The International Financial System INTERNATIONAL BUSINESS CHAPTER IX INTERNATIONAL FINANCIAL MARKETS The International Financial System

Learning Objectives Discuss the purposes, development, and financial centers of the international capital market. Describe the international bond, international equity, and Eurocurrency markets. Discuss the four primary functions of the foreign exchange market Explain how currencies are quoted and the different rates given Identify the main instruments and institutions of the foreign exchange market Explain why and how government restrict currency convertibility

INTERNATIONAL CAPITAL MARKET System that allocates financial resources in the form of debt and equity according to their most efficient uses.

INTERNATIONAL CAPITAL MARKET Purposes of National Capital Markets Purpose of the International Capital Market Forces Expanding the International Capital Market World Financial Centers

Purposes of National Capital Markets National Capital Markets help individuals and institutions borrow the money that other individuals and institutions want to lend.

Purposes of National Capital Markets The most common Capital-Market Intermediaries: Commercial Banks Lend borrowers their investors’ deposits at a specific rate of interest Investment Banks Help clients to invest excess capital and to borrow need capital.

Purposes of National Capital Markets Role of Debt Role of Equity

Role of Debt Debt: Loans in which the borrowers promises to repay the borrowed amount plus a predetermined rate of interest. Bond: Debt instrument that specifies the timing of principal and interest payments.

Role of Equity Equity: Part-ownership of a company in which the equity holder participates with other part owners in the company’s financial gains and losses Stock: Shares of ownership in a company’s assets that give shareholders a claim on the company’s future cash flows

Role of Equity Liquidity: Ease with which bondholders and shareholders may convert their investments into cash.

Purposes of National Capital Markets Equity Share Bond Company Assets Stock Debt

Purposes of the International Capital Markets International Capital Market : Network of individuals, companies financial institutions, and governments that invest and borrow across national boundaries.

Purposes of the International Capital Markets Expanding the Money Supply for Borrowers Reducing the Cost of Money for Borrowers Reducing Risk for Lenders

Reducing Risk for Lenders Two Ways: Investors enjoy a greater set of opportunities from which to choose. Investing in international securities benefits investors because some economies are growing while others are in decline.

Forces Expanding the International Capital Market Information Technology Deregulation Financial Instruments.

Forces Expanding the International Capital Market Securitization : Unbundling and repacking of hard-to-trade financial assets into more liquid, negotiable, and marketable financial instruments( or securities)

World Financial Centers

World Financial Centers Offshore financial center: Country or territory whose financial sector features very few regulations and few, if any, taxes.

MAIN COMPONENTS OF THE INTERNATIONAL CAPITAL MARKET International Bond Market International Equity Market Eurocurrency Market

International Bond Market Market consisting of all bonds sold by issuing companies, government, or other organizations outside their own countries .

International Bond Market Types of International Bonds Interest Rates

Types of International Bonds Eurobond Foreign Bond.

Eurobond Eurobond Bond issued outside the country in whose currency it is denominated.

Foreign bond Foreign bond Bond sold outside the borrower’s country and denominated in the currency of the country in which it is sold .

Interest Rates A Driving Force How can investors who are seeking higher returns and borrowers who are seeking to pay lower interest rates both come out ahead? By using bonds in the international bond market, borrowers from newly industrialized and developing countries can borrow money from other nations where interest rates are lower. Investors in developed countries buy bonds in newly industrialized and developing nations in order to obtain higher returns on their investments.

International Equity Market Market consisting of all stocks bought and sold outside the issuer’s home country.

International Equity Market Spread of Privatization Economic Growth in Developing Countries. Activity of Investment Banks Advent of Cybermarkets

Eurocurrency Market Eurocurrency market Market consisting of all the world’s currencies ( referred to as “Eurocurrency” ) that are banked outside their countries of origin.

Eurocurrency Market Deposits Originate Primarily from Four Sources: Governments with excess funds generated by a prolonged trade surplus Commercial Banks with large deposits of excess currency International companies with large amounts of excess cash Extremely wealthy individuals.

