International Business 10 e By Charles W. L. Hill Copyright © 2015 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Chapter 12 The Global Capital Market
Why Do Capital Markets Exist? Ø Capital markets bring together investors and borrowers Ø investors - corporations with surplus cash, individuals, and non-bank financial institutions Ø borrowers - individuals, companies, and governments Ø markets makers - the financial service companies that connect investors and borrowers, either directly (investment banks) or indirectly (commercial banks) Ø capital market loans can be equity or debt 12 -3
Who Are the Main Players in Capital Markets? The Main Players in the Generic Capital Market 12 -4
What Makes the Global Capital Market Attractive? Ø Today’s capital markets are highly interconnected and facilitate the free flow of money around the world Ø Borrowers benefit from the additional supply of funds global capital markets provide Ø lowers the cost of capital Ø the price of borrowing money or the rate of return that borrowers pay investors 12 -5
What Makes the Global Capital Market Attractive? Market Liquidity and the Cost of Capital 12 -6
What Makes the Global Capital Market Attractive? Ø Investors benefit from the wider range of investment opportunities Ø diversify portfolios and lower risk Ø But, volatile exchange rates can make what would otherwise be profitable investments, unprofitable 12 -7
What Makes the Global Capital Market Attractive? Risk Reduction through Portfolio Diversification 12 -8
How Have Global Capital Markets Changed Since 1990? Ø Global capital markets have grown rapidly Ø the stock of cross-border bank loans was just $3, 600 billion in 1990, $7, 859 billion in 2000, $33, 913 billion in 2012 Ø the international bond market has grown from $3, 515 billion in 1997, $5, 908 billion in 2000, $21, 979 billion in 2012 12 -9
Why Is the Global Capital Market Growing? Ø Two factors are responsible for the growth of capital markets 1. Advances in information technology Ø the growth of international communications technology and advances in data processing capabilities Ø 24 -hour-a-day trading Ø so, shocks that occur in one financial market spread around the globe very quickly 12 -10
Why Is the Global Capital Market Growing? 2. Deregulation by governments Ø has facilitated growth in international capital markets Ø governments have traditionally limited foreign investment in domestic companies, and the amount of foreign investment citizens could make Ø since the 1980 s, these restrictions have been falling 12 -11
Why Is the Global Capital Market Growing? Ø Deregulation began in the U. S. , then moved to Great Britain, Japan, and France Ø Many countries have dismantled capital controls making it easier for both inward and outward investment to occur Ø The 2008 -2009 global financial crisis raised questions as to whether deregulation had gone too far Ø Question: Are new regulations for the financial services industry needed? 12 -12
What Are the Risks of the Global Capital Markets? Ø Question: Could deregulation of capital markets and fewer controls on cross-border capital flows make nations more vulnerable to the effects of speculative capital flows? Ø can have a destabilizing effect on economies Ø Speculative capital flows may be the result of inaccurate information about investment opportunities Ø if global capital markets continue to grow, better quality information is likely to be available from financial intermediaries 12 -13
What Is a Eurocurrency? Ø A Eurocurrency is any currency banked outside its country of origin Ø About two-thirds of all Eurocurrencies are Eurodollars Ø dollars banked outside the U. S. Ø Other important Eurocurrencies are the euro-yen, the euro-pound, and the euro-euro Ø The Eurocurrency market is an important source of low-cost funds for international companies 12 -14
Why Has the Eurocurrency Market Grown? Ø The eurocurrency market began in the 1950 s when the Eastern bloc countries feared that the United States might seize their dollars Ø so, they deposited them in Europe Ø additional dollar deposits came from Western European central banks and companies that exported to the U. S. Ø could earn a higher rate of interest in London 12 -15
Why Has the Eurocurrency Market Grown? Ø In 1957, the market surged again after changes in British laws Ø under the new laws, British banks had to attract dollar deposits and loan dollars rather pounds to finance non-British trade Ø London became the leading center of the eurocurrency market Ø continues to hold this position today 12 -16
Why Has the Eurocurrency Market Grown? Ø In the 1960 s, the market grew once again Ø Changes in U. S. regulations discouraged U. S. banks from lending to non-U. S. residents Ø would-be borrowers of dollars outside the U. S. turned to the Euromarket as a source of dollars 12 -17
