International Finance Ch. 3
Single European Act
-Capital can flow freely throughout Europe. -Banks can offer a wide variety of lending, leasing, and securities activities in the EU. -Regulations regarding competition, mergers, and taxes are similar throughout the EU. -A bank established in any one of the EU countries has the right to expand into any or all of the other EU countries.
Syndicated Loans in the Credit Market
-Sometimes a single bank is unwilling or unable to lend the amount needed by an MNC or government agency. -A syndicate of banks can be formed to underwrite the loans and the lead bank is responsible for negotiating the terms with the borrower
Impact of the Credit Crisis on the Credit Market
-The credit crisis of 2008 triggered by defaults in subprime loans led to a halt in housing development, which reduced income, spending, and jobs. -Financial institutions became cautious with their funds and were less willing to lend funds to MNCs
More on Global Bond Markets
1. Bond markets have developed in Asia and South America 2. Changes in bond market yields among countries tend to be positively correlated over time. 3. When economic conditions weaken, aggregate demand for funds declines with the decline in corporate expansion. 4. When economic conditions strengthen, aggregate demand for funds increases with the increase in corporate expansion.
Global Integration of Money Market Interest Rates
1. Movements in money market interest rates among countries tend to be highly correlated over time. 2. When economic conditions weaken, the corporate need for liquidity declines, and corporations reduce the amount of short term funds they wish to borrow. 3. When economic conditions strengthen, there is an increase in corporate expansion, and corporations need additional liquidity to support their expansion.
Foreign Exchange Market
1.Allows for the exchange of one currency for another. 2.Exchange rate specifies the rate at which one currency can be exchanged for another. 3.The FX market is probably one of the largest, if not the largest, financial market in the world. 4.It's a highly fragmented market consisting of both public and private transactions.
Foreign Exchange Quotations
1.At any given point in time, a bank's bid (buy) quote for a foreign currency will be less than its ask (sell) quote. 2.The bid/ask spread covers the bank's cost of conducting foreign exchange transactions. 3.The spread can be calculated as an absolute value or as a percentage
How Financial Markets Serve MNCs
1.Corporate functions that require foreign exchange markets 2.Using international financial markets to raise capital as well as to create balance sheet hedges
Foreign Exchange Transactions
1.The over-the-counter market is the telecommunications network where companies normally exchange one currency for another. 2.Foreign exchange dealers serve as intermediaries in the foreign exchange market 3. A foreign exchange transaction for immediate exchange is said to trade in the spot market. The exchange rate in the spot market is the spot rate. 4.Trading between banks occurs in the interbank market.
Interpreting Changes in Exchange Rates
1.When the euro is appreciating against the dollar (based on an upward movement of the direct exchange rate of the euro), the indirect exchange rate of the euro is declining. 2.When the euro is depreciating (based on a downward movement of the direct exchange rate) against the dollar, the indirect exchange rate is rising.
Forward Contracts
Agreements between a foreign exchange dealer and an MNC that specifies the currencies to be exchanged, the exchange rate, and the date at which the transaction will occur.
Basel II Accord
Attempts to account for differences in collateral among banks. In addition, this accord encourages banks to improve their techniques for controlling operational risk, which could reduce failures in the banking system. Also plans to require banks to provide more information to existing and prospective shareholders about their exposure to different types of risk.
Basel Accord
Banks must maintain capital equal to at least 4 percent of their assets. For this purpose, banks' assets are weighted by risk.
Euro-bonds
Bonds sold in countries other than the country of the currency denominating the bond (some examples)
Agreements on Fixed Exchange Rates
Bretton Woods Agreement 1944 - 1971 Smithsonian Agreement 1971 - 1973
Basel III Accord
Called for new methods of estimating risk-weighted assets that would increase the level of risk-weighted assets, and therefore require banks to maintain higher levels of capital.
Asian Money Market
Centered in Hong Kong and Singapore. Originated as a market involving mostly dollar-denominated deposits, and was originally known as the Asian dollar market.
American Depository Receipts
Certificates representing bundles of stock. ADR shares can be traded just like shares of a stock and are priced in U.S. dollars. ADRs can either be sponsored on unsponsored
Spot Market
Commodities market in which goods are sold for cash and delivered immediately. Trades that take place in FUTURES CONTRACTS expiring in the current month are also called spot market trades.
