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  1. 1. InternationalBusiness 7eby Charles W.L. HillMcGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
  2. 2. Chapter 11The Global Capital Market
  3. 3. 11-3IntroductionThe rapid globalization of capital markets facilitates thefree flow of money around the worldTraditionally, national capital markets have beenseparated by regulatory barriersTherefore, it was difficult for firms to attract foreign capitalMany regulatory barriers fell during the 1980s and 1990s,allowing the global capital market to emergeToday, firms can list their stock on multiple exchanges,raise funds by issuing equity or debt to investors fromaround the world, and attract capital from internationalinvestors
  4. 4. 11-4Benefits Of The Global Capital MarketThere are market functions that are shared by bothdomestic and international capital marketsHowever, global capital markets offer some benefits notfound in domestic capital markets
  5. 5. 11-5Functions Of A Generic Capital MarketCapital markets bring together investors and borrowersInvestors include corporations with surplus cash,individuals, and non-bank financial institutionsBorrowers include individuals, companies, andgovernmentsMarkets makers are the financial service companies thatconnect investors and borrowers, either directly or indirectlyCommercial banks are indirect market makers, andinvestment banks are direct market makersCapital market loans can be equity (stock) or debt ( cashloans or bonds)
  6. 6. 11-6Classroom Performance SystemWhich of the following are market makers?a) commercial banksb) pension fundsc) insurance companiesd) governments
  7. 7. 11-7Functions Of A Generic Capital MarketFigure 11.1: The Main Players in a Generic Capital Market
  8. 8. 11-8Attractions Of The Global Capital MarketBorrowers benefit from:the additional supply of funds global capital marketsprovidethe associated lower cost of capital (the price ofborrowing money or the rate of return that borrowers payinvestors)The cost of capital is lower in international marketsbecause the pool of investors is much larger than in thedomestic capital market
  9. 9. 11-9Attractions Of The Global Capital MarketFigure 11.2: Market Liquidity and the Cost of Capital
  10. 10. 11-10Attractions Of The Global Capital MarketInvestors also benefit from the wider range of investmentopportunities in global capital markets that allow them todiversify their portfolios and lower their risksStudies show that fully diversified portfolios are onlyabout 27 percent as risky as individual stocksInternational portfolio diversification is even less riskybecause the movements of stock prices across countriesare not perfectly correlatedThis low correlation reflects the differences in nations’macroeconomic policies and economic policies and howtheir stock markets respond to different forces, and nations’restrictions on cross-border capital flows
  11. 11. 11-11Attractions Of The Global Capital MarketFigure 11.3: RiskReduction through PortfolioDiversification
  12. 12. 11-12Classroom Performance SystemCompared to developed nations, less developed nationshavea) smaller capital marketsb) more investment opportunitiesc) similar costs of capitald) greater liquidity
  13. 13. 11-13Classroom Performance SystemWhich of the following is not true of global capital marketsa) they benefit borrowersb) they benefit sellersc) they raise the cost of capitald) they provide a wider range of investment opportunities
  14. 14. 11-14Growth Of The Global Capital MarketGlobal capital markets are growing at a rapid paceIn 1990, the stock of cross-border bank loans was just$3,600 billionBy 2006, the stock of cross border bank loans was$17,875 billionThe international bond market shows a similar patternwith $3,515 billion in outstanding international bonds in1997, and $17, 561 billion in 2006International equity offerings were $18 billion in 1997 and$377 billion in 2006
  15. 15. 11-15Classroom Performance SystemIn 2006, the stock of cross-border bank loans was abouta) $3,600b) $7,800c) $17,800d) $33,600
  16. 16. 11-16Growth Of The Global Capital MarketTwo factors are responsible for the growth of capitalmarkets:1. advances in information technology – the growth ofinternational communications technology and advances indata processing capabilitiesFinancial services companies now engage in 24-hour-day trading – the international capital market never sleepsHowever, this also means that shocks that occur in onefinancial market spread around the globe very quickly
  17. 17. 11-17Growth Of The Global Capital Market2. deregulation by governments – has facilitated growth inthe international capital marketsTraditionally, governments have limited the ability offoreign investors to purchase significant equity positions indomestic companies, and the amount of foreign investmentcitizens could makeSince the 1980s, these restrictions have been falling inresponse to the development of the Eurocurrency market,and also pressure from financial services companiesDeregulation began in the United States, then moved onto other countries including Great Britain, Japan, andFrance
  18. 18. 11-18Classroom Performance SystemHistorically, the most tightly regulated industry has beena) agricultureb) consumer electronicsc) automotivesd) financial services
  19. 19. 11-19Growth Of The Global Capital MarketMany countries have also dismantled capital controlsmaking it easier for both inward and outward investment tooccurThis trend has spread from the developed world to theemerging nationsThe global capital market is expected to continue to grow
