1. International Financial Management P G Apte
CHAPTER - 6
Global Financial Markets
and Interest Rates
International Financial Management
P G Apte

2. 6.1 The Global Financial Market
The last two decades have witnessed the emergence of a vast global financial market enabling massive cross-border capital flows
Geographical integration and functional integration of financial markets
The early part of eighties saw the process of disintermediation get under way
The process of liberalization and integration continued into the 1990s with many of the developing countries carrying out substantive reforms and opening up their financial markets

3. 6.1 The Global Financial Market
Domestic and offshore markets
Eurocurrencies Market
Differences between offshore and domestic markets
Are domestic and offshore markets really two distinct markets or should we view the entire global financial market as a single market ?
Arbitrage will ensure that they will be closely linked together in terms of costs of funding and returns on assets
They do differ significantly on the regulatory dimension

4. 6.3 Euromarkets
It is mainly an interbank market trading in time deposits and various debt instruments
A "Eurocurrency Deposit" deposit is a deposit in the relevant currency with a bank outside the home country of that currency
Similarly a Eurodollar Loan
The prefix "Euro" is now outdated
These markets have evolved a variety of instruments
The key difference between Euromarkets and their domestic counterparts is one of regulation

5. 6.3 Euromarkets Eurodollar market originated in 1950’s
Growth of the eurodollar market was due to a number of other factors
Supply side
US restrictions on domestic banks and capital markets throughout the 60's and 70's (Regulation Q, Int.Equlization tax)
The importance of the dollar as a vehicle currency in international trade and finance
European companies’ preference for dealing with European banks
Demand side
Demand for Eurodollar loans by non-US entities and by US multinationals to finance their foreign operations

6. 6.3 Euromarkets
Like any other fractional reserve banking system, eurobanks can generate multiple expansion of eurodeposits on receiving a fresh injection of cash
The "modern" approach rejects the idea of a fixed reserve ratio and emphasizes the fact that supply of Eurodeposits on one hand and the demand for Euroloans on the other are both dependent upon the rate of interest
Also relevant are risks – mainly political – as perceived by depositors and borrowers.

7. 6.3 Euromarkets (contd.) Concerns about Euro and offshore markets
The market facilitates short term speculative capital flows - the so called "hot money"
National monetary authorities lose effective control over monetary policy since domestic residents can frustrate their efforts by borrowing or lending abroad
The market is based on a tremendously large volume of interbank lending

8. 6.3 Euromarkets (contd.)
Euromarkets create “private international liquidity”
The markets allow central banks of deficit countries to borrow for balance of payments purposes thus enabling them to put off needed adjustment measures

9. 6.3 Euromarkets (contd.) The advantages of Euro and offshore markets
More efficient allocation of capital worldwide
Smoothing out the effects of sudden shifts in balance of payments imbalances
The spate of financial innovations that have been created by the market which have vastly enhanced the ability of companies and governments to better manage their financial risks

10. 6.4 Interest Rates in the Global Money Markets
The linkages between interest rates in the domestic and offshore markets and between interest rates for different currencies in the offshore market
The spectrum of interest rates existing in an economy at any point of time is the result of the complex interaction between several forces as shown in figure 6.1

11. 6.4 Interest Rates in the Global Money Markets (contd.)
Figure 6.1
Determinants of Interest Rates

12. 6.4 Interest Rates in the Global Money Markets (contd.)
Interbank deposit market, the benchmark is provided by the interbank borrowing and lending rates in the Eurocurrency market e.g. LONDON INTER-BANK OFFER RATE abbreviated LIBOR
The relationship between interest rates in the domestic and euro segments of the money market

13. 6.4 Interest Rates in the Global Money Markets (contd.)
Arbitrage by borrowers and investors with access to both the markets should serve to keep the rates close together
Why are the rates not identical?
Demand side and supply side factors
Linkages between interest rates for different currencies in the euromarket
Forward contract: Under this contract, a depositor agrees to deliver a particular currency six months later in return for another currency, at an exchange rate specified now. This is the forward exchange rate.

