International Financial Markets

1
The Foreign Exchange Market The Global Capital
Market
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Chapter Preview

• Discuss the international capital market
• Describe the international bond, international
  equity and Eurocurrency markets
• Identify the foreign exchange markets functions
• Explain currency quotes and the rates given
• Identify the instruments of foreign exchange
• Discuss government restrictions on currencies

3
Capital Market
System that allocates financial
resources according to their most efficient uses

• Debt Repay principal plus interest
• Bond has timed principal interest payments
• Equity Part ownership of a company
• Stock shares in financial gains or losses

4
International Capital Market
Network of people, firms, financial institutions
and governments borrowing and investing
internationally

• Borrowers
• Expands money supply
• Reduces cost of money

• Lenders
• Spread / reduce risk
• Offset gains / losses

5
International CapitalMarket Drivers
Information technology
Deregulation
Financial instruments
6
Offshore Financial Centers
7
International Bond Market
Market of bonds sold by issuing companies,
governments and others outside their own countries
Bond that is issued outside the country in whose
currency the bond is denominated
Bond sold outside a borrowers country and
denominated in the currency of the country in
which it is sold
Driving growth are differential interest rates
between developed and developing nations
8
International Equity Market
Market of stocks bought and sold outside the
issuers home country
Privatization
Developing nations
Investment banks
Electronic markets
9
Eurocurrency Market
Unregulated market of currencies banked outside
their countries of origin

• Governments
• Commercial banks
• International companies
• Wealthy individuals

10
Foreign Exchange Market
Market in which currencies are bought and
sold and their prices are determined

• Conversion To facilitate sale or purchase, or
  invest directly abroad
• Hedging Insure against potential losses from
  adverse exchange-rate changes
• Arbitrage Instantaneous purchase and sale of a
  currency in different markets for profit
• Speculation Sequential purchase and sale (or
  vice-versa) of a currency for profit

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Quoting Currencies
Quoted currency numerator Base currency
denominator
(/) Japanese yen needed to buy one U.S. dollar
Yen is quoted currency, dollar is base currency
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Currency Values
Change in US dollar against Polish zloty
February 1 PLZ 5/ March 1 PLZ
4/ change (4-5)/5 x 100 -20 US dollar
fell 20
Change in Polish zloty against US dollar Make
zloty base currency (1 PLZ/)
February 1 .20/PLZ March 1
.25/PLZ change (.25-.20)/.20 x 100
25 Polish zloty rose 25
13
Cross Rate

• Exchange rate calculated using two other exchange
  rates
• Use direct or indirect exchange rates against a
  third currency

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Cross Rate Example

• Direct quote method
• Quote on euro 0.8461/
• Quote on yen 114.50/
• 0.8461/ 114.50/ 0.0074/
• Costs 0.0074 euros to buy 1 yen

• Indirect quote method
• Quote on euro 1.1819/
• Quote on yen 0.008734/
• 1.1819/ 0.008734/ 135.32/
• Final step 1 135.32/ 0.0074/
• Costs 0.0074 euros to buy 1 yen

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Spot Rate
Exchange rate requiring delivery of traded
currency within two business days
Repatriate income from sales abroad
Invest in another national market
Pay supplier in its own currency
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Forward Rate
Rate at which two parties will exchange currencies
on a specified future date

• Forward Contract
• Derivative
• Premium vs. Discount

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Swaps, Options and Futures
Currency swap Simultaneous purchase and sale of
foreign exchange for two different dates
Currency option Option to exchange a specific
amount of a currency on a specific date at a
specific rate
Currency futures contract Contract requiring the
exchange of a specific amount of a currency on a
specific date at a specific rate, with all
conditions fixed and not adjustable
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24 Hour Trading
19
Key Market Institutions
Interbank market
Securities exchange
Over-the-Counter (OTC) market
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Goals of Currency Restriction
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Currency Restriction Policies
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Chapter Summary

• This chapter presents two systems that comprise
  international financial markets the
  international capital market and the foreign
  exchange market. The international capital market
  offers advantages over domestic capital markets
  because it (1) increases the supply of funds
  available to borrowers and lowers the cost of
  capital and (2) provides a wider range of
  investment opportunities that allows investors to
  diversify their risk. The international capital
  market has grown dramatically because of
  information technology, deregulation by
  governments, and innovations in financial
  instruments. There are three main components of
  the international capital market the
  international bond market the international
  equity market and the Eurocurrency market. The
  foreign exchange market is the market in which
  currencies are bought and sold and in which
  currency prices are determined. The foreign
  exchange market is not a place, but a network of
  banks, brokers, and dealers that exchange
  currencies 24 hours a day. The foreign exchange
  market is used for (1) currency conversion, (2)
  currency hedging, (3) currency arbitrage, and (4)
  currency speculation.

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International Financial Markets