Lecture 8:

Economic Factors The Financial Markets

Financial opportunities and risks
for international business

THE GLOBAL BUSINESS ENVIRONMENT

Summary of contents
o International capital markets
Equity markets
Debt markets
Financial crisis of 2008
Regulatory issues
The international monetary system
The IMF and World Bank
Global markets for corporate control
Conclusions
THE CRISIS
THE GLOBAL BUSINESS ENVIRONMENT

International capital markets

o MNEs raise capital by offering shares to investors
(equity funding), and by borrowing (debt financing)
o Capital markets flows of capital, including equity and
debt markets
o The financial environment has become highly
globalized, due largely to improvements in
communications technology; characterized by:
Growing opportunities for cross-border financing and
investment in business
Growth of global financial institutions
Growing role played by governments, e.g. sovereign wealth
funds
Increased risks from volatility of markets
THE GLOBAL BUSINESS ENVIRONMENT

Equity markets
o Shares in listed companies are traded on stock
exchanges
o Global capital flows are shifting to Bric countries; China
has overtaken New York in new listings of companies
o Global companies now often seek listings outside their
home countries In countries which are growing markets or where new
investors are emerging
In countries where costs and regulation are more
advantageous
o Institutional investors, such as pension funds and
investment funds, are major players in capital markets
THE GLOBAL BUSINESS ENVIRONMENT

Debt markets
o A bond is a loan instrument which promises to pay a fixed
sum on a fixed date, and to pay interest to the lender
o Many organizations issue bonds, from companies to
governments
Sovereign debt, or government debt, has grown to huge
proportions

o Derivatives financial instruments which have facilitated

the securitization of debt
o Hedge funds investment funds active in bond markets
Their speculative behaviour can cause volatility in capital markets

o Private equity funds Investment funds which focus on

buy-out activities, often financed by debt
THE GLOBAL BUSINESS ENVIRONMENT

Financial crisis of 2008

o Financial growth in the preceding decade was based on
low interest rates and extensive borrowing
Growth in derivatives trading and the re-packaging of debt as
securities, especially mortgage-backed securities

o Banks became active in derivatives, using debt to fund

further lending a risky strategy
o The crash in the US housing market led to uncertainty in
financial markets and an abrupt halt to lending
o Failure of Lehman Brothers bank in the US a
watershed event
o Repercussions around the globe, affecting globalized
banks which were exposed in derivatives markets
THE GLOBAL BUSINESS ENVIRONMENT

Regulatory issues
o It had been widely assumed that financial markets
would be self-regulating
o The near-collapse of banks and other companies,
which had to be bailed out by governments, led to a
rethinking of stricter regulation
o How can future crises be prevented?
Compel banks to become more conservative in strategy and
national in focus
Raise capital adequacy requirements for banks
Bring derivatives trading within regulatory framework

o How far will governments co-operate internationally to

regulate banking?
THE GLOBAL BUSINESS ENVIRONMENT

The international monetary system

o Global gold standard system (1870s to 1914)
o Bretton Woods agreement (1944 1971)
Currencies pegged to the US dollar
Some flexibility for countries in setting the value of
their currencies
National capital controls allowed
Creation of the IMF
o Bretton Woods system collapsed, largely due to a
growing US trade deficit and steep rises in the price
of oil
THE GLOBAL BUSINESS ENVIRONMENT

Exchange rate system

o Overseen by IMF
o Provides guidelines to governments on managing
their currency
o Currencies can range from fixed rate to free-floating
o Pegged exchange rate currency pegged to another,
e.g. US$
The peg is adopted to provide stability, and is favoured by
developing and transition economies
Governments can come under pressure to devalue

o The IMF warns against the accumulation of vast

currency reserves, but many countries in fact hold
large reserves, e.g. China
THE GLOBAL BUSINESS ENVIRONMENT

The IMF and World Bank

o Both are involved in economic development policies for
member countries (numbering over 180)
o Both have taken on a role in shaping institutions in
recipient countries, e.g. attaching conditions to loans
o The World Bank focuses on development programmes,
especially in Africa, Asia and post-communist transition
economies
o The IMF focuses on broader development issues and
financial stability
The IMF now adopts a more flexible approach to national
economic crisis than during the Asian crisis of 1998
The IMF is a co-ordinating organization of the G20
THE GLOBAL BUSINESS ENVIRONMENT

