1. International Business An Asian PerspectiveBy
Charles W.L. Hill
Chow-Hou Wee
Krishna Udayasankar
Welcome to International Business, An Asian Perspective, by Charles W.L. Hill, Chow-Hou Wee and Krishna Udayasankar

2. The Global Capital Market
Chapter 11
The Global Capital Market
Chapter 11: Global Capital Markets
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

3. 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
Suppose your company has decided to expand into new markets and needs to raise some money to do so.
How should your firm raise the money?
Well, if it’s like many companies today, it’ll probably turn to the global capital markets.
Just a couple of decades ago, regulatory barriers made it difficult for firms to go outside their domestic markets when it came to raising capital, but today, thanks to the globalization of capital markets and lower barriers, firms have many more choices!
Before we start our discussion of the global capital markets, let’s go over some functions of a generic capital market.
Capital markets bring together investors and borrowers.
Investors include corporations with surplus cash, individuals, and non-bank financial institutions.
You can think of pension funds and insurance companies as being investors.
Borrowers include individuals, companies, and governments.
Markets makers are the financial service companies that connect investors and borrowers, either directly or indirectly.
You might think of companies like Citicorp.
Companies can raise money either through selling stock, or equity, to investors, or through debt like a cash loan or bond issue.

4. Who Are The Main Players in Capital Markets?
The Main Players in a Generic Capital Market
Here you can see the main players in a generic capital market.

5. 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
the associated lower cost of capital - the price of borrowing money or the rate of return that borrowers pay investors
Investors benefit from the wider range of investment opportunities
diversify portfolios and lower risk
Why makes the global capital market so attractive?
Well, from a borrower’s perspective, the global capital market is attractive because it’s bigger supply of funds means that the cost of capital, or the cost of borrowing the money, will be lower than what the firm could get it its more limited domestic market.
In other words, there’s a much bigger pool of potential investors in the global capital market than in the domestic market, so borrowers will pay less to borrow in the global market.
Deutsche Telekom, for example, kept its cost of capital lower by raising funds in multiple markets, rather than simply relying on its domestic market. You can learn more about Deutsche Telekom’s strategy in the Management Focus in your text.
Do investors also benefit from global capital markets?
The answer is yes!
Investors benefit because the wide range of investment opportunities available in the global capital markets allows them to diversify their portfolios and in doing so, reduce their risk.
Remember, a diversified portfolio means that instead of just having a few stocks, investors have many, and so losses in one stock can be offset by gains in another stock. One study found that a fully diversified portfolio is only about 27 percent as risky as individual sticks! Furthermore, by diversifying internationally, investors can take advantage of the fact that the movement of stock prices across borders is not perfectly correlated.
What does this mean?
Well, it means that because individual stock markets respond to their countries’ macroeconomic policies and economic conditions, they don’t necessarily follow the same pattern as other stock markets.
You might recall for example, that while stocks were plummeting in many Asian markets in 1997, the S&P actually went up by about 20 percent. So, for a diversified investor, a loss in Thailand may have been offset by a gain in the United States. Similarly, restrictions on capital flows across borders means that some markets have too much invested, while other have too little.
In either case, rates of return will be affected, and investors with diversified portfolios will be in a better position than those with undiversified portfolios.

6. What Makes The Global Capital Market Attractive?
Market Liquidity and the Cost of Capital
Here you can see an illustration of how liquidity and the cost of capital are linked.

7. What Makes The Global Capital Market Attractive?
Risk Reduction through Portfolio Diversification
Here you can see the relationship between international diversification and risk.
Notice that a fully diversified portfolio containing stock from many countries is less than half as risky as a fully diversified portfolio containing stock from just the United States.

