Chapter 11 - The Global Capital Market
The Global Capital Market
Learning objectives



Articulate the benefits of the
global capital market.
Understand why the global
capital market has grown so
rapidly over the last quarter
century.
Be familiar with the risks
associated with the
globalization of capital markets.

Appreciate the risks and
benefits associated with the
Eurocurrency market, the
global bond market, and the
global equity markets.

Understand how foreign
exchange risk impacts upon the
cost of capital.
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This chapter discusses the form and function of the global
capital market. The market is attractive because its size
lowers the cost of capital for borrowers, and allows
investors to diversify their portfolios, thereby reducing
their risk.
Advances in information technology, and the deregulation
of financial services and the relaxation of regulations on
cross-border capital flows have contributed to the growth
of the global capital market.
The chapter then goes on to explore the Eurocurrency
market, the global bond market, and the international
equities market.
The opening case describes how ICBC, China’s largest
bank, raised $21 billion in the international equities
market. The closing case examines how China Mobile
raised capital in international markets through a stock
offering and a bond issue.
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Chapter 11 - The Global Capital Market
OUTLINE OF CHAPTER 11: THE GLOBAL CAPITAL MARKET
Opening Case: Industrial and Commercial Bank of China
Introduction
Benefits of the Global Capital Market
Functions of a Generic Capital Market
Attractions of the Global Capital Market
The Borrower’s Perspective: Lower Cost of Capital
The Investor’s Perspective: Portfolio Diversification
Growth of the Global Capital Market
Information Technology
Deregulation
Global Capital Market Risks
Management Focus: Deutsche Telekom Taps the Global Capital Market
Country Focus: Did the Global Capital Markets Fail Mexico?
The Eurocurrency Market
Genesis and Growth of the Market
Attractions of the Eurocurrency Market
Drawbacks of the Eurocurrency Market
The Global Bond Market
Attractions of the Eurobond Market
Regulatory Interference
Disclosure Requirements
Favorable Tax Status
The Global Equity Market
Pegged Exchange Rates
Currency Boards
Country Focus: The Search for Capital in the Czech Republic
Foreign Exchange Risk and the Cost of Capital
Implications for Managers
Chapter Summary
Critical Thinking and Discussion Questions
Closing Case: China Mobile
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Chapter 11 - The Global Capital Market
CLASSROOM DISCUSSION POINT
Many of today’s students may be unaware of the limitations faced by companies that
wanted to raise capital just a couple of decades ago.
Encourage students to comprehend the significance and implications of the growth of the
global capital market by asking them to imagine a world where firms were limited to
their domestic market as a source of funds or investment opportunities.
Ask students to identify the advantages of this type of world, and then the disadvantages.
Finally, ask students to consider which type of system is better – the one that was in place
twenty years ago, or the current system.
OPENING CASE: Industrial and Commercial Bank of China
Summary
The opening case discusses the effort by the Industrial and Commercial Bank of China,
or ICBC, to raise money in the global capital market. ICBC raised a record $21 billion
dollars with its Initial Public Offering. In fact, the offering was hugely oversubscribed!
Tapping in global capital markets is becoming more common for Chinese companies.
Since 2000, they have raised over $100 billion dollars from global equity markets.
Discussion of the case can revolve around the following questions:
1. Why have Chinese companies been tapping global capital markets for funds, rather
than raising money in their domestic market? What are the advantages of doing this?
2. IBCN’s Initial Public Offering was massively oversubscribed. Why did so many
investors want to be part of IBCB?
3. IBCB listed on both the Shanghai exchange and the Hong Kong exchange. What was
IBCB’s goal with this strategy?
Another Perspective: To learn more about the Industrial and Commercial Bank of China
do to the company’s web site at {http://www.icbc.com.cn/e_index.jsp}.
LECTURE OUTLINE
This lecture outline follows the Power Point Presentation (PPT) provided along with this
instructor’s manual. The PPT slides include additional notes that can be viewed by
clicking on “view”, then on “notes”. The following provides a brief overview of each
Power Point slide along with teaching tips, and additional perspectives.
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Chapter 11 - The Global Capital Market
Slide 11-3 Introduction
The rapid globalization of capital markets facilitates the free flow of money around the
world. Traditionally, national capital markets have been separated by regulatory barriers.
Slide 11-4 Benefits of the Global Capital Market
Global capital markets , while providing many of the same function of domestic markets,
offer some benefits not found in domestic capital markets.