Global markets for corporate control

o A merger is the coming together of two or more
companies to form a new company
o An acquisition or takeover involves one company buying
out another
Often paid for by borrowing, in the leveraged buy-out
(LBO)
Buying a private company is less complicated than buying a
public one, with a large number of shareholders
If the board of the target company does not approve the
takeover, it becomes hostile, and is submitted for shareholder
approval

o Emerging markets are now the source of much merger

& acquisition (M&A) activity
THE GLOBAL BUSINESS ENVIRONMENT

Conclusions
o Financial markets have become globalized, offering
opportunities for companies and governments to access
capital, but also posing risks.
o Equity markets, once concentrated in the western
developed economies, are now rapidly growing in
emerging markets.
o New technology and innovative financial instruments
facilitated rapid growth in global finance, but also carried
risks, culminating in the financial crisis of 2008.
o The IMF and World Bank oversee both development
issues and financial stability in member countries.
o MNEs have benefited from financial globalization,
pursuing acquisition strategies.
THE GLOBAL BUSINESS ENVIRONMENT

SOME WELL KNOWN VICTIMS

THE GLOBAL BUSINESS13

ENVIRONMENT

Introduction
The credit crunch had its origins in 2007 when warnings
started coming out of America regarding the sub-prime
market for mortgages.
This led to a number of credit defaults and therefore losses
by banks and other financial institutions.
The global nature of banking meant the problem was spread
around the world.
As a result banks have been robbed of resources and find it
difficult to lend money.
This has caused a recession as businesses and households
find it hard to borrow money.

THE GLOBAL BUSINESS ENVIRONMENT

14

Origins
Sub-prime mortgage lending
Selling house loans to risky individuals such as
NINJAS no income, job or assets.
Started in the USA but also done in the UK by
companies such as Northern Rock.
Inevitably these individuals defaulted causing
losses and write downs in bank assets.
When a bank is owned money e.g. from a loan it
counts as an asset; if this loan defaults then it
becomes toxic and leads to a write down in
asset values.
THE GLOBAL BUSINESS ENVIRONMENT

15

Origins
Securitisation of these mortgage debts

Loans given by banks were then grouped together

by level of riskiness (of default) and then sold on to
other banks

Example:
Mortgagee 1
owes $100k
+
Mortgagee 2
owes $250k
+ etc
TOTAL = $350

SOLD
OF SAY
SOLDININPARCELS
BLOCKS EG
$10K
$10k TO
TO OTHER
OTHER BANKS
BANKS

THE GLOBAL BUSINESS ENVIRONMENT

16

Securitisation contd
As a loan can be an asset someone owes you
money it can be sold to another party
(bank).
Banks made mortgages attractive by grouping
them together in risk classes, eg, high, low
and medium risk (of default).
In some instances mixed risk securities
(called: slicing and dicing) were sold; when
the sub prime loans (high risk) defaulted, the
entire security dropped in value and became
worthless.
THE GLOBAL BUSINESS ENVIRONMENT

17

Origins
Sometimes these securitised loans were sold on with
insurance known as Credit Default Swaps, to make
them more attractive to buyers.
In addition, other credit derivative products
essentially bets placed on the performance of the
securitised products were created by banks and sold on to
other institutions. These too dropped in value or became
worthless when the original or underlying loan defaulted.

THE GLOBAL BUSINESS ENVIRONMENT

18

SUMMARY

THE GLOBAL BUSINESS ENVIRONMENT

19

Time lines
July 2007,Federal Reserve Chairman Ben
Bernanke says sub prime may cost US
$100bn.
Sept 2007
Banks wary of each other as the bank lending
rate (Libor) reaches a then record of 6.7%
Run on Northern Rock in UK as depositors
withdraw about 1b.

Oct 2007, Merrill Lynch (bank) announce a

$8b loss.
THE GLOBAL BUSINESS ENVIRONMENT

20

Time lines
Jan 2008, World Bank warns of worldwide recession;

FTSE (leading UK shares) suffer worse falls since 2001.

Feb 2008, Bear Sterns (bank) collapses and Northern
Rock nationalised by UK gov.
April 2008,International Monetary Fund warns that
global banking losses will exceed $1t; 20% of
mortgages available in UK removed from the
marketplace; first annual fall in UK house prices for 12
years announced.
Aug 2008, two biggest US mortgage lenders F. Mae
and Mac collapse; Bradford and Bingley report 30m
annual loss.