8. 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 $24,566 in 2008
the international bond market has grown from $3,515 billion in 1997 to $22,734 in 2008
international equity offerings were $18 billion in 1997 and $387 billion in 2008
Recall, that we said that global capital markets are growing.
In 1990, the stock of cross-border bank loans was just $3,600 billion, but by
2008, the stock of cross border bank loans was $24,566 billion!
We can see a similar pattern in the international bond market where there were $3,515 billion in outstanding international bonds in 1997, and $22,734 billion in 2008!
As you’d expect, International equity offerings have also grown from $18 billion in 1997 to $387 billion in 2008.

9. 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-day trading
so, shocks that occur in one financial market spread around the globe very quickly
Why have the global capital markets grown so significantly?
Well, there are two factors that have contributed to the growth.
First, advances in information technology.
You’re probably already aware of the tremendous advances in information technology that have occurred over the last few decades.
For example, the real cost of recording, transmitting, and processing information fell by an amazing 95 percent between 1964 and 1990!
Since then, the Internet has emerged as a force, as has additional computing power.
The financial services sector has been transformed by some of these advances. Today, you can trade foreign currencies, stocks, bonds, and other financial assets 24/7/365!
Keep in mind that this continuous trading environment has a downfall – shocks in one market can spread around the globe very quickly!
We saw this happen in the 1997 Asian financial crisis, and more recently in the 2008 crisis.

10. 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
deregulation began in the United States, then moved to other countries - Great Britain, Japan, and France
many countries have dismantled capital controls making it easier for both inward and outward investment to occur
The second factor contributing to the growth of global capital markets is deregulation by governments.
Historically, governments have kept tight controls on the movement of capital across borders, but since the 1980s, these restrictions have been falling.
This loosening of control was partly a response to the development of the Eurocurrency market, which we’ll talk more about later, and partly a response to pressure from financial services companies.
The deregulation began in the United States, and then moved on to other markets like Britain, Japan, and France.
More recently, some emerging markets began dismantling their barriers, and most experts expect this trend to continue.

11. What Are The Risks Of The Global Capital Markets?
Could deregulation of capital markets and fewer controls on cross-border capital flows make nations more vulnerable to the effects of speculative capital flows?
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
Are there any risks with global capital markets?
Yes!
Some analysts worry that the deregulation of capital markets and loosening of controls on cross-border capital flows could make individual nations more vulnerable to the destabilizing effects of speculative capital flows.
Mexico experienced this in the mid-1990s.
You can learn more about Mexico’s situation in the Country Focus in your text.
Keep in mind that speculative capital flows may be the result of inaccurate information about investment opportunities.
Some experts believe that Mexico’s problems may have been exacerbated by a lack of information about the long-term investment opportunities in the country.
If global capital markets continue to grow, we should expect that better quality information will be available from financial intermediaries.

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 United States
Other important eurocurrencies are the euro-yen, the euro-pound, and the euro-euro
Now, let’s go on to the Eurocurrency market.
A eurocurrency is any currency banked outside of its country of origin.
So, Japanese yen that have been deposited in a bank in London, are called euro-yen, and U.S. dollars banked in London are euro-dollars.
About two-thirds of all eurocurrencies are eurodollars.

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 United States
In 1957, the market surged again after changes in British laws
London continues to be the leading center of the eurocurrency market
How did the eurocurrency market emerge?
Well, the eurocurrency market began in the 1950s when the Eastern bloc countries including the Soviet Union, were afraid the United States might seize their holdings of dollars if they left them in the United States.
So, instead of depositing their dollars in the United States, they deposited them in Europe, and they became euro-dollars.
Additional dollar deposits came from Western European central banks and companies that exported to the United States.
These groups found the higher interest rates offered in London very attractive.
In 1957, the market surged again after changes in British laws prohibited British banks from lending pounds to finance non-British trade.
The banks started to finance the trade using dollars instead.
This led London to take a central role in the eurocurrency market, a role it continues today.

