Download international financial markets

INTERNATIONAL
FINANCIAL MARKETS
1
NATURE AND FUNCTIONS
International financial markets undertake intermediation by transferring
purchasing power from lenders and investors to parties who desire to acquire
assets that they expect to yield future benefits. International financial transactions
involve exchange of assets between residents of different financial centres
across national boundaries. International financial centres are reservoirs of
savings and transfer them to their most efficient use irrespective of where the
savings are generated.
There are three important functions of financial markets. First, the interactions
of buyers and sellers in the markets determine the prices of the assets traded
which is called the price discovery process. Secondly, the financial markets
ensure liquidity by providing a mechanism for an investor to sell a financial
asset. Finally, the financial markets reduce the cost of transactions and
information.
MONEY AND CAPITAL MARKETS
Like their domestic counterpart, international financial markets may be divided
into money and capital markets. Money markets deal with assets created or
traded with relatively short maturity, say less than a year. Capital markets deal
with instruments whose maturity exceeds one year or which lack definite maturity.
Again on lines similar to domestic markets, in the international financial markets
also we have primary and secondary markets dealing with issue of new
instruments and trading in existing instruments and negotiable debt instruments,
respectively. In international financial markets as in the domestic markets there
is a symbiotic relationship between primary and secondary markets.
International Financial Markets and India
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CATEGORIES
OF MARKETS
According to Garbbe (see reference at the end of the chapter) international
financial markets consist of international markets for foreign exchange, Euro
currencies and Euro bonds. In view of the development and rapid growth of
swaps and globalisation of equity markets, international financial markets have
been categorised into five markets here: foreign exchange market; lending by
financial institutions; issue and trading of negotiable instruments of debt; issue
and trading of equity securities; and lastly internationally arranged swaps. The
rates of foreign exchange as well as interest rates fluctuate and to hedge against
the risk of loss arising out of changes in them derivative instruments are traded
in the organised exchanges as well as in over-the-counter markets. Most of the
derivatives except the interest rate swaps are short term in nature. Derivatives
involve creation of assets that are based on other financial assets.
GROWTH OF INTERNATIONAL FINANCIAL MARKETS
Since the 1960’s, the growth of international financial transactions has been
profoundly influenced by the growth in international trade involving exchange of
goods and services. The value of imports in US dollars for the world as a whole
went up in the last five decades by a multiple of 14 from about $ 590 billion in
1960 to about $ 8000 billion in 2000. While international trade can exist in the
absence of international financing arrangements as under direct exchange, barter
and cash payment in gold, there are no international finance or markets where
no goods and services are exchanged between residents of different countries.
There would be no reason for borrowing, lending or investing between countries
since nothing could be bought with the product of loan or investment.
Benefits
International financial markets and the transactions therein have however
facilitated and helped the expansion of international trade based on comparative
absolute advantage resulting in welfare benefits in terms of higher income among
participant nations. Further, the growth of international financial markets has
facilitated cross-country financial flows which contribute to a more efficient
allocation of resources. Efficiency in use rather than origin of or abundance
governs allocation of resources internationally. This means that potentially high
return projects in countries with low savings will not be neglected in favour of
low return projects in high saving countries simply because of where savings
are generated.1 American and British institutional money is flooding foreign
markets.
1.
Ephrain, Clark, Michael, Levasseur and Patrick, Rousseau, International Finance,
Chapman and Hall, London, 1993.
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Stock
Components of Net
at year
International Financing
end1985
(Billions of US $)
Outstanding
amount at end
2000
CHANGES
1986 1987 1988
1989
1990
1991
1992 1993 1994 1995 1996
1997
1998
1999
2000
Total International
Claims of reporting
banks
3137.1 657.2 764.8 510.9
807.1 589.0 (-)103.4 146.7 316.5 263.2 608.1
Minus·lnter bank
redepositing
1652.1 4522.0 444.8 250.9
397.1 209.0 (-)183.3 -18.3 121.5 83.2 314.1 184.1
719.8
228.1 (-)214.3 658.7 6262.8
A. Net International
bank credit
1485.0 205.0 320.0 260.0
410.0 380.0
465.0
115.0
19.8
7.4
B. Net Money market
instruments
16.0
13.4 23.4 19.5
6.9
32.0
532.7 1142.6
80.0 165.0 195.0 180.0 330.0 420.0
34.9 40.4 72.1 140.2
17.4
41.1
331.0
276.1 1171.8 10764.4
61.8 1113.1 4501.6
66.4
86.5
346.1
Total completed
bond and note issues
-
220.5 180.0 220.7
263.6 239.4
Minus: redemption
and repurchases
-
64.6 73.0 82.6
89.4 108.4
149.3 223.0 306.8 227.9 291.0 363.4
460.5
497.5
–
–
–
319.7 332.7 437.1 381.8 536.8 859.6 1014.0 1167.8
1163.9 1148.2 6168.7
C. Net bond and note
financing
572.5
155.9 107.0 138.1
174.3 131.0
170.5 109.7 133.3 153.9 245.8 496.2
553.5
676.3
–
–
–
D. Total international
financing (A+B+C)
2073.5
374.3 450.4 417.2
591.2 543.0
285.4 315.1 397.5 474.1 593.1 957.3 1038.3
792.7
–
–
–
Minus: double counting
E. Total net
133.5
1940.0
79.3 50.4 67.6
76.2 78.0
295.0 400.0 350.0 515.0
465.0
40.4 70.1 127.5 69.1
48.1 197.3
245.0 245.0 27.0 405.0 545.0 760.0
227.7
565.0
163.3
875.0
International Financial Markets
Final Proof-3-02-09\SK
Table 1.1: Estimated Net Financing in International Financial Markets (1985–2000)
–
–
–
6410.4 295.7 11016.4
International Financing
Source: BI8, Annual Reports 1991, 1994, 1998 and 1999 and International Banking and Financial Market Developments,
November 1994, May 1995, March 1998, March 1999 and June 2000.