THE GLOBAL BUSINESS ENVIRONMENT

21

Time lines
Sept 2008: The Storm------ Lloyds Bank takes over HBOS in biggest banking
takeover
Bradford and Bingley nationalised
Lehman Brothers (US) collapse
Losses and bank collapses reported all over
Europe

Oct, 2008,US gov. invests $700b in a

rescue plan; UK pledges $50b; UK interest
rates cut to 4.55;UK banks saved with a
37b package by the gov.
THE GLOBAL BUSINESS ENVIRONMENT

22

Time lines
Nov/Dec 2008, UK interest rates cut to 3%;
Eurozone recession declared; FTSE falls a
record 32% in one year.
Jan/Feb 2009, Chinese exports fall for first
time in 20 years; several UK retailers announce
bankrupcy, eg, Woolworths; UK interest rates
cut to 1.5%; US gov. pump a further $800bn
into economy; total of 140b spent on bailing
out UK banks.
THE GLOBAL BUSINESS ENVIRONMENT

23

Net result: UK economy in

recession

Note a recession is defined technically as two consecutive quarters of negative

Business activity (Gross Domestic Product)
THE GLOBAL BUSINESS ENVIRONMENT

24

Latest situation
http://www.bbc.co.uk/news/special_reports/
global_economy/
http://www.ukpublicspending.co.uk/uk_natio
nal_debt_chart.html
http://www.telegraph.co.uk/finance/budget/
9932748/Budget-2013-Britains-debt-anddeficit.html
THE GLOBAL BUSINESS ENVIRONMENT

Key impacts (UK)

Huge increase in public debt;
-> Public sector cuts
Overall govt. debt =
c800b about 60%
of GDP
Inflation falls
to 2.7%

Unemployment
now 2.49m in UK
(7.7%)

Falling house prices:

down c30%
since 2007

Shortage of
credit

Base interest rates: now 0.5%

lowest ever
Personal and corporate insolvencies

THE GLOBAL BUSINESS ENVIRONMENT

26

Key impacts (UK)

One aspect of the credit crunch that is still
being discussed is the financial competence
of senior managers.
It is notable that Adam Applegarth and
Fred Godwin (ex-CEOs of Northern Rock
and RBS) both came from retail, not finance
backgrounds.
Could they understand the complex derivative
finance products sold by their banks?
Did they understand the risks?
THE GLOBAL BUSINESS ENVIRONMENT

27

Effects on Economy
(Short Term)
Unemployment/wage reductions +
Economic growth eg new business start
ups
Stock market falls/value of businesses Trust of the banking sector Corporate failures inluxury goods areas
e.g. Cars +
Prospects for credit dependent business,
e.g,. houses, cars, yachts etc THE GLOBAL BUSINESS ENVIRONMENT

28

Effects on Economy
(Long Term)
Anyone's guess but.... recessions often usher in
growth in new business areas in their wake.
Recession

Industries developed in wake

WW2

Jet engines, healthcare Automotive

1970/80s

Mobile telephony, IT Services

1992/93

Internet

2008/09

??? Green energy? Ecohomes??

THE GLOBAL BUSINESS ENVIRONMENT

29

Reasons to be cheerful?
Economists are looking for signs of
recovery
in the UK:
http://news.bbc.co.uk/1/hi/education/8244285.stm

Growth in house prices

Mortgage approvals
GDP showing growth
Some return of business confidence reported
Buy unemployment continues high (tends to
lag behind other indicators)
Real wages depressed so no feel-good factor
THE GLOBAL BUSINESS ENVIRONMENT

30

The future
Continuing austerity till 2018-2020?
Find out medium to long term forecasts from

Bank of England
BBC
FT
The Economist

THE GLOBAL BUSINESS ENVIRONMENT

31

Further reading
Kay, J. (2004) The Truth About Markets,
Penguin
http://www.policynetwork.net/uploadedFiles/Publications/Publication
s/pp2.2%2044-48_KAY.pdf

Brummer, A. (2008) The Crunch, rh books

bbc.co.uk/business
www.ft.com

THE GLOBAL BUSINESS ENVIRONMENT

32