Chapter 9 International Financial Markets Prentice Hall 2003

Chapter 9 International Financial Markets Prentice Hall 2003 1

Chapter Preview • Discuss the international capital market • Describe the international bond, international equity, and Eurocurrency markets • Identify the foreign exchange market’s functions • Explain currency quotes and the rates given • Identify the instruments of foreign exchange • Discuss government restrictions on currencies © Prentice Hall, 2008 International Business 4 e 2

Capital Market System that allocates financial resources according to their most efficient uses Debt: Repay principal plus interest Ø Bond has timed principal & interest payments Equity: Part ownership of a company Ø Stock © Prentice Hall, 2008 shares in financial gains or losses International Business 4 e 3

International Capital Market Network of people, firms, financial institutions, and governments borrowing and investing internationally Borrowers Ø Expands money supply Ø Reduces cost of money Lenders Ø Spread / reduce risk Ø Offset gains / losses © Prentice Hall, 2008 International Business 4 e 4

International Capital Market Drivers Information technology Deregulation Financial instruments © Prentice Hall, 2008 International Business 4 e 5

Offshore Financial Centers Operational center Extensive financial activity and currency trading Country or territory whose financial sector features few regulations and few, if any, taxes Booking center Mostly for bookkeeping and tax purposes © Prentice Hall, 2008 International Business 4 e 6

International Bond Market of bonds sold by issuing companies, governments, and others outside their own countries Eurobond Foreign bond Interest rates Bond that is issued outside the country in whose currency the bond is denominated Bond sold outside a borrower’s 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 © Prentice Hall, 2008 International Business 4 e 7

International Equity Market of stocks bought and sold outside the issuer’s home country Privatization Developing nations Investment banks Electronic markets © Prentice Hall, 2008 International Business 4 e 8

Eurocurrency Market Unregulated market of currencies banked outside their countries of origin Ø Ø Governments Commercial banks International companies Wealthy individuals © Prentice Hall, 2008 International Business 4 e 9

Foreign Exchange Market in which currencies are bought and sold and their prices are determined © Prentice Hall, 2008 ü Conversion: To facilitate sale or purchase, or invest directly abroad ü Hedging: Insure against potential losses from adverse exchange-rate changes ü Arbitrage: Instantaneous purchase and sale of a currency in different markets for profit ü Speculation: Sequential purchase and sale (or vice versa) of a currency for profit International Business 4 e 10

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 © Prentice Hall, 2008 International Business 4 e 11

Currency Values Change in U. S. dollar against Polish zloty Change in Polish zloty against U. S. dollar Make zloty base currency (1÷ PLZ/$) February 1: $. 20/PLZ March 1: $. 25/PLZ February 1: PLZ 5/$ March 1: PLZ 4/$ %change = [(4 -5)/5] x 100 = -20% %change = [(. 25 -. 20)/. 20] x 100 = 25% U. S. dollar fell 20% Polish zloty rose 25% © Prentice Hall, 2008 International Business 4 e 12

Cross Rate • Exchange rate calculated using two other exchange rates • Use direct or indirect exchange rates against a third currency © Prentice Hall, 2008 International Business 4 e 13

Cross Rate Example Direct quote method 1) 2) 3) 4) 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 1) 2) 3) 4) 5) © Prentice Hall, 2008 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

Spot Rate Exchange rate requiring delivery of traded currency within two business days Repatriate income from sales abroad © Prentice Hall, 2008 Pay supplier in its own currency International Business 4 e Invest in another national market 15

Forward Rate at which two parties will exchange currencies on a specified future date v Forward Contract v Derivative v Premium vs. Discount © Prentice Hall, 2008 International Business 4 e 16

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 © Prentice Hall, 2008 International Business 4 e 17

24 Hour Trading © Prentice Hall, 2008 International Business 4 e 18

Key Market Institutions Interbank market Market in which the world’s largest banks exchange currencies at spot and forward rates © Prentice Hall, 2008 Securities exchange Exchange that specializes in currency futures and options transactions International Business 4 e Over-the-Counter (OTC) market Global computer network of foreign exchange traders and other market participants 19

Goals of Currency Restriction Preserve hard currency to repay debts owed to other nations Preserve hard currency to pay for imports and finance trade deficits Protect a currency from speculators Constrain individuals and companies from investing abroad © Prentice Hall, 2008 International Business 4 e 20

Currency Restriction Policies Multiple exchange rate system Import deposit requirements Quantity restrictions What’s a firm to do? ? “Countertrade” © Prentice Hall, 2008 International Business 4 e 21

Chapter Review • Discuss the international capital market • Describe the international bond, international equity, and Eurocurrency markets • Identify the foreign exchange market’s functions • Explain currency quotes and the rates given • Identify the instruments of foreign exchange • Discuss government restrictions on currencies © Prentice Hall, 2008 International Business 4 e 22