International
Financial Management
by
Jeff Madura
Florida Atlantic University
Chapter
3
International Financial Markets
Chapter Objectives
 Due to growth in international business over the last 30 years, various
international financial markets have been developed. Financial managers of
MNCs must understand the various international financial markets that are
available so that they can use those markets to facilitate their international
business transactions. The basic objective is
 To describe the background and corporate use of the following international
financial markets:
1.
2.
3.
4.
5.
Foreign exchange market,
Eurocurrency market,
Euro credit market,
Eurobond market, and
International stock markets.
Introduction to International
Financial Markets and Motives for
Using them
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Definitions IFMs
 The International Financial Markets are financial markets
where individuals buy and sell foreign assets such as stock,
Bonds, currencies.
 The foreign exchange market is The market in which
participants are able to buy, sell, exchange and speculate on
currencies. Foreign exchange markets are made up of banks,
commercial companies, central banks, investment
management firms, hedge funds, and retail forex brokers
and investors.
Definitions IFMs
 Eurocurrency market is The money market in which
Eurocurrency is borrowed and lent by banks in Europe. The
currency is held in banks outside of the country where it is
legal tender. It is utilized by large firms and extremely wealthy
individuals who wish to circumvent regulatory requirements,
tax laws etc…
 Euro credit market is The market where financial banking
institutions provide banking services(accept deposits and
provide loans) denominated in foreign currencies. The banks
that constitute this market are the same banks that constitute
the Eurocurrency market; the difference is that Euro credit
loans are longer-term than so-called Eurocurrency loans.
Definitions IFMs
 Eurobond market is A market in which bonds are issued in the
capital market of one country to a non-resident borrower
from another country. The Eurobond market is made up of
investors, banks, borrowers, and trading agents that buy, sell,
and transfer Eurobonds. Eurobonds are a special kind of bond
issued by European governments and companies, but often
denominated in non-European currencies such as dollars and
yen. They are also issued by international bodies such as the
World Bank. A Eurobond is an international bond that is
denominated in a currency not native to the country where it
is issued.
Definitions IFMs
 International stock market is the market in which shares of
MNCs are issued and traded . Also known as the equity
market, it is one of the most vital areas of a market economy
as it provides companies with access to capital and investors
with a slice of ownership in the company and the potential of
gains based on the company's future performance.
 This market can be split into two main sections: the primary
and secondary market. The primary market is where new
issues are first offered, with any subsequent trading going on
in the secondary market.
Motives for Using
International Financial Markets
 The markets for real or financial assets are prevented
from complete integration by barriers such as tax
differentials, tariffs, quotas, labor immobility, cultural
differences, and financial reporting differences.
 Yet, these barriers can also create unique opportunities
for specific geographic markets that will attract foreign
investors.
Motives for Using
International Financial Markets
 Agents of International Financial Markets:
1. Borrowers
2. Investors
3. Creditors
 Borrowers borrow in foreign markets:
 to capitalize on lower foreign interest rates; and
 when they expect foreign currencies to depreciate against
their own.
Motives for Using
International Financial Markets
 Investors invest in foreign markets:
 to take advantage of favorable economic conditions;
 when they expect foreign currencies to appreciate against
their own; and
 to reap the benefits of international diversification.
 Creditors provide credit in foreign markets:
 to capitalize on higher foreign interest rates;
 when they expect foreign currencies to appreciate against
their own; and
 to reap the benefits of international diversification.
Foreign Exchange Market
&
International Money Market
Eurocurrency Market
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Foreign Exchange Market
 The foreign exchange market allows currencies to be
exchanged in order to facilitate international trade or
financial transactions.
 In this market a currency is traded to another at a rate called
exchange rate.
 Exchange rate specifies the rate at which one currency can
be exchanged for another.
 The system for establishing exchange rates has evolved over
time.
 It has passed to 3 stages until now.
History of
Foreign Exchange Market
1. Gold Standard (1876 – 1913)
Each currency was convertible into gold at a specified rate.
When World War I began in 1914, the gold standard was
suspended.
2. Agreements on Fixed Exchange Rates
a.Bretton Woods Agreement 1944 - 1971
b.Smithsonian Agreement 1971 - 1973
3. Floating Exchange Rate System
In 1973, the official boundaries for the more widely traded
currencies were eliminated and the floating exchange rate
system came into effect because governments had difficulties
maintaining exchange rates within the stated boundaries.