14. 6.4 Interest Rates in the Global Money Markets (contd.)
Effective interest rate
Covered Interest Arbitrage
The relationship between the domestic and offshore market interest rates for a currency are governed by risk premia, reserve requirements and other regulations that apply to domestic deposits and the presence of capital controls

15. 6.4 Interest Rates in the Global Money Markets (contd.)
The differences in interest rates between currencies in the euromarket are explained by the differences in the spot-forward margins.
In equilibrium, effective returns on all currencies would be equal

16. 6.5 An Overview of Money Market Instruments
During the decade of the eighties the markets have evolved a wide array of funding instruments
Commercial Paper
Commercial paper is a corporate short-term, unsecured promissory note issued on a discount to yield basis
It can be regarded as a corporate equivalent of CD (Certificate of Deposit) which is an interbank instrument

17. 6.5 An Overview of Money Market Instruments (contd.)
Certificates of Deposit
A Certificate of Deposit (CD) is a negotiable instrument evidencing a deposit with a bank
Unlike a traditional bank deposit which is non-transferable, a CD is a marketable instrument so that the investor can dispose it off in the secondary market when cash is needed
Banker’s Acceptance
This is an instrument widely used in the US money market to finance domestic as well as international trade

18. 6.5 An Overview of Money Market Instruments (contd.)
In a typical international trade transaction, the seller(exporter) draws a time or “usance” draft on the buyer's (importer's) bank. On completing the shipment, the exporter hands over the shipping document and the letter of credit issued by the importer's bank to its bank. The exporter gets paid the discounted value of the draft. The exporter's bank presents the draft to the importer's bank which stamps it as "accepted“.

19. MEDIUM TO LONG TERM INSTRUMENTS
Syndicated Credits
Foreign and Offshore Bonds (Eurobonds)
Buyer’s and Supplier’s Credits
Forfaiting
International Equity Issues - GDRs/ADRs ; Foreign
Listing
Project Finance
NIFs, RUFs and other Underwritten Facilities – Gone out of fashion

20. 2007 2008 2009(Q1+Q2) Facilities 2770 1682 449 Borrowers from
Borrowing on International Capital Markets (US$ Billion)
(Q1+Q2)
1 Syndicated Credit
Facilities
  Borrowers from
(i) Developed
Countries
(ii) Developing
Countries
 2 Debt Securities
(Net Issues)
  Issuers from
Countries
Countries
 2a Money Market
Instruments*
 2b Bonds and Notes

21. ANNOUNCED INTERNATIONAL EQUITY ISSUES (US $ BILLION)
ISSUERS FROM
Q Q2
  All Countries
Developed
Countries
Developing
Countries
China
India
S.Korea

22. Dragon Bond Yankee Bond Bulldog Bond Matilda Bond
A bond that is issued in Asia but denominated in U.S. dollars.
Yankee Bond
A bond denominated in U.S. dollars that is publicly issued in the U.S. by foreign banks and corporations. According to the Securities Act of 1933, these bonds must first be registered with the Securities and Exchange Commission (SEC) before they can be sold. Yankee bonds are often issued in tranches and each offering can be as large as $1 billion.
Bulldog Bond
A sterling denominated bond that is issued in London by a company that is not British.
Matilda Bond
An bond denominated in the Australian dollar and issued on the Australian market by a foreign entity.

23. Maple Bond Samurai Bond Shogun Bond Geisha Bond
A bond denominated in Canadian dollars that is sold in Canada by foreign financial institutions and companies. 
Samurai Bond
A yen-denominated bond issued in Tokyo by a non-Japanese company and subject to Japanese regulations.
Shogun Bond
A type of foreign-currency denominated bond that is issued in Japan by foreign entities. Organizations such as the World Bank have issued such debt instruments in the past.
Geisha Bond
Similar to Shogun bonds but privately placed.

24. 6.6 Summary
Examine the interest rate linkages between the different segments of the global money markets
Close link between interest rates in the domestic and offshore markets in a particular currency
Brief survey of common short-term funding instruments in global money markets