Slides11-5-11-7 Functions of a Generic Capital Market
Capital markets bring together investors (corporations with surplus cash, individuals, and
non-bank financial institutions) and borrowers (individuals, companies, and
governments).
Slides 11-8-11-11 Attractions of the Global Capital Market
Borrowers benefit from the global capital market’s lower cost of capital and greater
investment options.
Slides 11-14-11-19 Growth of the Global Capital Markets
Since 1990, the stock of cross-border bank loans has grown from just $3,600 billion to
$17,875 billion in 2006. The international bond market shows a similar pattern of
growth.
The two factors behind the growth are advances in information technology and
deregulation of the financial services industry.
Another Perspective: McKinsey & Company have been following the growth of the
global capital markets. Detailed analysis can be found at
{http://www.mckinsey.com/mgi/publications/third_annual_report/index.asp}.
Slide 11-20 Global Capital Market Risks
A key risk of an unregulated capital market and looser control on cross-border capital
flows is that individual nations may be more vulnerable to the destabilizing effects of
speculative capital flows.
Slide 11-21 The Eurocurrency Market
A eurocurrency is any currency banked outside of its country of origin.
Slides 11-23-11-24 Genesis and Growth of the Market
The eurocurrency market began in the 1950s when the Eastern bloc countries were afraid
the United States might seize their holdings of dollars. Today, London is the center of
the market.
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Chapter 11 - The Global Capital Market
Slides 11-23-11-24 Attractions of the Eurocurrency Market
The eurocurrency market is attractive to depositors and borrowers because it is not
regulated by the government.
Slide 11-27 Drawbacks of the Eurocurrency Market
The eurocurrency market has two drawbacks. First, because the eurocurrency market is
unregulated, there is a higher risk of bank failure. Second, companies borrowing
eurocurrencies can be exposed to foreign exchange risk.
Slide 11-28 The Global Bond Market
There are two types of international bonds:
1. foreign bonds are sold outside the borrower’s country and are denominated in the
currency of the country in which they are issued.
2. eurobonds are underwritten by a syndicate of banks and placed in countries other than
the one in whose currency the bond is denominated.
Slide 11-29 Attractions of the Eurobond Market
The eurobond market is attractive because it lacks regulatory interference, because it has
less stringent disclosure requirements than domestic bond markets, and because it is
more favorable from a tax perspective.
Slide 11-30 The Global Equity Market
The largest equity markets are in the United States, Britain, and Japan.
Slide 11-31 Foreign Exchange Risk and the Cost of Capital
While it may initially seem attractive to borrow foreign currencies, when exchange rate
risk is factored in, that can change.
Slide 11-32 Implications for Managers
Firms can often borrow at a lower cost than in the domestic capital market. Firms must
balance the foreign exchange risk associated with borrowing in foreign currencies against
the costs savings that may exist.
CRITICAL THINKING AND DISCUSSION QUESTIONS
QUESTION 1: Why has the global capital market grown so rapidly in recent decades?
Do you think this growth will continue throughout the next decade? Why?
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Chapter 11 - The Global Capital Market
ANSWER 1: The global capital market has experienced rapid growth in recent decades.
In 1990, for example, the stock of cross-border loans was just $3,600 billion. By 2006,
this number had increased to $17, 875 billion! Similarly, outstanding international bonds
increased from $3,515 billion in 1997 to $17,571 billion in 2006. A similar pattern exists
with international equities offerings. Two key factors are behind this growth: advances in
information technology and deregulation by government. The financial services industry
has been revolutionized by advances in information technology, and most students will
probably suggest that this trend will continue. Similarly, most students will probably
agree that the deregulation of the financial services industry that began in the United
States and spread to other markets facilitating the growth of the capital market will
continue.
QUESTION 2: Reread the Country Focus on the search for capital in the Czech Republic.
What are the advantages to Czech firms of listing their equity on the London stock
exchange? Can you see any disadvantages?
ANSWER 2: Because of the improprieties surrounding the Prague stock exchange, Czech
firms have little choice but to go outside the country to raise capital. By listing on the
London exchange, Czech firms have access to a wider pool of investors and a probably a
lower cost of capital. Some students will probably point out that by making the decision
to list on the London stock exchange, Czech companies are also making a commitment to
ensuring that it is complying with British accounting methods, and so raises its cost of
capital.