Why Has the Eurocurrency Market Grown? Ø The next big increase came after the 1973 -74 and 1979 -80 oil price increases Ø Arab members of OPEC accumulated huge amounts of dollars Ø avoided potential confiscation of their dollars by the U. S. by depositing them in banks in London 12 -18
What Makes the Eurocurrency Market Attractive? Ø The Eurocurrency market is attractive because it is not regulated by the government Ø banks can offer higher interest rates on Eurocurrency deposits than on deposits made in the home currency Ø banks can charge lower interest rates to Eurocurrency borrowers than to those who borrow the home currency 12 -19
What Makes the Eurocurrency Market Attractive? Ø The spread between the Eurocurrency deposit and lending rates is less than the spread between the domestic deposit and lending rates Ø Gives Eurocurrency banks a competitive edge over domestic banks 12 -20
What Makes the Eurocurrency Market Attractive? Interest Rate Spreads in Domestic and Eurocurrency Markets 12 -21
What Makes the Eurocurrency Market Unattractive? Ø The Eurocurrency market has two significant drawbacks: 1. Because the Eurocurrency market is unregulated, there is a higher risk that bank failure could cause depositors to lose funds Ø can avoid this risk by accepting a lower return on a home-country deposit 2. Companies borrowing Eurocurrencies can be exposed to foreign exchange risk Ø can minimize this risk through forward market hedges 12 -22
What Is the Global Bond Market? Ø Bonds are an important means of financing for many companies Ø the most common bond is a fixed rate which gives investors fixed cash payoffs Ø The global bond market grew rapidly during the 1980 s and 1990 s and continues to do in the new century 12 -23
What Is the Global Bond Market? Ø There are two types of international bonds 1. Foreign bonds are sold outside the borrower’s country and are denominated in the currency of the country in which they are issued Ø used by companies when they think it will reduce the cost of capital 2. Eurobonds are underwritten by a syndicate of banks and placed in countries other than the one in whose currency the bond is denominated 12 -24
What Makes the Eurobond Market Attractive? Ø The Eurobond market is attractive because 1. It lacks regulatory interference Ø since companies do not have to adhere to strict regulations, the cost of issuing bonds is lower 2. It has less stringent disclosure requirements than domestic bond markets Ø it can be cheaper and less time consuming to offer Eurobonds than dollar-denominated bonds 3. It is more favorable from a tax perspective Ø Eurobonds can be sold directly to foreign investors 12 -25
What Is the Global Equity Market? Ø The global equity market allows firms to 1. Attract capital from international investors Ø many investors buy foreign equities to diversify their portfolios 2. List their stock on multiple exchanges Ø this type of trend may result in an internationalization of corporate ownership 12 -26
What Is the Global Equity Market? 3. Raise funds by issuing debt or equity around the world Ø by issuing stock in other countries, firms open the door to raising capital in the foreign market Ø gives the firm the option of compensating local managers and employees with stock Ø provides for local ownership Ø increases visibility with local stakeholders 12 -27
How Do Exchange Rates Affect the Cost of Capital? Ø Adverse exchange rates can increase the cost of foreign currency loans Ø While it may initially seem attractive to borrow foreign currencies, when exchange rate risk is factored in, that can change Ø firms can hedge their risk by entering into forward contracts Ø but this will also raise costs Ø Firms must weigh the benefits of a lower interest rate against the risk of an increase in the real cost of capital 12 -28
What Do Global Capital Markets Mean for Managers? Ø Growth in global capital markets has created opportunities for firms to borrow or invest internationally Ø firms can often borrow at a lower cost than in the domestic capital market Ø firms must balance the foreign exchange risk associated with borrowing in foreign currencies against the costs savings 12 -29
What Do Global Capital Markets Mean for Managers? Ø Growth in capital markets offers opportunities for firms, institutions, and individuals to diversify their investments and reduce risk Ø again though, investors must consider foreign exchange rate risk Ø Capital markets are likely to continue to integrate providing more opportunities for business 12 -30
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