Fourth Edition

The Global Capital Market

The benefits of the global capital market.
Growth of the international capital market.
Macroeconomic risks associated with the growth.
Important segments of the market :
Eurocurrency market.
International bond market.
International equity market.
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Brings together those who want to invest with who want to borrow.
Invest:
Firms with surplus cash.
Individuals.
Nonbank financial institutions.
Borrow:
Individuals.
Companies.
Governments.
Market makers:
Financial service companies that connect investors and borrowers, either directly or indirectly.
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Investors:
Companies
Individuals
Institutions
Figure 11.1
Market makers:
Commercial bankers
Investment bankers
Borrowers:
Individuals
Companies
Governments
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Attractions of the Global Capital
Market
Benefits both borrowers and investors.
Borrowers:
Increases the money supply.
Lowers the cost of capital.
Investors:
Provides a wide range of investment opportunity.
Diversifies investor risk.
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10%
9
D SS B
SS l
D
0
1
D D
2
Dollars Figure 11.2
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(a) Risk reduction through domestic diversification
1.0
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Variance of portfolio return
Variance of return on typical stock
0.27
Figure 11.3a
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U.S. Stocks
Total
Risk
Systematic
Risk
1 10 20 30 40 50
Number of Stocks
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(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
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1 10 20 30 40 50
Number of Stocks
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International Portfolio Risk
Reduction
Movements of stock prices across across countries are not perfectly correlated .
Reflects two factors:
Countries pursue different macroeconomic policies and face different economic conditions.
Different stock markets are segmented by capital controls .
Perception that markets are integrating, but not as rapidly as thought.
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Growth of Global Capital Markets
Information Technology:
Diminishing costs of sharing information.
Internet.
Computer power.
Shocks in one market affect other markets
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Deregulation:
Response to:
Eurocurrency market.
Financial services firms.
Increasing acceptance a
‘free market’ concept.
Dismantling of national capital controls.
Less restrictions on inward/outward capital flows.
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Nations more vulnerable to speculative capital flows.
Potential destabilization of economies.
Capital pursuing short term gains.
Hot money.
Patient money.
Martin Feldstein
Lack of quality information.
Investors react to quickly to news events.
Differing accounting conventions.
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0.64
0.62
0.6
0.58
0.56
0.54
0.52
Figure 11.4
0.68
0.66
0 = No Capital controls
1 = Tight Capital Controls
86 87 88 89 90 91 92 93 94 95 96
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A eurocurrency is any currency banked outside its country of origin.
It’s not the euro!
Eurodollars are dollars banked outside the United States.
!950s. Eastern Europeans, fearing U.S. seizure of their dollars to reimburse U.S. citizens for property expropriated by their governments, deposited them in foreign banks (mostly in London).
Other events:
Britain – 1957.
U.S. – 1960s.
Failure of Bretton Woods.
Oil crisis – 1970s.
Gave opportunity to those who wanted to deposit or borrow dollars (later,other currencies, as well).
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Interest Rate Spreads in Domestic and Eurocurrency Markets
Rate of interest
Domestic lending rate
Eurocurrency lending rate
Domestic deposit rate
Eurocurrency deposit rate
0%
Figure 11.5
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Attraction
Lack of government regulation.
Pay higher interest rates.
Charge lower rates.
Reserve restrictions are less costly.
Drawbacks:
Probability of bank failure
(low).
Foreign exchange risk.
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Fixed rate.
Two types:
Foreign:
Sold outside borrower’s country and denominated by the currency of the country where issued.
Desire to lower cost of capital.
Eurobonds:
Underwritten by a bank syndicate and placed in countries other than the one in whose currency the bond is denominated.
Issued by multinational corporations,large domestic corporations, and international institutions.
Not offered in capital market, or to residents, of the country whose currency they are denominated.
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Attraction:
An absence of regulatory interference.
Less stringent disclosure requirements than domestic bond markets.
Favorable tax status.
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No equity market in the sense of the international currency and bond markets.
Countries have their own markets to trade corporate stocks.
Many open to foreign investors.
Two trends:
Internationalization of corporate ownership.
Companies broadening stock ownership by listing stock on foreign exchanges.
Tap into larger pool of funds for investment.
Lowering capital costs.
Facilitate future acquisitions.
Stock and stock options for local employees, suppliers and bankers.
Increasing, firms from developing countries are taking advantage of the opportunity to access these funds.
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Foreign Exchange Risk and the Cost of Capital
Unpredictable movements in rates.
Increases cost of currency Forward exchange market provides some hedge.
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Lower costs
Global capital markets
Provide opportunities for
For firms wishing
To borrow or
Invest money.
FX risk
Diversify investments
Perhaps the emergence of a unified capital market in the EU?
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