Attributes of Banks That Provide Foreign Exchange
Competitiveness of quote Special relationship with the bank Speed of execution Advice about current market conditions Forecasting advice
International Money Market
Corporations or governments need short-term funds denominated in a currency different from their home currency.
Currency Options Contracts
Currency Call Option: provides the right to buy currency at a specified strike price within a specified period of time. Currency Put Option: provides the right to sell currency at specified strike price within a specified period of time. There are options on actual currencies as well as options on currency futures contracts.
European Money Market
Dollar deposits in banks in Europe and other continents are called Eurodollars or Eurocurrency. Origins of the European money market can be traced to the Eurocurrency market that developed during the 1960s and 1970s.
Gold Standard (1876 - 1913)
Each currency was convertible into gold at a specified rate. When World War I began in 1914, the gold standard was suspended.
Spot market time zones
Foreign exchange trading is conducted only during normal business hours in a given location. Thus, at any given time on a weekday, somewhere around the world a bank is open and ready to accommodate foreign exchange requests.
Currency Derivatives
Forward Contracts, Futures Contracts, Currency Options Contracts
Foreign Bonds
Issued by borrower foreign to the country where the bond is placed (examples are Yankee and Bulldog bonds).
Money Market Interest Rates Among Currencies pt.2
Money market rates vary due to differences in the interaction of the total supply of short-term funds available (bank deposits) in a specific country versus the total demand for short-term funds by borrowers in that country.
Spot market liquidity
More buyers and sellers means more liquidity.
Yankee Stock Offerings
Non-U.S. corporations that need large amounts of funds sometimes issue stock in the United States Shares of foreign companies cannot be directly listed on U.S. stock exchanges unless the firm conforms to GAAP in its financial reporting (most non-U.S. firms use the IFRS)
Factors that Affect the Spread
Order Costs Inventory Costs Competition Volume Currency Risk
Credit Risk
Represents the potential for default.
Regulations in Credit Market
Single European Act Basel Accord Basel II Basel III
Issuance of Stock in Foreign Markets
Some U.S. firms list stock in foreign markets to enhance their global image
Money Market Interest Rates Among Currencies
The money market interest rates in any particular country are dependent on the demand for short-term funds by borrowers, relative to the supply of available short-term funds that are provided by savers.
Future Spot Rate
The spot rate that will exist at a future point in time and is uncertain as of today.
Floating Exchange Rate System
Widely traded currencies were allowed to fluctuate in accordance with market forces
Issuance of Foreign Stock in the U.S.
Yankee stock offerings American Depository Receipts
The international money market has grown because firms:
a. May need to borrow funds to pay for imports denominated in a foreign currency. b. May choose to borrow in a currency in which the interest rate is lower. c. May choose to borrow in a currency that is expected to depreciate against their home currency
Cross Exchange Rate
calculated using two direct or indirect FX rates involving three currencies, with one currency in common Example: Direct FX rate (US$/€) =1.3387 Direct FX rate (US$/£) = 1.6786 Cross rate (£/€) = 1.3387/1.6786 = .7975 £0.7975 = 1.0000€ or 1.2539€ = £1.0000
Forward Market
over-the-counter market where forward contracts are traded.
Interest Rate Risk
potential for the value of bonds to decline in response to rising long-term interest rates
Indirect Quotation
represents the number of units of a foreign currency per one dollar.
Exchange Rate Risk
represents the potential for the value of bonds to decline (from the investor's perspective) because the currency denominating the bond depreciates against the home currency.
Liquidity Risk
represents the potential for the value of bonds to decline because there is not a consistently active market for the bonds.
Direct Quotation
represents the value of a foreign currency in dollars (number of dollars per one unit of the other currency).
Futures Contracts
similar to forward contracts but sold on an exchange Specifies a standard volume of a particular currency to be exchanged on a specific settlement date.
Futures Rate
the exchange rate at which one can purchase or sell a specified currency on the specified settlement date.
Forward Rate
the exchange rate specified by the forward contract.
