International Financial Markets. © Prentice Hall, 2006International Business 3e Chapter 9 - 2...

International International Financial MarketsFinancial Markets

© Prentice Hall, 2006 International Business 3e Chapter 9 - 2

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• 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


Capital MarketCapital 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


International Capital MarketInternational 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


International CapitalInternational CapitalMarket DriversMarket Drivers

Information technology

Deregulation

Financial instruments


Offshore Financial CentersOffshore Financial Centers

Country or territory whose financial sector features few regulations and few, if any, taxes- Operational center

• Extensive financial activity and currency trading

- Booking center• Mostly for bookkeeping and tax purposes


International Bond MarketInternational Bond Market

Market of bonds sold by issuing companies, governments and others outside their own countries- Eurobond

• Bond that is issued outside the country in whose currency the bond is denominated

- Foreign bond• Bond sold outside a borrower’s country and denominated in

the currency of the country in which it is sold

- Interest rates• Driving growth are differential interest rates between

developed and developing nations


International Equity MarketInternational Equity Market

Market of stocks bought and sold outside the issuer’s home country- Privatization

- Developing nations

- Investment banks

- Electronic markets


Eurocurrency MarketEurocurrency Market

• Unregulated market of currencies banked outside their countries of origin

- Governments

- Commercial banks

- International companies

- Wealthy individuals


Foreign Exchange MarketForeign 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


Quoting CurrenciesQuoting Currencies

Quoted currency = numeratorBase currency = denominator(¥/$) = Japanese yen needed to buy one U.S. dollarYen is quoted currency, dollar is base currency


Currency ValuesCurrency 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 dollarMake zloty base currency (1÷ PLZ/$) February 1: $.20/PLZ March 1: $.25/PLZ% change = [(.25-.20)/.20] x 100 = 25%

Polish zloty rose 25%


Cross RateCross Rate

• Exchange rate calculated using two other exchange rates

• Use direct or indirect exchange rates against a third currency


Cross Rate ExampleCross 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 yenIndirect 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


Spot RateSpot Rate

Exchange rate requiring delivery of traded currency within two business days- Repatriate income from sales abroad

- Pay supplier in its own currency

- Invest in another national market


Forward RateForward Rate

Rate at which two parties will exchange currencies on a specified future date- Forward Contract

- Derivative

- Premium vs. Discount


Swaps, Options and FuturesSwaps, 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


Key Market InstitutionsKey Market Institutions

Interbank market- Market in which the world’s largest banks exchange

currencies at spot and forward rates

Securities exchange- Exchange that specializes in currency futures and

options transactions

Over-the-Counter (OTC) market- Global computer network of foreign exchange traders

and other market participants


Goals of Currency RestrictionGoals 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


Currency Restriction PoliciesCurrency Restriction Policies

Multiple exchange rate system

Import deposit requirements

Quantity restrictions

What’s a firm to do? “Countertrade”

International Financial Markets. © Prentice Hall, 2006International Business 3e Chapter 9 - 2...

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