The Global Capital Market
Chapter 11
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Functions of a Generic Capital
Market

Brings together:

Those who want to invest:
• corporations, individuals, nonbank financial institutions.

Those who want to borrow:
• individuals, companies, governments.

Market makers:

Commercial and investment banks that connect investors with borrowers.
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11-1

The Main Players in a Generic
Capital Market
Investors:
Companies
Individuals
Institutions
Figure 11.1
Market makers:
Commercial bankers
Investment bankers
Borrowers:
Individuals
Companies
Governments
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11-2

Attraction of the Global Capital
Market?

Increases the supply of funds available for borrowing.
 Borrower’s perspective

Lowers the cost of capital.
 Investor’s perspective

Provides a wider range of investment opportunities.
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11-3

Market Liquidity and the Cost of
Capital
10%
9
D SS
B
SS l
D
0
D 1 D 2
Dollars
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Figure 11.2
11-4

Risk Reduction Through Portfolio
Diversification
(a) Risk reduction through domestic diversification
1.0
Variance of portfolio return
Variance of return on typical stock
0.27
U.S. Stocks
Figure 11.3a
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Total
Risk
Systematic
Risk
1 10 20 30 40 50
Number of stocks
11-5

Risk Reduction Through Portfolio
Diversification
(b) Risk reduction through domestic and international diversification
1.0
Variance of portfolio return
Variance of return on typical stock
0.27
0.12
U.S. Stocks
International Stocks
Figure 11.3b
© McGraw Hill Companies, Inc., 2000
1 10 20 30 40 50
Number of stocks
11-6

Net International Bank Lending
6000
5000
4000
3000
2000
1000
0
83 84 85 86 87 88 89 90 91 92 93 94 95 96 97
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$Billions
Figure 11.4
11-7

International Bond Issues and the
US Dollar Exchange Rate
180
160
140
120
Left-hand Scale (31
Dec 1993=100):
Exchange Rate against US$
DM
YEN
100
Right-hand Scale ($ Billion): announced Issues
US Dollar European Currencies
Yen Other
300
200
100
80
60
0 94-1Q 94-2Q 94-3Q 94-4Q 95-1Q 95-2Q 95-3Q 95-4Q 96-1Q 96-2Q 96-3Q 96-4Q 97-1Q 97-2Q 97-3Q
© McGraw Hill Companies, Inc., 2000
Figure 11.5
11-8

International Equity Offerings and Equity Price Developments
1000
900
800
700
600
500
400
300
200
100
0
85
Left-Hand Scale (US$)
M.S.C.I. World Index
Right-hand Scale ($ Billions)
US$
Yen
86 87 88 89 90 95 96 97 91 92 93
Figure 11.6
94
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11-9
80
60
40
20

Why The Growth?

TECHNOLOGY.

Deregulation by governments of capital flows and financial services.

Risk: Nations may be more vulnerable to speculative capital flows.

Short term investing.
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11-10

Index of Capital Controls in
Emerging Markets
0.6
0.58
0.56
0.54
0.52
0.68
0.66
0.64
0.62
0 = No Capital controls
1 = Tight Capital Controls
86 87 88 89 90 91 92 93 94 95 96
© McGraw Hill Companies, Inc., 2000 Figure 11.7
11-11

Eurocurrency
 It’s not the Euro!

It is any currency banked outside its country of origin.

1950s. Eastern Europeans afraid US would seize deposits to reimburse claims for business losses as a result of Communist takeover of Eastern Europe.
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11-12

Growth in Eurocurrency Funds
1.5 Trillion
1600
1400
1200
1000
800
600
400
200
0
One Billion
1961
1998
1961 1998
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11-13

The Eurocurrency Market

Characterized by a lack of regulation compared to domestic financial markets.
 This means that you don’t have to pay for the cost of regulation.

Hence, cheap (or cheaper) money.

Downside:

Banks could be more likely to fail (not probable)

Because you are getting foreign money, you have currency exchange risks.
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11-14

Interest Rate Spreads in Domestic and
Eurocurrency Markets
Rate of interest
Domestic lending rate
Eurocurrency lending rate
Eurocurrency deposit rate Domestic deposit rate
Figure 11.8
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0%
11-15

The International Bond Market

Bonds tend to be fixed rate.

Foreign bonds
 Sold outside the borrower’s country and in currency of country where issued.

Eurobonds
 underwritten by an international syndicate.
 issued by large corporations, international institutions and governments.
 placed in country other than country of currency and its residents.
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11-16

Euro vs Foreign Bonds
(Billions of Dollars)
Foreign
Euro
0 50
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100 150 200
11-17

Attraction of the Eurobond
Market?

No government interference.

Few disclosure requirements.

Favorable tax status.
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11-18

Global Equity Markets

Where investors can buy/sell stocks.

Made up of many stock exchanges around the world.
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11-19

Trading in Non-US Stocks
US Billions
NASDAQ
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NYSE
500
400
300
200
100
0
1994
1995
1996
1997
11- 20

Who Uses These Markets?

Investors seeking to diversify their portfolios.

Companies seeking to
 issue stock in the country
 use stock and options as a form of employee incentives
 satisfy local ownership requirements
 create funding for future acquisitions
 increase the visibility of the company.
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11-21