3
International Financial Markets and India
4
SEGMENTATION
OF THE GLOBAL CAPITAL MARKET
Martin Feldstein in a study on Global Capital Flows1, argues that the world
capital market remains essentially segmented along national lines. “Capital may
be free to move internationally, but its owners and managers prefer to keep all
of each individual nation’s savings at home.”2 Feldstein argues that the best
evidence of this segmentation is the strong correlation between national rates
of saving and investment. He observes that if there were perfectly integrated
world capital markets, the differences in national savings rates would not lead
to differences among countries in national rates of investment in business
equipment and inventories. Capital would flow from the high saving countries
to the best investment opportunities around the globe.
Feldstein finds that much of the capital that moves internationally is pursuing
temporary gains and shifts quickly as conditions change. The large gross
international flows of funds are often part of offsetting transactions that leave
no net transfer of capital from one country to another. Feldstein argues that the
segmented nature of the world capital market is confirmed by the strong, homecountry bias of institutional portfolios. Only 10 per cent of the value of assets
in the 500 largest institutional portfolios in the world is invested in foreign
securities despite the advice of economists and financial analysts who advocate
global diversification as a way of increasing returns and reducing overall
portfolio risk. No country can count on sustained inflows of foreign capital to
finance domestic investment even when their local investment opportunities are
attractive. Mexico’s economic crisis in 1994 broke out because it let its savings
rates slip from 14 to 10 per cent and looked to the rest of the world to finance
its savings gap. Mexico’s low saving rate was the problem because of the
limited international flow of capital. The crisis arose out of the fact that too little
capital crosses borders and not too much.
ESTIMATED NET FINANCING IN INTERNATIONAL FINANCIAL
MARKETS
While world imports went up by a multiple of 14, the growth of international
financial activity as measured by the external assets of banks reporting to the
Bank for International Settlements3 rose from US$ 37.7 billion in 1968 to
1.
2.
3.
The Economist, June 24, 1995.
Ibid.
Includes Austria, Belgium, Luxembourgh, Denmark, Finland, France, Germany,
Ireland, Italy, Netherlands, Norway, Spain, Sweden, Switzerland, United Kingdom,
Japan, United States, Bahamas, Bahrain, Cayman Islands, Hongkong, Netherlands
Antilles, Singapore and branches of US banks in Panama.
Final Proof-3-02-09\SK
International Financial Markets
5
$ 11,016.4 billion in 2000. Apart from the external assets of banks there was a
large growth in Euro notes and Euro bonds.
Table 1.1 presents the estimated net financing in international financial
markets between 1985–2000. The Table presents, apart from external claims,
net international bank credit, net money market instruments (including commercial
paper, short-term Euro notes and medium-term notes), bonds and total net
international financing. Outstanding net international bank credit largely consisting
of syndicated loans rose from $ 1,485 billion in 1985 to $ 4,501.6 billion in 2000
(a 203 per cent increase); money market instruments from $ 16 billion to $ 346.1
billion (2,063 per cent); bond financing from $ 572.5 billion to $ 6,168.7 billion
(947.5 per cent); and total net international financing from $ 1,940 billion to
$ 11,016.4 billion (468 per cent).
MONEY MARKET AND CAPITAL MARKET INSTRUMENTS
In the international money market, short-term notes, bankers’ acceptances
including, Euro commercial paper are traded. The assets created and traded
have relatively short maturities. The outstanding amount at end-2000 was
$ 333.8 billion consisting of commercial paper ($ 223.3 billion) and other shortterm paper ($ 110.5 billion).
International capital markets deal in assets with maturities above one year
or those which lack definite maturities. These instruments consist of Euro mediumterm notes ($ 879.3 billion at end 2000), bonds ($ 6,049.7 billions at end-2000);
and Euro loans ($ 7,878 billion at end-2000).
The secondary markets are important for securities and negotiated debt
instruments. The securities consist of certificates of deposits and bankers
acceptances.
EURO MARKET
In international lending and trading of securities some operations are called
‘Euro’. It refers to types of financial activity that take place outside the countries
in whose currencies they are denominated. Euro dollar markets are offshore
money and capital markets, in the sense that the currency denomination is not
the official currency of the country where the transaction takes place. The term
‘Euro’ was first used for US dollar deposits made in London after the Second
World War when the US dollar replaced pound sterling as the leading international
currency. The term Euro dollar market was later generalised to Euro currency
when offshore centres for other currencies emerged. The reason for the
popularity of Euro dollar or Euro markets was that Euro markets were less
regulated than the U.S. markets. Further, the absence of reserve requirements,
Final Proof-3-02-09\SK