14. Why Has The Eurocurrency Market Grown?
In the 1960s, the market grew once again when, after changes in U.S. regulations discouraged U.S. banks from lending to non-U.S. residents, would-be borrowers of dollars outside the United States turned to the euromarket as a source of dollars
The next big increase came after the and oil price increases
OPEC members avoided potential confiscation of their dollars by depositing them in banks in London
During the 1960s, the eurocurrency market got another boost after changes in U.S. regulations discouraged U.S. banks from lending to non-U.S. residents.
Would-be borrowers of dollars outside the United States turned to the euromarket instead.
The next big increase in the eurocurrency market came after the and oil price increases that gave OPEC members huge amounts of dollars.
The OPEC countries, worried that the United States might confiscate the dollars, deposited them in banks in London instead.
Today, the market continues to be popular with both borrowers and depositors because of the advantages is offers.

15. 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
The spread between the eurocurrency deposit and lending rates is less than the spread between the domestic deposit and lending rates giving eurocurrency banks a competitive edge over domestic banks
What are the advantages of the eurocurrency market?
The eurocurrency market is unlike most markets in that it’s unregulated.
What does this mean?
Well, without the costs of following government regulations, banks are able to offer higher rates of interest on deposits, and make loans at lower interest rates.
This makes the market attractive to both borrowers and lenders, and give eurocurrency banks an edge of their domestic competitors.

16. What Makes The Eurocurrency Market Attractive?
Interest Rate Spreads in Domestic and Eurocurrency Markets
In this figure, you can see the interest rate spreads in domestic and eurocurrency markets.

17. What Makes The Eurocurrency Market Unattractive?
The eurocurrency market has two significant drawbacks
Because the eurocurrency market is unregulated, there is a higher risk of bank failure
Companies borrowing eurocurrencies can be exposed to foreign exchange risk
Does the eurocurrency market have any disadvantages?
Yes, there are two main drawbacks.
First, because the market’s unregulated, the chance for bank failure is higher, so it’s a riskier market.
Second, companies that borrow eurocurrencies are exposed to exchange rate risk, whereas if they borrowed in their domestic currency, they would avoid that risk.

18. What Is The Global Bond Market?
Bonds are an important means of financing for many companies
The most common kind is a fixed rate bond which gives investors fixed cash payoffs
The global bond market grew rapidly during the 1980s and 1990s
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
Eurobonds are underwritten by a syndicate of banks and placed in countries other than the one in whose currency the bond is denominated
Next, let’s go on to the global bond market.
You probably already know that bonds are an important means of raising funds for many companies.
The global bond market experienced rapid growth in the 1980s and 1990s, a trend that continues today.
The most common type of bond is a fixed rate bond which pays the investor a fixed amount each year until it reaches maturity.
International bonds come in two forms – foreign bonds and eurobonds.
Let’s talk about each one.
Foreign bonds are sold outside the borrower’s country and are denominated in the currency of the country in which they are issued.
So, if your company issues bonds in Japanese yen, and sells them in Japan, it’s selling foreign bonds.
In contrast, eurobonds are underwritten by a syndicate of banks and placed in countries other than the one in whose currency the bond is denominated.
So, your company might offer bonds denominated in Japanese yen, that are sold in Germany.
Eurobonds used to be more common than foreign bonds, but today that trend is beginning to shift.

19. 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 makes the eurobond market attractive?
There are three main reasons.
First, it lacks regulatory interference.
As you’ve probably guessed, since companies do not have to adhere to strict regulations, the cost of issuing bonds is lower.
Second, it has less stringent disclosure requirements than domestic bond markets, so it can be cheaper and less time consuming to offer eurobonds than to issue dollar-denominated bonds.
Finally, it’s more favorable from a tax perspective .
Because of special tax exemptions, eurobonds can be sold directly to foreign investors.

