Download The Global Capital Market

Chapter 12
The Global Capital
Market
Why Do We Have
Capital Markets?
 Capital markets bring together investors and
borrowers
 investors - corporations with surplus cash, individuals,
and non-bank financial institutions
 borrowers - individuals, companies, and governments
 markets makers - the financial service companies that
connect investors and borrowers, either directly
(investment banks) or indirectly (commercial banks)
 capital market loans can be equity or debt
12-2
Who Are The Main Players
in Capital Markets?
The Main Players in a Generic Capital Market
12-3
What Makes The Global
Capital Market Attractive?
Today’s capital markets are highly
interconnected and facilitate the free flow
of money around the world
Borrowers benefit from the additional
supply of funds global capital markets
provide
lowers the cost of capital
the price of borrowing money or the rate of
return that borrowers pay investors
12-4
What Makes The Global
Capital Market Attractive?
Market Liquidity and the Cost of Capital
12-5
What Makes The Global
Capital Market Attractive?
Investors benefit from the wider range of
investment opportunities
diversify portfolios and lower risk
But, volatile exchange rates can make
what would otherwise be profitable
investments, unprofitable
12-6
What Makes The Global
Capital Market Attractive?
Risk Reduction through Portfolio Diversification
12-7
How Have Global Capital
Markets Changed Since 1990?
Global capital markets have grown rapidly
the stock of cross-border bank loans was just
$3,600 billion in 1990, but $32,430 in 2010
the international bond market has grown from
$3,515 billion in 1997 to $26,613 in 2010
international equity offerings were just $18
billion in 1990, but grew to $750 billion in
2009
12-8
Why Is The Global Capital
Market Growing?
 Two factors are responsible for the
growth of capital markets
1. Advances in information technology
 the growth of international communications
technology and advances in data processing
capabilities
 24-hour-day trading
 so, shocks that occur in one financial market
spread around the globe very quickly
12-9
Why Is The Global Capital
Market Growing?
2. Deregulation by governments
 has facilitated growth in international capital
markets
 governments have traditionally limited foreign
investment in domestic companies, and the
amount of foreign investment citizens could
make
 since the 1980s, these restrictions have been
falling
12-10
Why Is The Global Capital
Market Growing?
 deregulation began in the U.S., then moved to
Great Britain, Japan, and France
 many countries have dismantled capital controls
making it easier for both inward and outward
investment to occur
 The 2008-2009 global financial crisis raised
questions as to whether deregulation had gone
too far
 Question: Are new regulations for the financial
services industry needed?
12-11
What Are The Risks Of The
Global Capital Markets?
 Question: Could deregulation of capital markets
and fewer controls on cross-border capital flows
make nations more vulnerable to the effects of
speculative capital flows?
 can have a destabilizing effect on economies
 Speculative capital flows may be the result of
inaccurate information about investment
opportunities
 if global capital markets continue to grow, better
quality information is likely to be available from
financial intermediaries
12-12
What Is A Eurocurrency?
 A eurocurrency is any currency banked outside
its country of origin
 About two-thirds of all eurocurrencies are Eurodollars
 dollars banked outside the U.S.
 Other important eurocurrencies are the euro-yen, the
euro-pound, and the euro-euro
 The eurocurrency market is an important source
of low-cost funds for international companies
12-13
Why Has The Eurocurrency
Market Grown?
The eurocurrency market began in the
1950s when the Eastern bloc countries
feared that the United States might seize
their dollars
so, they deposited them in Europe
additional dollar deposits came from Western
European central banks and companies that
exported to the U.S.
could earn a higher rate of interest in London
12-14
Why Has The Eurocurrency
Market Grown?
In 1957, the market surged again after
changes in British laws
under the new laws, British banks had to
attract dollar deposits and loan dollars rather
pounds to finance non-British trade
London became the leading center of the
eurocurrency market
continues to hold this position today
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Why Has The Eurocurrency
Market Grown?
