international financial markets copyright © 2014 pearson education, inc. 9

International International Financial MarketsFinancial Markets

Copyright © 2014 Pearson Education, Inc.

9

9 - 2Copyright © 2014 Pearson Education, Inc.

Chapter ObjectivesChapter 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 that are given

• Identify the main instruments and institutions of the foreign exchange market

• Explain why and how governments restrict currency convertibility


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• Exchange rates affect financial performance• Convert foreign earnings into home currency• Rising home currency means lower earnings


Capital MarketCapital Market

System that allocates financial resourcesaccording to their most efficient uses

Debt: Repay principal plus interest Bond has timed principal & interest payments

Equity: Part ownership of a company Stock shares in financial gains or losses


International Capital MarketInternational Capital Market

Network of people, firms, financial institutions, and governments borrowing and investing internationally

Borrowers Expands money supply Reduces cost of money

Borrowers Expands money supply Reduces cost of money

Lenders Spread / reduce risk Offset gains / losses

Lenders Spread / reduce risk Offset gains / losses


International CapitalInternational CapitalMarket DriversMarket Drivers

Information technology

Deregulation

Financial instruments


Country or territorywhose financial sector

features few regulationsand few, if any, taxes

Country or territorywhose financial sector

features few regulationsand few, if any, taxes

Operational centerExtensive financial activity

and currency trading

Operational centerExtensive financial activity

and currency trading

Booking centerMostly for bookkeeping

and tax purposes

Booking centerMostly for bookkeeping

and tax purposes

Offshore Financial CentersOffshore Financial Centers


Discussion QuestionDiscussion Question

What key factors are driving growth of the international capital market?


Answer to Discussion Answer to Discussion QuestionQuestion

Information technology is reducing the costs of global communication. Deregulation increases competition, lowers the cost of financial transactions, and opens national markets to global investing and borrowing. Innovative financial instruments expand the options available to lenders and borrowers.


International Bond MarketInternational Bond Market

Foreign bond Interest ratesEurobond

Bond that is issued outside the country in whose currency the bond is denominated

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

Driving growth are differential interest rates between developed and developing nations

Market of bonds sold by issuing companies, governments, and others outside their own countries


International Equity MarketInternational Equity Market

Market of stocks bought and sold outsidethe issuer’s home country

PrivatizationPrivatization

Investment banksInvestment banks

Emerging marketsEmerging markets

Electronic marketsElectronic markets


Governments Commercial banks International companies Wealthy individuals

Eurocurrency MarketEurocurrency Market

Unregulated market of currencies banked outside

their countries of origin


Foreign Exchange MarketForeign Exchange Market

Conversion: To facilitate transactions, invest directly abroad, or repatriate profits

Hedging: Insure against potential losses from adverse exchange-rate changes

Arbitrage: Instantaneous purchase and sale of a currency in different markets for profit

Speculation: Sequential purchase and sale (or vice-versa) of a currency for profit

Market in which currencies are bought and sold and their prices are determined


Largest Currency MarketsLargest Currency Markets

UK:$1.33 trillion

US:$0.62 trillion

Japan:$0.24 trillion Source: */Kyodo/NewscomSource: */Kyodo/Newscom



Using the foreign exchange market to insure against potential losses from adverse changes in exchange rates is called currency __________.

a. Arbitrage

b. Hedging

c. Speculation


Quoting CurrenciesQuoting Currencies

Quoted currency = numeratorBase currency = denominatorQuoted currency = numeratorBase currency = denominator

(¥/$) = Japanese yen needed to buy one U.S. dollar(¥/$) = Japanese yen needed to buy one U.S. dollar

Yen is quoted currency, dollar is base currencyYen is quoted currency, dollar is base currency


Currency ValuesCurrency Values

Change in U.S. dollar against Norwegian

krone

February 1: NOK 5/$ March 1: NOK 4/$

%change = [(4-5)/5] x 100 = -20%

U.S. dollar fell 20%

Change in Norwegian krone against U.S. dollar

Make krone base currency (1÷ NOK/$) February 1: $.20/NOK March 1: $.25/NOK

%change = [(.25-.20)/.20] x 100 = 25%

Norwegian krone rose 25%


Cross RateCross Rate

• Exchange rate calculated using two other exchange rates• Use direct or indirect exchange rates against a third currency


Cross Rate ExampleCross Rate Example

Direct quote method

1) Quote on euro = € 0.7883/$2) Quote on yen = ¥ 84.3770/$3) € 0.7883/$ ÷ ¥ 84.3770/$ = € 0.0093/¥4) Costs 0.0093 euros to buy 1 yen


Spot RateSpot Rate

Exchange rate requiring deliveryExchange rate requiring deliveryof traded currency within two business daysof traded currency within two business days

Repatriate incomeRepatriate incomefrom sales abroadfrom sales abroad

Invest in anotherInvest in anothernational marketnational market

Pay supplier inPay supplier inits own currencyits own currency


Forward RateForward Rate

Rate at which two parties will exchangecurrencies on a specified future date

Forward Contracts

Reduce exchange-rate risk

30, 90, 180 days or custom lengths


Currency swapSimultaneous purchase and sale of foreign exchange

for two different dates

Currency swapSimultaneous purchase and sale of foreign exchange

for two different dates

Currency optionOption to exchange a specified amount of currency on a

specified date at a specified rate

Currency optionOption to exchange a specified amount of currency on a

specified date at a specified rate

Currency futures contractContract requiring the exchange of a specified amount of a currency

on a specified date at a specified exchange rate, with allconditions fixed and not adjustable

Currency futures contractContract requiring the exchange of a specified amount of a currency

on a specified date at a specified exchange rate, with allconditions fixed and not adjustable

Swaps, Options, and FuturesSwaps, Options, and Futures



Why is exchange rate risk important to companies involved in international business?



Exchange-rate risk is important because it can jeopardize profits from current and future international transactions.


24-Hour Trading24-Hour Trading


Key Market InstitutionsKey Market Institutions

Interbankmarket

Securitiesexchange

Market in whichthe world’s largestbanks exchangecurrencies at spotand forward rates

Market in whichthe world’s largestbanks exchangecurrencies at spotand forward rates

Exchange that specializes in currency futures and options transactions

Exchange that specializes in currency futures and options transactions

Global computer network of foreignexchange tradersand other marketparticipants

Global computer network of foreignexchange tradersand other marketparticipants

Over-the-Counter(OTC) market


Manager’s Briefcase:Manager’s Briefcase:Managing Foreign ExchangeManaging Foreign Exchange

1. Match Needs to Providers

2. Work with the Major Banks

3. Consolidate Multiple Transactions

4. Get the Best Rate Possible

5. Embrace Information Technology


Goals of Currency RestrictionGoals of Currency RestrictionGoals of Currency RestrictionGoals of Currency Restriction

Protect a currencyfrom speculators

Constrain individualsand companies from

investing abroad

Preserve hard currencyto repay debts owed

to other nations

Preserve hard currencyto pay for imports andfinance trade deficits


Currency Restriction PoliciesCurrency Restriction Policies

Multiple exchange rate system

Import deposit requirements

What’s a firm to do?

Countertrade

Quantity restrictions

Import licenses

Central bank approval



A currency that trades freely in the foreign exchange market is called a __________ currency.

a. Cross

b. Vehicle

c. Convertible

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