opportunities for firms to borrow or invest internationally
firms can often borrow at a lower cost than in the domestic capital market firms must balance the foreign exchange risk associated with borrowing in foreign currencies against the costs savings

Growth in capital markets offers opportunities for firms, institutions, and individuals to diversify their investments and reduce risk
again though, investors must consider foreign exchange rate risk
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Review Question
Which of the following are market makers? a) commercial banks b) pension funds c) insurance companies d) governments

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Review Question
Which of the following is not true of global capital markets a) they benefit borrowers b) they benefit sellers c) they raise the cost of capital d) they provide a wider range of investment opportunities
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Review Question
Compared to developed nations, less developed nations have

a) smaller capital markets b) more investment opportunities c) similar costs of capital d) greater liquidity
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Review Question
In 2008, the stock of cross-border bank loans was about

a) $3,620 b) $7,840 c) $24, 560 d) $33,630

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Review Question
Historically, the most tightly regulated industry has been

a) agriculture b) consumer electronics c) automotives d) financial services

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Review Question
The term eurocurrency refers to a) the currency used by the European Union countries b) any currency banked outside its country of origin c) currencies purchased in the international equities market d) bonds sold outside the borrowers country that are denominated in the currency of the country in which they are issued
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