international money market Essay

Chapter 3 International Financial Markets South-Western/Thomson Learning 2006 Chapter Objectives To describe the background and corporate use of the following international financial markets: 0 foreign exchange market, 0 international money market, 0 international credit market, 0 international bond market, and 0 international stock markets. 3-2 Motives for Using ??? The markets for real or financial assets are prevented from full integration by barriers like tax differentials, tariffs, quotas, labor immobility, communication costs, cultural and financial reporting differences. ?? Yet, such market imperfections also create nique opportunities for specific geographic markets, helping these markets attract foreign creditors and investors. 3-3 ??? Investors invest in foreign markets: conditions; when they expect foreign currencies to appreciate against their own; and to reap the benefits of international diversification. 3-4 ??? Creditors provide credit in foreign markets: to capitalize on higher foreign interest rates; to reap the benefits of diversification. ??? Borrowers borrow in foreign markets: to capitalize on lower foreign interest rates; and when they expect foreign currencies to depreciate against their own. -5 Foreign Exchange Market ?? The foreign exchange market allows currencies to be exchanged in order to facilitate international trade or financial transactions. ??? The system for exchanging foreign currencies has evolved from the gold standard, to agreements on fixed exchange rates, to a floating rate system. 3-6 Foreign Exchange Transactions known as the spot market. ??? Trading between banks occurs in the interbank market. Within this market, brokers sometimes act as intermediaries. -7 ??? The forward market enables an MNC to lock in the exchange rate at which it will buy or sell a certain quantity of currency on a specified future date. ?? Customers in need of foreign exchange are concerned with quote competitiveness, special banking relationship, speed of execution, advice about current market conditions, and forecasting advice. 3-8 ??? Banks provide foreign exchange services for a fee: a banks bid (buy) quote for a foreign currency will be less than its ask (sell) quote. bid/ask spread = ask rate – bid rate ask rate Example Suppose bid price for E = $1. 52, ask price = $1. 60. pread = (1. 60- 1. 52) = . 05 or 1. 60 3-9 ??? The spread on currency quotations is positively influenced by order costs, inventory costs, and currency risk, and egatively influenced by competition, and ??? The markets for heavily traded currencies like the ?‚¬,E, and are very liquid. 3-10 Interpreting Foreign Exchange Quotations ??? The exchange rate quotations published in newspapers normally reflect the ask prices for large transactions. ??? Direct quotations represent the value of a foreign currency in dollars, while indirect quotations represent the number of units of a foreign currency per dollar. ?? Indirect quotation = Direct quotation 3-11 ??? A cross exchange rate reflects the amount of one foreign currency per unit of another foreign currency. Example Direct quote: $1. 0/E, Indirect quote: . 67E/$, 111. 11%/$ Value of E in Y = value of E in $ value in $ = $1. 50/E = 166. 67WE 3-12 Currency Futures and Options Market ??? Currency futures contracts specify a standard volume of a particular currency to be exchanged on a specific settlement date. They are sold on exchanges, unlike forward contracts. to buy (sell) a specific currency at a specific price (called the strike or exercise price) within a specific period of time. -13 International Money Market ??? Financial institutions in this market serve MNCs by accepting deposits and offering loans in a variety of currencies. 3-14 ?? Both the European and Asian money markets originated as markets involving mostly dollar-denominated deposits. ??? The Eurocurrency market (market for Eurodollars) developed during the 1960s and 1970s, stimulated by regulatory changes in the U. S. and the growing importance of OPEC. 3-15 ??? The growing standardization of global banking regulations has contributed towards the globalization of the industry.

The Single European Act opened up the European banking industry and increased its efficiency. The Basel Accord outlined risk-weighted capital adequacy requirements for banks. The proposed Basel II Accord attempts to ccount for operational risk. 3-16 International Credit Market ??? MNCs sometimes obtain medium-term funds through banks located in foreign markets. ??? Eurocredit loans refer to loans of one year foreign MNCs or government agencies. ??? Floating rate loans, such as those based on the LIBOR, are common, since bank asset and liability maturities may not match. -17 ??? Sometimes a single bank is unwilling or unable to lend the amount needed by a particular MNC or government agency. ??? A lead bank may then organize a syndicate of banks to underwrite the loan. ??? Borrowers that receive a syndicated loan typically incur front-end management and ommitment fees, in addition to the interest on the loan. 3-18 International Bond Market There are two types of international bonds: 0 Bonds denominated in the currency of the country where they are placed but issued by borrowers foreign to the country are called foreign bonds or parallel bonds. Bonds that are sold in countries other than the country of the currency denominating the bonds are called Eurobonds. 3-19 ??? The emergence of the Eurobond market was partly due to the 1963 U. S. Interest Equalization Tax (IET). They have become very popular, perhaps in part because they circumvent registration requirements. ?? Usually, Eurobonds are issued in bearer form, pay annual coupons, and have call provisions. Some also carry convertibility 3-20 ??? 70 to 75 percent of Eurobonds are denominated in the U.

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S. dollar. ??? Eurobonds are underwritten by a multinational syndicate of investment banks and simultaneously placed in many countries. ??? In the secondary market, the market makers are often the same underwriters who sell the primary issues. 3-21 Comparing Interest Rates Among Currencies Annualized Short-Term Interest Rates among Countries in 2001 3-22 Comparing Interest Rates Among Currencies ??? Interest rates are crucial because they ffect the MNC’s cost of financing. ?? The interest rate for a specific currency is determined by the demand for and supply of funds in that currency. ??? As the demand and supply schedules for a specific currency change over time, the equilibrium interest rate will also change. 3-23 Why U. S. Dollar Interest Rates Differ from Mexican Peso Interest Rates Interest Rate for $ for le Pesos Speso Dpeso Quantity of $ Quantity of Pesos ??? The curves are further to the right for the dollar because the U. S. economy is larger. ?? The curves are higher for the Mexican peso because of the higher inflation in Mexico. -24 International Stock Markets ??? In addition to issuing stock locally, MNCs can also obtain funds by issuing stock in international markets. ??? This will enhance the firms’ image and name recognition, and diversify their shareholder base. ??? A stock offering may also be more easily digested when it is issued in several 3- 25 ??? Stock issued in the U. S. by non-U. S. firms or governments are called Yankee stock offerings.

Many of such recent stock offerings resulted from privatization programs in Latin America and Europe. ??? Non-U. S. firms may also issue American depository receipts (ADRs), which are ertificates representing bundles of stock. ??? The locations of an MNC’s operations can influence the decision about where to place its stock, in view of the cash flows needed to cover dividend payments. ??? Market characteristics are important too. Stock markets may differ in size, trading activity level, and proportion of individual versus institutional share ownership. -27 Comparison of ??? The foreign cash flow movements of a typical MNC can be classified into: 0 Foreign trade – exports and imports 0 Direct foreign investment (DFI) – acquisition of foreign real assets 0 Short-term investment or financing in foreign securities Longer-term financing in the international bond or stock markets 3-28 Foreign Cash Flow Chart of an MNC MNC parent Export/lmport Foreign Business Clients Dividend Remittance & Financing Medium- & Long-Term Financing Short-Term Investment Exchange Markets International Money Markets Subsidiaries Investment & Financing Credit Stock Markets Medium- & Long-Term Financing Long-Term Financing 3-29 How Financial Markets Affect an MNC’s Value ??? Since interest rates commonly vary among countries, an MNC may use the international financial markets to reduce its cost of capital, thereby achieving a higher valuation. 3-30

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