Chapter 12: The Global Capital Market

Drawbacks of the Eurocurrency Market

(1) 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), (2) Companies borrowing Eurocurrencies can be exposed to foreign exchange risk (can minimize this risk through forward market hedges)

Growth of the Global Capital Market

(1) Has created opportunities for international businesses that wish to borrow and/or invest money, (2) Firms can often borrow funds at a lower cost than is possible in a purely domestic capital market, (3) The global market is not regulated, (4) Foreign exchange risk is greater, (5) Firms, institutions, and individuals can diversify their investments to limit risk

Information technology

(1) Instantaneous communication, (2) Allows market makers to absorb and process large volumes of information from around the world, (3) 24-hour a day trading ("Shocks" spread quickly)

Attractions of the Eurobond Market

(1) It lacks regulatory interference (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 (it can be cheaper and less time-consuming to offer Eurobonds than dollar-denominated bonds), (3) It is more favorable from a tax perspective (Eurobonds can be sold directly to foreign investors)

The Eurocurrency Market

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; 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 and banks can charge lower interest rates to Eurocurrency borrowers than to those who borrow the home currency)

Floating Exchange Risk and the Cost of Capital

Adverse movements in foreign exchange rates can substantially increase the cost of foreign currency loans; Unpredictable movements in exchange rates can inject risk into foreign currency borrowing

EuroBond

An international bond that is denominated in a currency not native to the country where it is issued

Bonds

Are an important means of financing; Most common is a fixed-rate bond (receives a fixed set of cash payoffs), International bonds (Foreign bonds and Eurobonds); The global bond market grew rapidly during the 1980s and 1990s and continues to do so in the 20th century

Global Equity Market (1980's - 1990's)

Barriers to the Global Equity Market Tumbled: this (1) Enabled firms to attract capital from international investors, (2) to list their stock on multiple exchanges, (3) and to raise funds by issuing equity or debt around the world; Internationalization of corporate ownership (Companies with historic roots in one nation are broadening their stock ownership by listing their stock in the equity markets of other nations)

Functions of a Generic Capital Market

Capital market loans; (1) Equity loans - made when a corporation sells stock to investors, (2) Debt loans - requires corporation to repay a predetermined portion of the loan amount at regular intervals regardless of how much profit it is making

Why Do Capital Markets Exist?

Capital markets bring together investors and borrowers

Investors

Corporations with surplus cash, individuals, and non-bank financial institutions

Genesis and Growth of the Market

Eastern European holders of dollars did not want to deposit their money in the U.S. and instead deposited them in London banks; British government prohibited British banks from lending British pounds to finance non-British trade; U.S. government enacted regulations that discouraged U.S. banks from lending to non-U.S. residents; Oil price increases engineered by OPEC created huge amounts of dollars that were deposited in banks in London

Benefits of the Global Capital Market

Growth: Information technology, deregulation

National Equity Markets

Historically, it is difficult to take capital out of a country and invest if elsewhere; corporations frequently lacked the ability to list their shares on stock markets outside their home nations

Global Capital Market Risks

Individual nations may be more vulnerable to speculative capital flows (Could destabilize national economies); Martin Feldstein: "Hot money" vs. "patient money"; Lack of information about the quality of foreign investments may encourage speculative flows

Borrowers

Individuals, companies, and governments

Foreign Bond

Issued by a foreign borrower in the currency of the country in which it is sold

Deregulation

Response to the Eurocurrency market; Increasing acceptance of the free market ideology; Hedge funds

Markets Makers

The financial service companies that connect investors and borrowers, either directly (investment banks) or indirectly (commercial banks)

What Makes the Global Capital Market Attractive?

Today's 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 (1) lowers the cost of capital and (2) the price of borrowing money or the rate of return that borrowers pay investors; 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