In the 1960s, the market grew once again
Changes in U.S. regulations discouraged
U.S. banks from lending to non-U.S.
residents
would-be borrowers of dollars outside the
U.S. turned to the euromarket as a source of
dollars
12-16
Why Has The Eurocurrency
Market Grown?
The next big increase came after the
1973-74 and 1979-80 oil price increases
Arab members of OPEC accumulated
huge amounts of dollars
avoided potential confiscation of their dollars
by the U.S. by depositing them in banks in
London
12-17
What Makes The Eurocurrency
Market Attractive?
The eurocurrency market is attractive
because it is not regulated by the
government
banks can offer higher interest rates on
eurocurrency deposits than on deposits made
in the home currency
banks can charge lower interest rates to
eurocurrency borrowers than to those who
borrow the home currency
12-18
What Makes The Eurocurrency
Market Attractive?
The spread between the eurocurrency
deposit and lending rates is less than the
spread between the domestic deposit and
lending rates
gives eurocurrency banks a competitive edge
over domestic banks
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What Makes The Eurocurrency
Market Attractive?
Interest Rate Spreads in Domestic and Eurocurrency Markets
12-20
What Makes The Eurocurrency
Market Unattractive?
 The eurocurrency market has two significant
drawbacks:
1. Because the eurocurrency market is
unregulated, there is a higher risk that bank
failure could cause depositors to lose funds
 can avoid this risk by accepting a lower return on a
home-country deposit
2. Companies borrowing eurocurrencies can be
exposed to foreign exchange risk
 can minimize this risk through forward market
hedges
12-21
What Is The
Global Bond Market?
 Bonds are an important means of
financing for many companies
 the most common bond is a fixed rate which
gives investors fixed cash payoffs
 The global bond market grew rapidly
during the 1980s and 1990s and
continues to grow today
12-22
What Is The
Global Bond Market?
 There are two types of international bonds
1. Foreign bonds are sold outside the borrower’s
country and are denominated in the currency of
the country in which they are issued
 used by companies when they think it will reduce the
cost of capital
2. Eurobonds are underwritten by a syndicate of
banks and placed in countries other than the
one in whose currency the bond is
denominated
12-23
What Makes The Eurobond
Market Attractive?
 The eurobond market is attractive because
1. It lacks regulatory interference
 since companies do not have to adhere to strict
regulations, the cost of issuing bonds is lower
2. It has less stringent disclosure requirements
than domestic bond markets
 it can be cheaper and less time consuming to offer
eurobonds than dollar-denominated bonds
3. It is more favorable from a tax perspective
 eurobonds can be sold directly to foreign investors
12-24
What Is The
Global Equity Market?
 The global equity market allows firms to
1. Attract capital from international investors
 many investors buy foreign equities to
diversify their portfolios
2. List their stock on multiple exchanges
 this type of trend may result in an
internationalization of corporate ownership
12-25
What Is The
Global Equity Market?
3. Raise funds by issuing debt or equity
around the world
 by issuing stock in other countries, firms
open the door to raising capital in the foreign
market
 gives the firm the option of compensating
local managers and employees with stock
 provides for local ownership
 increases visibility with local stakeholders
12-26
How Do Exchange Rates
Affect The Cost Of Capital?
 Adverse exchange rates can increase the cost of
foreign currency loans
 While it may initially seem attractive to borrow
foreign currencies, when exchange rate risk is
factored in, that can change
 firms can hedge their risk by entering into forward
contracts
 but this will also raise costs
 Firms must weigh the benefits of a lower interest
rate against the risk of an increase in the real
cost of capital
12-27
What Do Global Capital
Markets Mean For Managers?
Growth in global capital markets has
created opportunities for firms to borrow or
invest internationally
firms can often borrow at a lower cost than in
the domestic capital market
firms must balance the foreign exchange risk
associated with borrowing in foreign
currencies against the costs savings
12-28
What Do Global Capital
Markets Mean For Managers?
Growth in capital markets offers
opportunities for firms, institutions, and
individuals to diversify their investments
and reduce risk
again though, investors must consider foreign
exchange rate risk
Capital markets are likely to continue to
integrate providing more opportunities for
business
12-29