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International
Business
Fourth Edition
CHAPTER 11
The Global Capital Market
11-3
Chapter Focus
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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Functions of a Generic Capital
Market
Brings together those who
want to invest with who
want to borrow.
Invest:
Market makers:
Financial service companies that
connect investors and borrowers,
either directly or indirectly.
Firms with surplus cash.
Individuals.
Nonbank financial
institutions.
Borrow:
Individuals.
Companies.
Governments.
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The Main Players in a Generic
Capital Market
Investors:
Companies
Individuals
Institutions
Market makers:
Commercial bankers
Investment bankers
Borrowers:
Individuals
Companies
Governments
Figure 11.1
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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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Market Liquidity and the Cost of
Capital
D
SS
B
SS
10%
9
l
D
0
McGraw-Hill/Irwin
D
1
2
D
Dollars
Figure 11.2
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Risk Reduction Through Portfolio
Diversification
(a) Risk reduction through domestic diversification
1.0
Variance of
portfolio return
Variance of
return on
typical stock
Figure 11.3a
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U.S. Stocks
0.27
Total
Risk
1
Systematic
Risk
10
20
30
40
50
Number of Stocks
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11-9
Risk Reduction Through Portfolio
Diversification
(b) Risk reduction through domestic and
international diversification
1.0
Variance of
portfolio return
Variance of
return on
typical stock
Figure 11.3b
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U.S. Stocks
0.27
International Stocks
0.12
1
10
20
30
40
Number of Stocks
50
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11-10
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
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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Global Capital Market Risks
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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Index of Capital Controls in
Emerging Markets
Figure 11.4
0.68
0.66
0.64
0.62
0.6
0.58
0 = No Capital controls
0.56
1 = Tight Capital Controls
0.54
0.52
86
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88
89
90
91
92
93
94
95
96
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The Euro Currency Market.
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
Eurocurrency
deposit rate
Domestic
deposit
rate
Figure 11.5
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0%
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The Eurocurrency Market
Attraction
Drawbacks:
Lack of government
regulation.
Pay higher interest rates.
Charge lower rates.
Reserve restrictions are
less costly.
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Probability of bank failure
(low).
Foreign exchange risk.
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11-17
Global Bond Market
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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Attractions of the Eurobond
Market
Attraction:
An absence of regulatory interference.
Less stringent disclosure requirements than
domestic bond markets.
Favorable tax status.
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Global Equity Market
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
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Forward
exchange
market provides
some hedge.
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Implications for Business
Lower costs
Global capital markets
Provide opportunities for
For firms wishing
To borrow or
Invest money.
FX risk
Diversify
investments
McGraw-Hill/Irwin
Perhaps the emergence
of a unified
capital market
in the EU?
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