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The Global Capital Market Chapter 11

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Functions of a Generic Capital Market

Brings together: Those who want to invest:

• corporations, individuals, nonbank financial institutions.

Those who want to borrow:• individuals, companies, governments.

Market makers: Commercial and investment banks that connect

investors with borrowers.

11-1

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The Main Players in a Generic Capital Market

Investors: Companies Individuals Institutions

Market makers: Commercial bankers Investment bankers

Borrowers: Individuals Companies Governments

11-2

Figure 11.1

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Attraction of the Global Capital Market?

Increases the supply of funds available for borrowing.

Borrower’s perspective Lowers the cost of capital.

Investor’s perspective Provides a wider range of investment

opportunities.

11-3

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Market Liquidity and the Cost of Capital

SSB

D

SSl

D

D D21

Dollars

0

9

10%

Cost

of

Cap

ital

11-4

Figure 11.2

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Risk Reduction Through Portfolio Diversification

(a) Risk reduction through domestic diversification

0.27

1.0

1 10 20 30 40 50

U.S. Stocks

TotalRisk

SystematicRisk

Number of stocks

Variance of portfolio return

Variance of return on

typical stock

11-5

Figure 11.3a

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Risk Reduction Through Portfolio Diversification

(b) Risk reduction through domestic and international diversification

0.27

1.0

1 10 20 30 40 50

U.S. Stocks

International Stocks

Number of stocks

Variance of portfolio return

Variance of return on

typical stock0.12

11-6

Figure 11.3b

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Net International Bank Lending

0

1000

2000

3000

4000

5000

6000

83 84 85 86 87 88 89 90 91 92 93 94 95 96 97

$Billions

11-7

Figure 11.4

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International Bond Issues and the US Dollar Exchange Rate

60

80

100

120

140

160

180

0 94-1Q 94-2Q 94-3Q 94-4Q 95-1Q 95-2Q 95-3Q 95-4Q 96-1Q 96-2Q 96-3Q 96-4Q 97-1Q 97-2Q 97-3Q

DMYEN

Left-hand Scale (31 Dec 1993=100): Exchange Rate against US$

Right-hand Scale ($ Billion): announced IssuesUS DollarYen

European Currencies

Other

100

200

300

11-8Figure 11.5

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International Equity Offerings and Equity Price Developments

0

100

200

300

400

500

600

700

800

900

1000

85 86 87 88 89 90 91 92 93 94 95 96 97

20

60

40

80Left-Hand Scale (US$)

M.S.C.I. World Index

Right-hand Scale ($ Billions)US$

Yen

11-9Figure 11.6

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Why The Growth?

TECHNOLOGY. Deregulation by governments of capital

flows and financial services. Risk: Nations may be more vulnerable

to speculative capital flows. Short term investing.

11-10

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Index of Capital Controls in Emerging Markets

0.52

0.54

0.56

0.58

0.6

0.62

0.64

0.66

0.68

86 87 88 89 90 91 92 93 94 95 96

0 = No Capital controls

1 = Tight Capital Controls

11-11Figure 11.7

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Eurocurrency

It’s not the Euro! It is any currency banked outside its country

of origin. 1950s. Eastern Europeans afraid US would

seize deposits to reimburse claims for business losses as a result of Communist takeover of Eastern Europe.

11-12

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Growth in Eurocurrency Funds

0

200

400

600

800

1000

1200

1400

1600

1961 1998

19611998

One Billion

1.5 Trillion

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The Eurocurrency Market Characterized by a lack of regulation compared

to domestic financial markets. This means that you don’t have to pay for the

cost of regulation. Hence, cheap (or cheaper) money. Downside:

Banks could be more likely to fail (not probable) Because you are getting foreign money, you have

currency exchange risks.

11-14

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Interest Rate Spreads in Domestic and Eurocurrency Markets

Rate of interest

Domestic lendingrate

Domesticdeposit rate

Eurocurrencylending rate

Eurocurrencydeposit rate

0%

11-15

Figure 11.8

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The International Bond Market Bonds tend to be fixed rate. Foreign bonds

Sold outside the borrower’s country and in currency of country where issued.

Eurobonds underwritten by an international syndicate. issued by large corporations, international institutions

and governments. placed in country other than country of currency and

its residents.11-16

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Euro vs Foreign Bonds(Billions of Dollars)

0 50 100 150 200

Euro

Foreign

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Attraction of the Eurobond Market?

No government interference. Few disclosure requirements. Favorable tax status.

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Global Equity Markets

Where investors can buy/sell stocks. Made up of many stock exchanges

around the world.

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Trading in Non-US Stocks

0

100

200

300

400

500

NASDAQ NYSE

1994199519961997

US Billions

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Who Uses These Markets?

Investors seeking to diversify their portfolios. Companies seeking to

issue stock in the country use stock and options as a form of employee incentives satisfy local ownership requirements create funding for future acquisitions increase the visibility of the company.

11-21