Eurocurrency Market Interbank Interest Rates Interest rates that the world’s largest banks charge one another for loans.

FOREIGN EXCHANGE MARKET Market in which currencies are bought and sold and their prices determined .

FOREIGN EXCHANGE MARKET Exchange rate Rate at which one currency is exchange for another .

Functions of the Foreign Exchange Market Currency Conversion Currency Hedging Currency Arbitrage Currency Speculation

Functions of the Foreign Exchange Market Currency Hedging Practice of insuring against potential losses that result from adverse changes in exchange rates .

Functions of the Foreign Exchange Market Currency Arbitrage Instantaneous purchase and sale of a currency in different markets for profit.

Functions of the Foreign Exchange Market Interest arbitrage Profit-motivated purchase and sale of interest-paying securities denominated in different currencies.

Functions of the Foreign Exchange Market Currency speculation Purchase or sale of a currency with the expectation that its value will change and generate a profit .

HOW THE FOREIGN EXCHANGE MARKET WORKS Quoting Currencies Spot Rates Forward Rates Swaps, Options, and Futures.

Quoting Currencies Quoted Currency: In a quoted exchange rate ,the currency with which another currency is to be purchased. Base Currency: In a quoted exchange rate, the currency that is to be purchased with another currency.

Quoting Currencies Direct and Indirect Rate Quotes Calculating Percent Change Cross Rates

Spot Rates Spot Rate: Exchange rate requiring delivery of the traded currency within 2 business days. Spot Market: Market for currency transactions at spot rates.

Forward Rates Forward Rate: Exchange rate a which two parties agree to exchange currencies on a specified future date. Forward Market: Market for currency transactions at forward rates .

Forward Rates Forward contract: Contract that requires the exchange of an agreed-upon amount of a currency on an agreed-upon date at a specific exchange rate . Derivative: Financial instrument whose value derives from other commodities or financial instruments

Swaps, Options, and Futures Currency Swap: Simultaneous purchase and sale of foreign exchange for two different dates. Currency Option: Right, or option ,to exchange a specific amount of a currency on a specific date at a specific rate.

Swaps, Options, and Futures Currency Futures Contract: Contract requiring the exchange of a specific amount of currency on a specific date at a specific exchange rate, with all conditions fixed and not adjustable.

FOREIGN EXCHANGE MARKET TODAY Trading Centers Important currencies Institutions of the Foreign Exchange Market

Trading Centers Most of world’s mayor cities participate in trading on the foreign exchange market. Three mayor cities: The United Kingdom The United States Japan

Important Currencies Vehicle currencies: Currency used as an intermediary to convert funds between two other currencies.

Institutions of the Foreign Exchange Market Interbank Market Securities Exchanges Over-the-Counter Market

Interbank Market Interbank Market: Market in which the world’s largest banks exchange currencies at spot and forward rates. Clearing: Process of aggregating the currencies that one bank owes another and them carrying out the transaction.

Securities Exchange Securities Exchange: Exchange specializing in currency futures and options transactions.

Over-the- Counter Market Over-the- counter (OTC) market: Exchange consisting of a global computer network of foreign exchange traders and other market participants.

CURRENCY CONVERTIBILITY Convertible (hard) Currency: Currency that trades freely in the foreign exchange market, with its price determined by the forces of supply and demand.

CURRENCY CONVERTIBILITY Goals of Currency Restriction Policies for Restricting Currencies

Goals of Currency Restriction To preserve a country reserve of hard currencies. To preserve hard currencies to pay for imports and to finance trade deficits. To protect a currency from speculators.

Policies for Restricting Currencies Restrict currencies convertibility Government’s requires: Foreign exchange transactions be performed at or approved by the country’s central banks. Import licenses for some or all import transactions.

Policies for Restricting Currencies Countertrade: Practice of selling goods or services that are paid for , in whole or part ,with other goods or services.

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