Foreign Exchange
Transactions
 There is no specific building or location where traders exchange
currencies. Trading also occurs around the clock.
 The market for immediate exchange is known as the spot
market. 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.
 Trading between banks occurs in the interbank market. Within
this market, foreign exchange brokerage firms sometimes act
as middlemen.
 Hundreds of banks facilitate foreign exchange transactions,
though the top 20 handle about 50% of the transactions.
Foreign Exchange
Transactions
 Banks provide foreign exchange services for a fee: the bank’s
bid (buy) quote for a foreign currency will be less than its ask
(sell) quote. This is the bid/ask spread.
 bid/ask % spread = ask rate – bid rate
ask rate
Example: Suppose bid price for £ = $1.52, ask price = $1.60.
bid/ask % spread = (1.60–1.52)/1.60 = 5%
 The bid/ask spread is normally larger for those currencies that
are less frequently traded.
 The spread is also larger for “retail” transactions than for
“wholesale” transactions between banks or large corporations.
Interpreting
Foreign Exchange Quotations
 Exchange rate quotations for widely traded currencies are
frequently listed in the news media on a daily basis. The
quotations 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.
 A cross exchange rate reflects the amount of one foreign
currency per unit of another foreign currency.
 Value of 1 unit of currency A in units of currency B
= value of currency A in $
value of currency B in $
Currency Futures, Options & Forward
Market
 Currency futures contract specifies a standard volume of a
particular currency to be exchanged on a specific settlement
date. Futures contracts are sold on exchanges.
 Currency options contracts give the right to buy or sell a specific
currency at a specific price within a specific period of time. They
are sold on exchange too.
 Currency forward Contracts are agreements between a foreign
exchange dealer and an MNC that specifies the currencies to be
exchanged, the exchange rate, and the date at which the
transaction will occur. They are not sold on exchange.
International Money market
(Eurocurrency Market)
International Money Market
1.
Corporations or governments need short-term funds
denominated in a currency different from their home
currency.
2. The international money market has grown because firms:
a. May need to borrow funds to pay for imports
denominated in a foreign currency.
b. May choose to borrow in a currency in which the interest
rate is lower.
c. May choose to borrow in a currency that is expected to
depreciate against their home currency
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Origins and Development
1. European Money Market: Dollar deposits in banks in
Europe and other continents are called Eurodollars or
Eurocurrency. Origins of the European money market can be
traced to the Eurocurrency market that developed during the
1960s and 1970s.
2. Asian Money Market: Centered in Hong Kong and
Singapore. Originated as a market involving mostly dollardenominated deposits, and was originally known as the Asian
dollar market.
21
Eurocurrency Market
$
 U.S. dollar deposits placed in banks in Europe and other
continents are called Eurodollars.
 In the 1960s and 70s, the Eurodollar market, or what is now
referred to as the Eurocurrency market, grew to accommodate
increasing international business and to bypass stricter U.S.
regulations on banks in the U.S.
 The Eurocurrency market is made up of several large banks
called Euro banks that accept deposits and provide loans in
various currencies.
Eurocurrency Market
 Although the Eurocurrency market focuses on large-volume
transactions, there are times when no single bank is willing to
lend the needed amount.
 The recent standardization of regulations around the world has
promoted the globalization of the banking industry.
 In particular, the Single European Act has opened up the
European banking industry.
 The 1988 Basel Accord signed by G-10 central banks outlined
common capital standards, such as the structure of risk
weights, for their banking industries.
Eurocurrency Market
 The Eurocurrency market in Asia is sometimes referred to
separately as the Asian dollar market. Asian banks that collect
deposits and make loans denominated in US dollars.
 The primary function of banks in the Asian dollar market is to
channel funds from depositors to borrowers.
 Another function is interbank lending and borrowing.
 The market located in East Asia used for loans or
bank deposits that are denominated in United States dollars.
International Credit Market
( Euro credit Market)
International Bond Market
(Eurobond Market)
International Stock Market
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International Credit Market
 MNCs sometimes obtain medium-term funds through term
loans from local financial institutions or through the issuance of
notes (medium-term debt obligations) in their local markets.
