International Financial Markets: Chapter Objectives

International Financial Markets
Chapter Objectives
• To describe the background and corporate

use of the following international financial
markets:
¤ foreign exchange market,
¤ Eurocurrency market,
¤ Eurocredit market,
¤ Eurobond market, and
¤ international stock markets.
1
Motives for Using
• Several barriers deter the complete integration
of the markets for real or financial assets.
• Examples include tax differentials, tariffs,
quotas, labor immobility, cultural differences,
financial reporting differences, and costs of
communication.
• Yet, these barriers can also create unique
opportunities for specific geographic markets
that will attract foreign creditors and investors.
2
Motives for Using
• Motives for investing in foreign markets:
¤ economic conditions
¤ exchange rate expectations
¤ international diversification
• Motives for providing credit in foreign markets:

¤ high foreign interest rates
¤ international diversification
3
Motives for Using
• Motives for borrowing in foreign markets:

¤ low interest rates
4
Foreign Exchange Market
• The foreign exchange market allows currencies to be
exchanged to facilitate international trade or financial
transactions.
• The system for establishing exchange rates has
changed over time:
¤ 1876-1913: gold standard
¤ WWI & Great Depression: period of instability
¤ 1944: Bretton Woods Agreement
¤ 1971: Smithsonian Agreement
¤ 1973: some official boundaries were eliminated
5
• There is no specific building or location where
traders exchange currencies. Trading also occurs
around the clock.
• The market for immediate exchange is known as
the spot market.
• Trading between banks makes up what is often
referred to as the interbank market.
• The forward market for currencies enables an
MNC to lock in the exchange rate (called a forward
rate) at which it will buy or sell a currency.
6
• Attributes of banks important to customers in
need of foreign exchange:
¤ competitiveness of quote
¤ special relationship with the bank
¤ speed of execution
¤ advice about current market conditions
¤ forecasting advice
• Banks provide foreign exchange transactions for

a fee: the bid (buy) quote for a foreign currency
will be less than its ask (sell) quote.
7
ask rate - bid rate

• bid/ask spread =
ask rate
• The bid/ask spread is normally greater for
those currencies that are less frequently
traded.
• Exchange rate quotations for widely traded
currencies are listed in many newspapers on a
daily basis. Forward rates and cross exchange
rates may be quoted too.
8
• cross exchange rate :
value of 1 unit of value of currency A in $
currency A in units =
of currency B value of currency B in $
• Quotations that represent the value of a

foreign currency in home currency are
referred to as direct quotations, while those
that represent the number of units of a
foreign currency per home currency are
referred to as indirect quotations.
9
• Some MNCs involved in international trade

use the currency futures and options markets
to hedge their positions.
• Futures are similar to forward contracts,
except that they are sold on an exchange
while forward contracts are offered by banks.
• Currency options are classified as either calls
or puts. They can be purchased on an
exchange too.
10
Eurocurrency Market $
• U.S. dollar deposits placed in banks in Europe and
other continents are called Eurodollars and are not
subject to U.S. regulations.
• In the 1960s and 70s, the Eurodollar market, or
what is now called the Eurocurrency market, grew
to accommodate increasing international business.
• The market is made up of several large banks
called Eurobanks that accept deposits and provide
loans in various currencies.
11
• Although the market focuses on large-volume
transactions, at times no single bank is willing to
lend the needed amount. A syndicate of
Eurobanks may then be composed.
• Two regulatory events allow for a more
competitive global playing field:
¤ The Single European Act opens up the European
banking industry and calls for similar regulations.
¤ The Basel Accord includes standardized guidelines
on the classification of capital.
12
• The Eurocurrency market in Asia is
sometimes referred to separately as the
Asian dollar market.
• The primary function of banks in the Asian
dollar market is to channel funds from
depositors to borrowers. Another function
is interbank lending and borrowing.
13
Eurocredit Market LOANS
• Loans of one year or longer extended by

Eurobanks to MNCs or government agencies
are called Eurocredit loans. These loans are
provided in the Eurocredit market.
• Eurocredit loans often have a floating rate, to
lessen the risk resulting from a mismatch in
the banks’ asset and liability maturities.
• Syndicated Eurocredit loans are popular
among big borrowers too.
14
Eurobond Market BONDS
• There are two types of international bonds:

¤ A foreign bond is issued by a borrower foreign to
the country where the bond is placed.
¤ Eurobonds are sold in countries other than the
country represented by the currency
denominating them.
• Eurobonds are underwritten by a multi-national
syndicate of investment banks and
simultaneously placed in many countries. They
are usually issued in bearer form.
15
Eurobond Market BONDS
• Eurobonds increased rapidly in volume when in

1984, the withholding tax was abolished in the
U.S. and corporations were allowed to issue
bonds directly to non-U.S. investors.
• Interest rates for each currency and credit
conditions change constantly, causing the
market’s popularity to vary among currencies.
• In recent years, governments and corporations
from emerging markets have frequently utilized
the Eurobond market.
16
Why Interest Rates Vary Among Currencies
• Interest rates, which can vary substantially for

different currencies, are crucial because they
affect the MNC’s cost of financing.
• The interest rate for a specific currency is
determined by the demand for and supply of
funds in that currency.
• As the demand and supply schedules change
over time for a specific currency, the
equilibrium interest rate for that currency will
also change.
17
Global Integration of Interest Rates
• Many investors shift their savings around
currencies to take advantage of higher interest
rates.
• Borrowers sometimes also borrow a currency
different from what they need to take advantage
of a lower interest rate.
• Ultimately, the freedom to transfer funds across
countries causes the demand and supply
conditions for funds to be integrated, which in
turn causes interest rates to be integrated.
18
International Stock Markets
• MNCs can obtain funds by issuing stock in
international markets, in addition to the local
market.
• By having access to various markets, the
stocks may be more easily digested, the image
of the MNC may be enhanced, and the
shareholder base may be diversified.
• The proportion of individual versus institutional
ownership of shares varies across stock
markets. The regulations are different too.
19
International Stock Markets
• The locations of the MNC’s operations may affect
the decision about where to place stock, in view
of the cash flows needed to cover dividend
payments in the future.
• Stock issued in the U.S. by non-U.S. firms or
governments are called Yankee stock offerings.
• Non-U.S. firms can also issue American
depository receipts (ADRs), which are certificates
representing bundles of stock. The use of ADRs
circumvents some disclosure requirements.
20
Use of International Financial Markets
Foreign cash flow movements of a typical MNC:
• Foreign trade. Exports generate foreign cash
inflows, while imports require cash outflows.
• Direct foreign investment. Cash outflows to
acquire foreign assets generate future inflows.
• Short-term investment or financing in foreign
securities, usually in the Eurocurrency market.
• Longer-term financing in the Eurocredit,
Eurobond, or international stock markets.
21

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International Financial Markets

• To describe the background and corporate

• Motives for providing credit in foreign markets:

• Motives for borrowing in foreign markets:

• Banks provide foreign exchange transactions for

ask rate - bid rate

• Quotations that represent the value of a

• Some MNCs involved in international trade

• Loans of one year or longer extended by

• There are two types of international bonds:

• Eurobonds increased rapidly in volume when in

• Interest rates, which can vary substantially for

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