Chapter 12

The Global Capital

Market

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

12-2

Who Are The Main Players

in Capital Markets?
The Main Players in a Generic Capital Market

12-3

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
lowers the cost of capital
the price of borrowing money or the rate of
return that
borrowers pay investors
12-4

What Makes The Global

Capital Market Attractive?
Market Liquidity and the Cost of Capital

12-5

What Makes The Global

Capital Market Attractive?
Investors benefit from the wider range of
investment opportunities
diversify portfolios and lower risk

But, volatile exchange rates can make

what would otherwise be profitable
investments, unprofitable

12-6

What Makes The Global

Capital Market Attractive?
Risk Reduction through Portfolio Diversification

12-7

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 $32,430 in 2010
the international bond market has grown from
$3,515 billion in 1997 to $26,613 in 2010
international equity offerings were just $18
billion in 1990, but grew to $750 billion in
2009

12-8

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

12-9

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

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Why Is The Global Capital

Market Growing?
deregulation began in the U.S., then moved to
Great Britain, Japan, and France
many countries have dismantled capital controls
making it easier for both inward and outward
investment to occur

The 2008-2009 global financial crisis raised

questions as to whether deregulation had gone
too far
Question: Are new regulations for the financial
services industry needed?

12-11

What Are The Risks Of

The Global Capital
Markets?
Question: Could
deregulation of capital markets

and fewer controls on cross-border capital flows

make nations more vulnerable to the effects of
speculative capital flows?
can have a destabilizing effect on economies

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
12-12

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 U.S.
Other important eurocurrencies are the euro-yen, the
euro-pound, and the euro-euro

The eurocurrency market is an important source

of low-cost funds for international companies

12-13

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 U.S.
could earn a higher rate of interest in London
12-14

Why Has The

Eurocurrency Market
Grown?
In 1957, the market surged again after
changes in British laws
under the new laws, British banks had to
attract dollar deposits and loan dollars rather
pounds to finance non-British trade

London became the leading center of the

eurocurrency market
continues to hold this position today

12-15

Why Has The

Eurocurrency Market
Grown?
In the 1960s, the market grew once again
Changes in U.S. regulations discouraged
U.S. banks from lending to non-U.S.
residents
would-be borrowers of dollars outside the U.S.
turned to the euromarket as a source of
dollars

12-16

Why Has The

Eurocurrency Market
Grown?
The next big increase came after the
1973-74 and 1979-80 oil price increases
Arab members of OPEC accumulated
huge amounts of dollars
avoided potential confiscation of their dollars
by the U.S. by depositing them in banks in
London

12-17

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
12-18

What Makes The

Eurocurrency Market
Attractive?

The spread between the eurocurrency

deposit and lending rates is less than the
spread between the domestic deposit and
lending rates
gives eurocurrency banks a competitive edge
over domestic banks

12-19

What Makes The

Eurocurrency Market
Attractive?
Interest Rate Spreads in Domestic and Eurocurrency Markets

12-20

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 that bank
failure could cause depositors to lose funds

can avoid this risk by accepting a lower return on a

home-country deposit

2. Companies borrowing eurocurrencies can be

exposed to foreign exchange risk
can minimize this risk through forward market
hedges
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What Is The
Global Bond Market?
Bonds are an important means of
financing for many companies
the most common bond is a fixed rate which
gives investors fixed cash payoffs

The global bond market grew rapidly

during the 1980s and 1990s and
continues to grow today

12-22

What Is The
Global Bond Market?
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
used by companies when they think it will reduce the
cost of capital

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

12-24

What Is The
Global Equity Market?
The global equity market allows firms to
1. Attract capital from international investors
many investors buy 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

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What Is The
Global Equity Market?
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
gives the firm the option of compensating
local managers and employees with stock
provides for local ownership
increases visibility with local stakeholders
12-26

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
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
12-27

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

12-28

What Do Global Capital

Markets Mean For
Managers?
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

Capital markets are likely to continue to

integrate providing more opportunities for
business
12-29