 Loans of 1 year or longer extended by banks to MNCs or
government agencies in Europe are commonly called
Eurocredits or Eurocredit loans.
 International Credit market is constituted by the banks who
provide long term loans in foreign currency.
26
Regulations in the Credit Market
1. Single European Act:
 Capital can flow freely throughout Europe.
 Banks can offer a wide variety of lending, leasing, and
securities activities in the EU.
 Regulations regarding competition, mergers, and taxes are
similar throughout the EU.
 A bank established in any one of the EU countries has the
right to expand into any or all of the other EU countries.
2. Basel Accord - Banks must maintain capital equal to at least 4
percent of their assets. For this purpose, banks’ assets are
weighted by risk.
27
Eurocredit Market
LOANS
 Loans of one year or longer are extended by Eurobanks to
MNCs or government agencies in the Eurocredit market. These
loans are known as Eurocredit loans.
 Floating rates are commonly used, since the banks’ asset and
liability maturities may not match - Eurobanks accept shortterm deposits but sometimes provide longer term loans.
Eurobond Market
BONDS
There are two types of international bonds.
 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 represented by the currency denominating
them are called Eurobonds.
Eurobond Market
 Eurobonds are underwritten by a multi-national syndicate of
investment banks and simultaneously placed in many countries
through second-stage, and in many cases, third-stage,
underwriters.
 Eurobonds are usually issued in bearer form, pay annual
coupons, may be convertible, may have variable rates, and
typically have few protective covenants.
 Interest rates for each currency and credit conditions in the
Eurobond market change constantly, causing the popularity of
the market to vary among currencies.
 About 70% of the Eurobonds are denominated in the U.S. dollar.
International Stock
Markets
 In addition to issuing stock locally, MNCs can also obtain funds
by issuing stock in international markets.
 This will enhance the firm’s image and name recognition, and
diversify the shareholder base.
 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 certificates representing bundles of stock.
ADRs are less strictly regulated.
International Stock
Markets
 Market characteristics are important too. Stock markets may
differ in size, trading activity level, regulatory requirements,
taxation rate, and proportion of individual versus institutional
share ownership.
 Electronic communications networks (ECNs) have been created
to match orders between buyers and sellers in recent years.
 As ECNs become more popular over time, they may ultimately
be merged with one another or with other exchanges to create
a single global stock exchange.
Comparison of
International Financial Markets
 The foreign cash flow movements of a typical MNC can be
classified into four corporate functions, all of which generally
require the use of the foreign exchange markets.
 Foreign trade. Exports generate foreign cash inflows while
imports require cash outflows.
 Direct foreign investment (DFI). Cash outflows to acquire
foreign assets generate future inflows.
 Short-term investment or financing in foreign securities, usually
in the Eurocurrency market.
 Longer-term financing in the Eurocredit, Eurobond, or
international stock markets.
Foreign Cash Flow Chart of an MNC
MNC Parent
Export/Import
Foreign
Business
Clients
Export/Import
Dividend
Remittance
& Financing
Short-Term
Investment
& Financing
Eurocurrency
Market
Foreign
Subsidiaries
Short-Term
Investment & Financing
Medium- &
Long-Term
Financing
Eurocredit &
Eurobond
Markets
Foreign
Exchange
Transactions
Foreign
Exchange
Markets
Long-Term
Financing
International
Stock Markets
Medium- & Long-Term Financing
Long-Term Financing
Chapter Review
 Motives for Using International Financial Markets
 Motives for Investing in Foreign Markets
 Motives for Providing Credit in Foreign Markets
 Motives for Borrowing in Foreign Markets
 Foreign Exchange Market




History of Foreign Exchange
Foreign Exchange Transactions
Interpreting Foreign Exchange Quotations
Currency Futures and Options Markets
Chapter Review
 Eurocurrency Market
 Development of the Eurocurrency Market
 Composition of the Eurocurrency Market
 Standardizing Bank Regulations within the Eurocurrency Market
 Eurocredit Market
 Eurobond Market
 International Stock Markets
 Issuance of Foreign Stock in the U.S.
 Issuance of Stock in Foreign Markets
 Comparison of International Financial Markets