QUESTION 3: A firm based in Mexico has found its growth is restricted by the limited
liquidity of the Mexican capital market. List the firm’s options for raising money on the
global capital market. Discuss the pros and cons of each option, and make a
recommendation. How might your recommended options be affected if the Mexican
peso depreciates significantly on the foreign exchange market over the next two years?
ANSWER 3: Companies seeking to raise money in the global capital markets can pursue
equity loans or debt loans. Equity loans involve selling stock to investors, while debt
loans involve issuing bonds. In either case, the cost of capital is generally lower than it
would be in the domestic market. The firm could also simply borrow money from a
bank. In any situation, firms must be careful to factor in the risk of adverse exchange
rates. If the peso is expected to depreciate significantly, the firm should be aware that it
will cost more to purchase the currency necessary to repay a foreign currency loan.
QUESTION 4: Happy Company wants to raise $2 million with debt financing. The
funds are needed to finance working capital, and the firm will repay them with interest in
one year. Happy Company’s treasurer is considering three options:
a) Borrowing U.S. dollars from Security Pacific Bank at 8 percent.
b) Borrowing British pounds from Midland Bank at 14 percent.
c) Borrowing Japanese yen from Sanwa Bank at 5 percent.
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Chapter 11 - The Global Capital Market
If Happy borrows foreign currency, it will not cover it; that is, it will simply change
foreign currency for dollars at today’s spot rate and buy the same foreign currency a year
later at the spot rate that is in effect. Happy Company estimates the pound will
depreciate by 5 percent relative to the dollar and the yen will appreciate 3 percent relative
to the dollar in the next year. From which bank should Happy Company borrow?
ANSWER 4: Happy Company needs to consider both the cost of capital and foreign
exchange risk. If Happy Company borrows $2 million from Security Pacific Bank, in
one year it will owe the bank $2 million plus 8 percent. If Happy Company borrows
British pounds from Midland it has to factor in the higher interest rate (14 percent), and
also its estimate that the pound will depreciate by 5 percent. If its prediction about the
pound is accurate, this could prove to be an attractive option. Finally, while the interest
rate at the Japanese bank is the lowest of the three, if the yen does appreciate by 3
percent, this option becomes less attractive. In the end, given that its expectations about
the future value of the British pound and the Japanese yen are only guesses into the
future, Happy Bank will have to decide how much risk it is willing to take on before it
can choose which bank to approach.
CLOSING CASE: China Mobile
Summary
The closing case describes China Mobile’s expansion plans and efforts to raise the capital
necessary to implement them. China Mobile, based in Hong Kong, is one of the world’s
largest mobile telephone service providers. China Mobile, concerned about the new
competition it might face if China joined the World Trade Organization, wanted to
quickly establish itself in seven more Chinese provinces. To do so, the company needed
to raise $32.8 billion. China Mobile made the decision to raise the capital in the global
capital market. Discussion of the case can revolve around the following questions:
QUESTION 1: Why did China Mobile feel it was necessary to issue equity in markets
outside of its home base in Hong Kong? What are the advantages if such a move?
ANSWER 1: China Mobile need to raise over $32 billion. The company was concerned
that if it simply relied on its home market of Hong Kong for this capital, the cost would
get too high. Therefore, China Mobile made the decision to seek funds in the
international market.
QUESTION 2: Why did China Mobile price the bond issue in U.S. dollars instead of
Hong Kong dollars?
ANSWER 2: At the time of its offering, China Mobile was already listed on the New
York Stick Exchange in American Depository Receipts, or ADRs. China Mobile decided
to sell more ADRs and also raise additional funds through convertible bonds.
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Chapter 11 - The Global Capital Market
QUESTION 3: Can you see any downside to China Mobile’s international equity and
bond issue?
ANSWER 3: Many students will probably focus on the fact that China Mobile priced its
bond issue in U.S. dollars instead of Hong Kong dollars. The bonds issue involved 5year convertible bonds that can be converted in equity after five years. By issuing the
bonds in a foreign currency, China Mobile has exposed itself to exchange rate risk.
Another Perspective: To earn more about China Mobile, go to the company’s web site at
{http://www.chinamobileltd.com/about.php?menu=1}.
