International Business 10e By Charles W.L. Hill Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

The Global Capital Market Chapter 12 The Global Capital Market

Why Do Capital Markets Exist? 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 LO 1: Describe the benefits of the global capital market.

Who Are the Main Players in Capital Markets? The Main Players in the Generic Capital Market The Opening Case: Declining Cross-Border Capital Flows: Retreat or Reset? explores the challenges that today’s highly integrated capital markets present. The financial crisis that began in the United States in 2008, quickly spread to other nations resulting in worldwide recession. Five years after the global crisis, the global capital market has not reached its 2007 peak. Is that a sign of permanent retreat or a global reset?

What Makes the Global Capital Market Attractive? Today’s 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 Capital market loans include Equity loans- when corporations sell stock to investors Debt loans - when a corporation borrows money and agrees to repay a predetermined portion of the loan amount at regular intervals regardless of how much profit it is making In a purely domestic capital market the pool of investors is limited to residents of the country. This places an upper limit on the supply of funds available increases the cost of capital

What Makes the Global Capital Market Attractive? Market Liquidity and the Cost of Capital Management Focus: Deutsche Telekom Taps the Global Capital Market examines Deutsche Telekom’s privatization strategy. Deutsche Telekom, one of the world’s largest telephone companies was state-owned until 1996 when the decision was made to privatize the company in order to increase efficiency and be in a better position to face the greater competition the deregulation of the European Union’s telecommunications sector was expected to create.

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 A fully diversified portfolio that contains stocks from many countries is less than half as risky as a fully diversified portfolio that contains only U.S. stocks.

What Makes the Global Capital Market Attractive? Risk Reduction through Portfolio Diversification Source: B. Solnik, “Why Not Diversify Internationally Rather than Domestically?” Adapted with permission from Financial Analysts Journal, July-August 1974, p. 17. Copyright 1974. Financial Analysts Federation, Charlottesville, VA. All rights reserved.

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, $7,859 billion in 2000, $33,913 billion in 2012 the international bond market has grown from $3,515 billion in 1997, $5,908 billion in 2000, $21,979 billion in 2012 LO 2: Identify why the global capital market has grown so rapidly.

Why Is the Global Capital Market Growing? Two factors are responsible for the growth of capital markets Advances in information technology the growth of international communications technology and advances in data processing capabilities 24-hour-a-day trading so, shocks that occur in one financial market spread around the globe very quickly

Why Is the Global Capital Market Growing? 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

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?

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 LO 3: Understand the risks associated with the globalization of capital markets. Country Focus: Did the Global Capital Markets Fail Mexico? explores Mexico’s economic problems in the mid-1990s. Mexico went from being a strong developing country with a good future to a country facing a financial crisis.

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 LO 4: Compare and contrast the benefits and risks associated with the Eurocurrency market, the global bond market, and the global equity markets.

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

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

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

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

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

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

What Makes the Eurocurrency Market Attractive? Interest Rate Spreads in Domestic and Eurocurrency Markets

What Makes the Eurocurrency Market Unattractive? The Eurocurrency market has two significant drawbacks: 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 Companies borrowing Eurocurrencies can be exposed to foreign exchange risk can minimize this risk through forward market hedges

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 do in the new century Foreign bonds sold in the United States are called Yankee bonds. Foreign bonds sold in Japan are Samurai bonds. Foreign bonds sold in Great Britain are bulldogs.

What Is the Global Bond Market? There are two types of international bonds Foreign bonds are sold outside the borrower’s 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 Eurobonds are underwritten by a syndicate of banks and placed in countries other than the one in whose currency the bond is denominated

What Makes the Eurobond Market Attractive? The Eurobond market is attractive because It lacks regulatory interference since companies do not have to adhere to strict regulations, the cost of issuing bonds is lower 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 It is more favorable from a tax perspective Eurobonds can be sold directly to foreign investors

What Is the Global Equity Market? The global equity market allows firms to Attract capital from international investors many investors buy foreign equities to diversify their portfolios List their stock on multiple exchanges this type of trend may result in an internationalization of corporate ownership

What Is the Global Equity Market? 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

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 LO 5: Understand how foreign exchange risks affect the cost of capital.

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

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