The Global Capital Market

1
Chapter 12

• The Global Capital Market

2
Why Do We Have Capital Markets?

• Capital markets bring together investors and
  borrowers
• investors - corporations with surplus cash,
  individuals, and non-bank financial institutions
• borrowers - individuals, companies, and
  governments
• markets makers - the financial service companies
  that connect investors and borrowers, either
  directly (investment banks) or indirectly
  (commercial banks)
• capital market loans can be equity or debt

3
Who Are The Main Players in Capital Markets?

• The Main Players in a Generic Capital Market

4
What Makes The Global Capital Market Attractive?

• Todays capital markets are highly interconnected
  and facilitate the free flow of money around the
  world
• Borrowers benefit from the additional supply of
  funds global capital markets provide
• lowers the cost of capital
• the price of borrowing money or the rate of
  return that
  borrowers pay investors

5
What Makes The Global Capital Market Attractive?

• Market Liquidity and the Cost of Capital

6
What Makes The Global Capital Market Attractive?

• Investors benefit from the wider range of
  investment opportunities
• diversify portfolios and lower risk
• But, volatile exchange rates can make what would
  otherwise be profitable investments, unprofitable

7
What Makes The Global Capital Market Attractive?

• Risk Reduction through Portfolio Diversification

8
How Have Global Capital Markets Changed Since
1990?

• Global capital markets have grown rapidly
• the stock of cross-border bank loans was just
  3,600 billion in 1990, but 32,430 in 2010
• the international bond market has grown from
  3,515 billion in 1997 to 26,613 in 2010
• international equity offerings were just 18
  billion in 1990, but grew to 750 billion in 2009

9
Why Is The Global Capital Market Growing?

• Two factors are responsible for the growth of
  capital markets
• Advances in information technology
• the growth of international communications
  technology and advances in data processing
  capabilities
• 24-hour-day trading
• so, shocks that occur in one financial market
  spread around the globe very quickly

10
Why Is The Global Capital Market Growing?

• Deregulation by governments
• has facilitated growth in international capital
  markets
• governments have traditionally limited foreign
  investment in domestic companies, and the amount
  of foreign investment citizens could make
• since the 1980s, these restrictions have been
  falling

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Why Is The Global Capital Market Growing?

• deregulation began in the U.S., then moved to
• Great Britain, Japan, and France
• many countries have dismantled capital controls
  making it easier for both inward and outward
  investment to occur
• The 2008-2009 global financial crisis raised
  questions as to whether deregulation had gone too
  far
• Question Are new regulations for the financial
  services industry needed?

12
What Are The Risks Of The Global Capital Markets?

• 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?
• can have a destabilizing effect on economies
• Speculative capital flows may be the result of
  inaccurate information about investment
  opportunities
• if global capital markets continue to grow,
  better quality information is likely to be
  available from financial intermediaries

13
What Is A Eurocurrency?

• A eurocurrency is any currency banked outside its
  country of origin
• About two-thirds of all eurocurrencies are
  Eurodollars
• dollars banked outside the U.S.
• Other important eurocurrencies are the euro-yen,
  the euro-pound, and the euro-euro
• The eurocurrency market is an important source of
  low-cost funds for international companies

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Why Has The Eurocurrency Market Grown?

• The eurocurrency market began in the 1950s when
  the Eastern bloc countries feared that the United
  States might seize their dollars
• so, they deposited them in Europe
• additional dollar deposits came from Western
  European central banks and companies that
  exported to the U.S.
• could earn a higher rate of interest in London

15
Why Has The Eurocurrency Market Grown?

• In 1957, the market surged again after changes in
  British laws
• under the new laws, British banks had to attract
  dollar deposits and loan dollars rather pounds to
  finance non-British trade
• London became the leading center of the
  eurocurrency market
• continues to hold this position today

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Why Has The Eurocurrency Market Grown?

