International Business 9e

By Charles W.L. Hill

McGraw-Hill/Irwin Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 12The Global Capital Market

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Why Do We Have Capital Markets?Capital markets bring together investors and borrowersinvestors - corporations with surplus cash, individuals, and non-bank financial institutionsborrowers - individuals, companies, and governmentsmarkets 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

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Who Are The Main Players in Capital Markets?The Main Players in a Generic Capital Market

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What Makes The Global Capital Market Attractive? Todays capital markets are highly interconnected and facilitate the free flow of money around the worldBorrowers benefit from the additional supply of funds global capital markets providelowers the cost of capital the price of borrowing money or the rate of return that borrowers pay investors

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What Makes The Global Capital Market Attractive?Market Liquidity and the Cost of Capital

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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

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What Makes The Global Capital Market Attractive?Risk Reduction through Portfolio Diversification

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How Have Global Capital Markets Changed Since 1990?Global capital markets have grown rapidlythe stock of cross-border bank loans was just $3,600 billion in 1990, but $32,430 in 2010the international bond market has grown from $3,515 billion in 1997 to $26,613 in 2010international equity offerings were just $18 billion in 1990, but grew to $750 billion in 2009

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Why Is The Global Capital Market Growing?Two factors are responsible for the growth of capital marketsAdvances in information technologythe 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

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Why Is The Global Capital Market Growing?Deregulation by governments has facilitated growth in international capital marketsgovernments have traditionally limited foreign investment in domestic companies, and the amount of foreign investment citizens could makesince 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 toGreat Britain, Japan, and Francemany countries have dismantled capital controls making it easier for both inward and outward investment to occurThe 2008-2009 global financial crisis raised questions as to whether deregulation had gone too farQuestion: Are new regulations for the financial services industry needed?

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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 economiesSpeculative capital flows may be the result of inaccurate information about investment opportunitiesif global capital markets continue to grow, better quality information is likely to be available from financial intermediaries

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What Is A Eurocurrency?A eurocurrency is any currency banked outside its country of originAbout 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-euroThe 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 dollarsso, they deposited them in Europeadditional 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

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Why Has The Eurocurrency Market Grown?In 1957, the market surged again after changes in British lawsunder 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 marketcontinues 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. residentswould-be borrowers of dollars outside the U.S. turned to the euromarket as a source of dollars

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Why Has The Eurocurrency Market Grown?The next big increase came after the 1973-74 and 1979-80 oil price increasesArab members of OPEC accumulated huge amounts of dollarsavoided 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 governmentbanks can offer higher interest rates on eurocurrency deposits than on deposits made in the home currencybanks can charge lower interest rates to eurocurrency borrowers than to those who borrow the home currency

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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

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What Makes The Eurocurrency Market Attractive?Interest Rate Spreads in Domestic and Eurocurrency Markets

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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 fundscan 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

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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 payoffsThe global bond market grew rapidly during the 1980s and 1990s and continues to grow today

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What Is The Global Bond Market?There are two types of international bondsForeign bonds are sold outside the borrowers country and are denominated in the currency of the country in which they are issuedused by companies when they think it will reduce the cost of capitalEurobonds 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 becauseIt lacks regulatory interference since companies do not have to adhere to strict regulations, the cost of issuing bonds is lowerIt has less stringent disclosure requirements than domestic bond markets it can be cheaper and less time consuming to offer eurobonds than dollar-denominated bondsIt is more favorable from a tax perspective eurobonds can be sold directly to foreign investors

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What Is The Global Equity Market?The global equity market allows firms toAttract capital from international investors many investors buy foreign equities to diversify their portfoliosList 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 worldby issuing stock in other countries, firms open the door to raising capital in the foreign marketgives the firm the option of compensating local managers and employees with stock provides for local ownershipincreases visibility with local stakeholders

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How Do Exchange Rates Affect The Cost Of Capital?Adverse exchange rates can increase the cost of foreign currency loansWhile it may initially seem attractive to borrow foreign currencies, when exchange rate risk is factored in, that can changefirms can hedge their risk by entering into forward contracts but this will also raise costsFirms must weigh the benefits of a lower interest rate against the risk of an increase in the real cost of capital

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What Do Global Capital Markets Mean For Managers? Growth in global capital markets has created opportunities for firms to borrow or invest internationallyfirms can often borrow at a lower cost than in the domestic capital marketfirms must balance the foreign exchange risk associated with borrowing in foreign currencies against the costs savings

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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 riskagain though, investors must consider foreign exchange rate riskCapital markets are likely to continue to integrate providing more opportunities for business

LO1: Describe the benefits of the global capital market. The Opening Case: Global Capital Markets explores the challenges that todays highly integrated capital markets present. The financial crisis that began in the United States in 2008, quickly spread to other nations resulting in worldwide recession.

Capital market loans includeEquity loans- when corporations sell stock to investorsDebt loans - when a corporation borrows money and agrees to repay a predetermined portion of the loan amount at regular intervals regardless of how much profit it is makingIn a purely domestic capital market the pool of investors is limited to residents of the country. Thisplaces an upper limit on the supply of funds availableincreases the cost of capital

Management Focus: Deutsche Telekom Taps the Global Capital Market examines Deutsche Telekoms privatization strategy. Deutsche Telekom, one of the worlds largest telephone companies was state-owned until 1996 when the decision was made to privatize the company in order to increase efficiency and be in a better position to face the greater competition the deregulation of the European Unions telecommunications sector was expected to create. A fully diversified portfolio that contains stocks from many countries is less than half as risky as a fully diversified portfolio that contains only U.S. stocks.

LO2: Identify why the global capital market had grown so rapidly.LO3: Understand the risks associated with the globalization of capital markets.Country Focus: Did the Global Capital Markets Fail Mexico explores Mexicos economic problems in the mid-1990s. Mexico went from being a strong developing country with a good future to a country facing a financial crisis. LO4: Compare and contrast the benefits and risks associated with the Eurocurrency market, the global bond market, and the global equity market. Foreign bonds sold in the United States are called Yankee bonds.Foreign bonds sold in Japan are Samurai bonds.Foreign bonds sold in Great Britain are bulldogs.

Country Focus: The Search for Capital in the Czech Republic explores the difficulties firms face raising capital in the Czech Republic. Although the Czech Republic was initially seen as a vibrant economy following the collapse of communism, macroeconomic problems caused the country to fall out of favor with investors. In addition, the Prague stock exchange was the target of allegations of financial misconduct, a situation which effectively raised the cost of capital for Czech firms.

LO5: Understand how foreign exchange risk impacts upon the cost of capital.