INTEGRATING iGLOBES
There are several iGLOBE video clips that can be integrated with the material presented
in this chapter. In particular, you might consider the following:
Title: Federal Reserve Moves to Stabilize Market
Federal Reserve Spends Billions
Run Time: 10:21
Abstract: This video explores the efforts by the Federal Reserve and other central banks
to stabilize financial markets.
Key Concepts: international monetary system, investor psychology and the bandwagon
effect, globalization
Notes: Global markets, concerned about the availability of credit, received some
reassurance recently when the Federal Reserve, along with the European Central Bank,
and other central banks, announced that they would pump billions of dollars into the
global financial system. The hope is that the additional liquidity will ensure that prices in
the market reflect underlying risks. As a result of the Federal Reserve’s actions, the
federal funds rate, which had been 6 percent, dropped back to the targeted 5.25 percent.
Liquidity in the market had been disrupted by a very abrupt re-pricing of risk in the
economy.
Glenn Hubbard, dean of the Columbia Business School, believes that the move was
important for restoring market confidence and ensuring that there were no developments
in the market that could lead to a financial crisis. Laurence Meyer, former governor of
the Federal Reserve Board, noted that the problems that were addressed began in the
United States, and in particular with sub-prime loans. However, because financial
markets today are global in nature, the problems quickly spread to other countries in
Europe. Glenn Hubbard also stresses the need to fully understand the global nature of
financial markets, and the interconnectedness of the global economy.
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Chapter 11 - The Global Capital Market
Hubbard points out that while the current problem began in the United States and spread
to other countries, the contributions to global liquidity and investments in the United
States came from foreign markets. He notes that today, risks are spread and diversified
around the world. Hubbard expects further intervention in the market. Hubbard believes
the current situation is actually a correction in the market that will more accurately price
risk. He notes that the correction took place very quickly as people became worried
about credit spreads.
Discussion Questions:
1. Why did the Federal Reserve recently pump money into financial markets? What
problems was it trying to address? Did it succeed?
2. Consider the recent move by the Federal Reserve to inject additional liquidity into
financial markets. The Federal Reserve’s efforts were just part of a worldwide effort to
reassure investors of the availability of credit. Why was it important for the Federal
Reserve to work in tandem with other central banks? Could the Federal Reserve have
corrected the problem by working alone?
2. Reflect on the global nature of world financial markets. What are the implications of
this interconnectedness? As an investor, how does this affect you?
4. Discuss the implications of global financial markets, and the potential for a worldwide
economic crisis.
globalEDGE™ Exercise Questions
Use the globalEDGE™ site {http://globalEDGE.msu.edu/} to complete the following
exercises:
Exercise 1
The top management of your company is looking for somebody to analyze the current
position of the United States in world trade. Remembering that you learned about the
dynamics of the Balance of Payments in your studies, you decide to prepare the analysis
of the latest state of U.S. trade.
Exercise 2
The Bureau of Economic Analysis is an agency of the U.S. Department of Commerce. It
lists data about the U.S. International Accounts, including current investment positions
and the amount of direct investment by multinational corporations. Prepare a brief report
regarding the direct investments of other countries in the U.S. Which are the leading
countries in foreign direct investment?
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Chapter 11 - The Global Capital Market
Answers to the Exercises
Exercise 1
The Balance of Payments data can be found at the Bureau of Economic Analysis, which
is an agency of the U.S. Department of Commerce. The webpage can be accessed by
searching the term “Bureau of Economic Analysis” at
http://globaledge.msu.edu/ResourceDesk/. This resource is found under the globalEDGE
category “Research: Government Resources”. Be sure to check the “Resource Desk only”
checkbox of the search function on the globalEDGE website.
Search Phrase: “Bureau of Economic Analysis”
Resource Name: United States: Bureau of Economic Analysis
Website: http://www.bea.doc.gov/
globalEDGE™ Category: “Research: Government Resources”
Exercise 2
The investment positions of foreign direct investment by multinational corporations in
the US can be found at the Bureau of Economic Analysis. The webpage can be accessed
by searching the term “International Accounts Data” at
http://globaledge.msu.edu/ResourceDesk/. This resource is found under the globalEDGE
category “Research: Government Resources”. Be sure to check the “Resource Desk only”
checkbox of the search function on the globalEDGE website.
Search Phrase: “International Accounts Data”
Resource Name: United States: Bureau of Economic Analysis: International Accounts
Data
Website: http://www.bea.gov/bea/ai1.htm
globalEDGE™ Category: “Research: Government Resources”
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