• In the 1960s, the market grew once again
• Changes in U.S. regulations discouraged U.S.
  banks from lending to non-U.S. residents
• would-be borrowers of dollars outside the U.S.
  turned to the euromarket as a source of dollars

17
Why Has The Eurocurrency Market Grown?

• The next big increase came after the 1973-74 and
  1979-80 oil price increases
• Arab members of OPEC accumulated huge amounts of
  dollars
• avoided potential confiscation of their dollars
  by the U.S. by depositing them in banks in London

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What Makes The Eurocurrency Market Attractive?

• The eurocurrency market is attractive because it
  is not regulated by the government
• banks can offer higher interest rates on
  eurocurrency deposits than on deposits made in
  the home currency
• banks can charge lower interest rates to
  eurocurrency borrowers than to those who borrow
  the home currency

19
What Makes The Eurocurrency Market Attractive?

• The spread between the eurocurrency deposit and
  lending rates is less than the spread between the
  domestic deposit and lending rates
• gives eurocurrency banks a competitive edge over
  domestic banks

20
What Makes The Eurocurrency Market Attractive?

• Interest Rate Spreads in Domestic and
  Eurocurrency Markets

21
What Makes The Eurocurrency Market Unattractive?

• The eurocurrency market has two significant
  drawbacks
• Because the eurocurrency market is unregulated,
  there is a higher risk that bank failure could
  cause depositors to lose funds
• can avoid this risk by accepting a lower return
  on a home-country deposit
• Companies borrowing eurocurrencies can be exposed
  to foreign exchange risk
• can minimize this risk through forward market
  hedges

22
What Is The Global Bond Market?

• Bonds are an important means of financing for
  many companies
• the most common bond is a fixed rate which gives
  investors fixed cash payoffs
• The global bond market grew rapidly during the
  1980s and 1990s and continues to grow today

23
What Is The Global Bond Market?

• There are two types of international bonds
• Foreign bonds are sold outside the borrowers
  country and are denominated in the currency of
  the country in which they are issued
• used by companies when they think it will reduce
  the cost of capital
• Eurobonds are underwritten by a syndicate of
  banks and placed in countries other than the one
  in whose currency the bond is denominated

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What Makes The Eurobond Market Attractive?

• The eurobond market is attractive because
• It lacks regulatory interference
• since companies do not have to adhere to strict
  regulations, the cost of issuing bonds is lower
• It has less stringent disclosure requirements
  than domestic bond markets
• it can be cheaper and less time consuming to
  offer eurobonds than dollar-denominated bonds
• It is more favorable from a tax perspective
• eurobonds can be sold directly to foreign
  investors

25
What Is The Global Equity Market?

• The global equity market allows firms to
• Attract capital from international investors
• many investors buy foreign equities to diversify
  their portfolios
• List their stock on multiple exchanges
• this type of trend may result in an
  internationalization of corporate ownership

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What Is The Global Equity Market?

• Raise funds by issuing debt or equity around the
  world
• by issuing stock in other countries, firms open
  the door to raising capital in the foreign market
• gives the firm the option of compensating local
  managers and employees with stock
• provides for local ownership
• increases visibility with local stakeholders

27
How Do Exchange Rates Affect The Cost Of Capital?

• Adverse exchange rates can increase the cost of
  foreign currency loans
• While it may initially seem attractive to borrow
  foreign currencies, when exchange rate risk is
  factored in, that can change
• firms can hedge their risk by entering into
  forward contracts
• but this will also raise costs
• Firms must weigh the benefits of a lower interest
  rate against the risk of an increase in the real
  cost of capital

28
What Do Global Capital Markets Mean For Managers?

• Growth in global capital markets has created
  opportunities for firms to borrow or invest
  internationally
• firms can often borrow at a lower cost than in
  the domestic capital market
• firms must balance the foreign exchange risk
  associated with borrowing in foreign currencies
  against the costs savings

29
What Do Global Capital Markets Mean For Managers?

• Growth in capital markets offers opportunities
  for firms, institutions, and individuals to
  diversify their investments and reduce risk
• again though, investors must consider foreign
  exchange rate risk
• Capital markets are likely to continue to
  integrate providing more opportunities for
  business