20. What Is The Global Equity Market?
The global equity market allows firms to
Attract capital from international investors
many investors invest in foreign equities to diversify their portfolios
List their stock on multiple exchanges
this type of trend may result in an internationalization of corporate ownership
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, and give the firm the option of compensating local managers and employees with stock
Let’s move on to the global equity market.
Strictly speaking, the global equity market simply refers to the individual equity markets that exist in many countries where investors from around the world diversify their portfolios.
The largest equity markets are in the United States, Britain, and Japan.
One interesting trend that’s beginning to emerge with the growth of these markets is the internationalizing of corporate ownership.
In the future, it may be impossible to talk about American companies or British companies, instead companies will be owned by investors from around the world.
Keep in mind that the companies themselves are encouraging this development by listing their stock on multiple exchanges.
Traditionally, only firms from developed countries participated in this type of activity, but today, companies from emerging markets are seeing the value of raising capital in the global marketplace.
As the Country Focus in your text outlines for example, companies from the Czech Republic are seeking funds in London.

21. 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 to purchase the necessary currency and lock in the exchange rate, 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 due to adverse exchange rate movements
It’s important to remember that adverse exchange rates can increase the cost of foreign currency loans.
At first glance, borrowing foreign currencies may seem like the way to go, but once exchange rate risk is factored in, this may not seem so attractive.
Those firms that do borrow foreign currencies can hedge their risk through forward contracts, but in doing so, will incur additional transaction costs, which again could make the option of borrowing foreign currencies less attractive.
In the end, firms have to weigh the benefits of a lower interest rate against the risk of an increase in the real cost of capital due to adverse exchange rate movements.

22. 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
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
So, for managers, growth in the global capital markets has created opportunities for firms to borrow and invest internationally.
While It typically costs less to borrow in the global capital market, firms need to be aware of the foreign exchange risk involved.
Similarly, while the global capital markets offer investors the opportunity to diversify their portfolios, and therefore reduce their risk, once again firms need to consider how exposure to foreign exchange risk factors into the equation.

23. Review Question Which of the following are market makers?
a) commercial banks
b) pension funds
c) insurance companies
d) governments
Now, let’s see how well you understand the material in this chapter. I’ll ask you a few questions. See if you can get them right. Ready?
Which of the following are market makers?
a) commercial banks
b) pension funds
c) insurance companies
d) governments
The answer is a.

24. Review Question Which of the following is not true of global
capital markets
a) they benefit borrowers
b) they benefit sellers
c) they raise the cost of capital
d) they provide a wider range of investment opportunities
Which of the following is not true of global capital markets
a) they benefit borrowers
b) they benefit sellers
c) they raise the cost of capital
d) they provide a wider range of investment opportunities
The answer is c.

25. Review Question Compared to developed nations, less
developed nations have
a) smaller capital markets
b) more investment opportunities
c) similar costs of capital
d) greater liquidity
Compared to developed nations, less developed nations have
a) smaller capital markets
b) more investment opportunities
c) similar costs of capital
d) greater liquidity
The answer is a.

26. Review Question In 2008, the stock of cross-border bank loans
was about
a) $3,620
b) $7,840
c) $24, 560
d) $33,630
In 2008, the stock of cross-border bank loans was about
a) $3,620
b) $7,840
c) $24,560
d) $33,630
The answer is c.

27. Review Question Historically, the most tightly regulated
industry has been
a) agriculture
b) consumer electronics
c) automotives
d) financial services
Historically, the most tightly regulated industry has been
a) agriculture
b) consumer electronics
c) automotives
d) financial services
The answer is d.

28. Review Question The term eurocurrency refers to
a) the currency used by the European Union countries
b) any currency banked outside its country of origin
c) currencies purchased in the international equities market
d) bonds sold outside the borrower’s country that are denominated in the currency of the country in which they are issued
The term eurocurrency refers to
a) the currency used by the European Union countries
b) any currency banked outside its country of origin
c) currencies purchased in the international equities market
d) bonds sold outside the borrower’s country that are denominated in the currency of the country in which they are issued
The answer is b.