  20. 20. 11-20Global Capital Market RisksSome analysts worry that the deregulation of capitalmarkets and loosening of controls on cross-border capitalflows make individual nations more vulnerable to thedestabilizing effects of speculative capital flowsSpeculative capital flows may be the result of inaccurateinformation about investment opportunitiesIf global capital markets continue to grow, better qualityinformation is likely to be available from financialintermediaries
  21. 21. 11-21The Eurocurrency MarketA eurocurrency is any currency banked outside of itscountry of originAbout two-thirds of all eurocurrencies are Eurodollars(dollars banked outside the United States)Other important eurocurrencies are the euro-yen, theeuro-pound, and the euro-euro
  22. 22. 11-22Classroom Performance SystemThe term eurocurrency refers toa) the currency used by the European Union countriesb) any currency banked outside its country of originc) currencies purchased in the international equities marketd) bonds sold outside the borrower’s country that aredenominated in the currency of the country in which theyare issued
  23. 23. 11-23Genesis And Growth Of The MarketThe eurocurrency market began in the 1950s when theEastern bloc countries were afraid the United States mightseize their holdings of dollarsSo, instead of depositing their dollars in the UnitedStates, they deposited them in EuropeAdditional dollar deposits came from Western Europeancentral banks and companies that exported to the UnitedStatesIn 1957, the market surged again after changes in BritishlawsToday, London continues to be the leading center of theeurocurrency market
  24. 24. 11-24Growth Of The Global Capital MarketIn the 1960s, the market grew once again when, afterchanges in U.S. regulations discouraged U.S. banks fromlending to non-U.S. residents, would-be borrowers ofdollars outside the United States turned to the euromarketas a source of dollarsThe next big increase in the eurocurrency market cameafter the 1973-74 and 1979-80 oil price increasesOPEC members avoided potential confiscation of theirdollars by depositing them in banks in London
  25. 25. 11-25Attractions Of The Eurocurrency MarketThe eurocurrency market is attractive to depositors andborrowers because it is not regulated by the governmentThis means that banks can offer higher interest rates oneurocurrency deposits than on deposits made in the homecurrencySimilarly, banks can also charge lower interest rates toeurocurrency borrowers than to those who borrow thehome currencyThe spread between the eurocurrency deposit andlending rates is less than the spread between the domesticdeposit and lending rates giving eurocurrency banks acompetitive edge over domestic banks
  26. 26. 11-26Attractions Of The Eurocurrency MarketFigure 11.4: Interest Rate Spreads in Domestic andEurocurrency Markets
  27. 27. 11-27Drawbacks Of The Eurocurrency MarketThe eurocurrency market has two drawbacks:1. because the eurocurrency market is unregulated, thereis a higher risk of bank failure2. companies borrowing eurocurrencies can be exposed toforeign exchange risk
  28. 28. 11-28The Global Bond MarketThe global bond market grew rapidly during the 1980sand 1990sThe most common kind of bond is a fixed rate bondwhich gives investors fixed cash payoffsThere are two types of international bonds:1. foreign bonds are sold outside the borrower’s countryand are denominated in the currency of the country inwhich they are issued2. eurobonds are underwritten by a syndicate of banks andplaced in countries other than the one in whose currencythe bond is denominated
  29. 29. 11-29Attractions Of The Eurobond MarketThe eurobond market is attractive for three main reasons:1. it lacks regulatory interference – since companies do nothave to adhere to strict regulations, the cost of issuingbonds is lower2. it has less stringent disclosure requirements thandomestic bond markets – it can be cheaper and less timeconsuming to offer eurobonds than to issue dollar-denominated bonds3. it is more favorable from a tax perspective – eurobondscan be sold directly to foreign investors
  30. 30. 11-30The Global Equity MarketThe largest equity markets are in the United States,Britain, and JapanToday, many investors invest in foreign equities todiversify their portfoliosIn the future, this type of trend may result in aninternationalization of corporate ownershipCompanies are also helping to promote this type of shiftby listing their stock in the equity markets of other nationsBy issuing stock in other countries, firms open the door toraising capital in the foreign market, and give the firm theoption of compensating local managers and employeeswith stock
  31. 31. 11-31Foreign Exchange RiskAnd The Cost Of CapitalAdverse exchange rates can increase the cost of foreigncurrency loansWhile it may initially seem attractive to borrow foreigncurrencies, when exchange rate risk is factored in, that canchangeFirms can hedge their risk by entering into forwardcontracts to purchase the necessary currency and lock inthe exchange rate, but this will also raise costsFirms must weigh the benefits of a lower interest rateagainst the risk of an increase in the real cost of capital dueto adverse exchange rate movements
  32. 32. 11-32Implications For ManagersGrowth in global capital markets has createdopportunities for firms to borrow or invest internationallyFirms can often borrow at a lower cost than in thedomestic capital marketFirms must balance the foreign exchange risk associatedwith borrowing in foreign currencies against the costssavings that may existThe growth of capital markets also offers opportunities forfirms, institutions, and individuals to diversify theirinvestments and reduce riskAgain, though investors must consider foreign exchangerate risk