INTERNATIONAL FINANCIAL MARKETS

 Importance of International capital market

& its main components

 Functions of foreign exchange market

OBJECTIVES  Different types of currency quotes and

exchange rates

 Instruments and institutions of foreign

exchange market
A system that allocates
financial resources
according to their most
efficient uses

CAPITAL MARKET
Main purpose – Provide a
mechanism through which
borrowing or investment
could be made efficiently
 NATIONAL CAPITAL MARKET - PURPOSE

Help individuals & institutions borrow money from lenders; intermediaries exist to
facilitate financial exchanges
2 primary means for financing –
 ROLE OF DEBT – Loans, Borrower repays principal amount plus predetermined
rate of interest
Bonds (company debt) – instruments specifying the timing of principal and
interest payments
Holder of Bond (the Lender) – can force borrower into bankruptcy
 NATIONAL CAPITAL MARKET - PURPOSE

2 primary means for financing –

 ROLE OF EQUITY – Part ownership of a company – equity holder participates with other
part owners in company’s financial gains and losses.
Stock (shares of ownership in company’s assets) gives stockholder ( shareholders) a
claim on company’s future cash flows
Shareholders – rewarded with dividends (payments made out of surplus funds) – or
by increasing value of their shares
Shareholders - can sell one stock and buy another or liquidate exchange stock for
cash
INTERNATIONAL CAPITAL MARKET

A network of individuals, International banks play a

companies, financial
institutions and
governments that invest
and borrow across
national borders
central role – gather
excess cash of investors &
savers around the world –
channel this cash to
borrowers across globe

Formal exchanges - buyer Electronic exchanges -

& seller meet to trade trading occurs
financial instruments anonymously
INTERNATIONAL CAPITAL MARKET - PURPOSE

Expands money supply – borrowers

• Financing opportunities for investors outside home nation – important for small or developing
capital markets

Reduces Cost of money – borrowers

• Expanded money supply – reduce cost of borrowing
• Price – Reflect supply and demand
• If supply ↑ - price in form of interest rate will fall

Reduces risk - lender

• Expands available lending opportunities
• Investors have choices to make from these lenders - reduce overall portfolio risk by spreading
their money
• Invest in international securities – benefit as some economies are growing and some declining
 FORCES - International Capital Market EXPANSION

Information Increases competition, Financial

Technology Deregulation
lowers cost of financial Instruments
Reduces time and Increased competition
transactions, and
money needed to is creating the need to
opens many national
communicate globally. develop innovative
markets to global
financial instruments
investing and
borrowing
Securitization –
Electronic trading after unbundling &
Continued growth repackaging of hard-
close of formal
depends on further to-trade financial
exchanges facilitates
deregulation. assets – to liquid,
fast response times.
negotiable, &
marketable financial
instruments
WORLD FINANCIAL CENTERS

Three most important financial centers are London, New

York, and Tokyo.
• Offshore Financial Centers
• Country or territory where financial sector features few regulations and
few, if any, taxes.
• Are economically and politically stable
• Are advanced in telecommunications
• Offer large amounts of funding in many currencies
• Provide a less costly source of financing
 OFFSHORE FINANCIAL CENTERS –
2 Categories

Operational Centers

• See a great deal of financial activity (e.g., London for currency trading; Switzerland for
investment capital).

Booking Centers
• Are usually located on a small, island nation or territory with favorable tax and/or secrecy
laws.
• Funds pass through on their way to large operational centers.
• Typically are offshore branches of domestic banks used to record tax and currency exchange
information.
 International Bond Market
• Consists - bonds sold by issuing companies &
governments outside their own countries

COMPONENTS –
• Buyers include medium- to large-size banks, pension
funds, mutual funds, and governments.
International Types of International Bonds
Bond Market
• Eurobond
• Issued outside the country in whose currency it is
denominated (e.g., Issued in Venezuela in U.S.
dollars, and sold in Britain, France, and Germany)
• Accounts for 75-80% of all international bonds
• Absence of regulation reduces the cost of issuing a
bond but increases its risk
 Types of International Bonds
• Foreign Bond
COMPONENTS - • Sold outside borrower’s country and
denominated in currency of country in which
International it is sold (e.g., Yen-denominated bond issued
Bond Market by German carmaker BMW in Japan’s bond
market)
• Accounts for 20-25% of all international bonds
• Issuers must meet certain regulatory
requirements and disclose details about
company activities, owners, and upper
management.
 - Consists of all stocks bought and sold outside the
International issuer’s home country.
COMPONENTS – Equity - Companies and governments issue equity

International Market - Buyers include other companies, banks, mutual

funds, pension funds, and individuals.
Equity Market

•- Single privatization often places billions of dollars

Spread of of new equity on stock markets.
Privatization •- Increased privatization in Europe is expanding
worldwide equity.
 Economic - Growth in newly industrialized and developing countries
Growth in contributes to growth in the international equity market.
Developing - Because of a limited supply of funds in emerging economies,
Countries the international equity market is a major source of funding.

COMPONENTS –
International
Equity Market Activity of •- Investment banks facilitate the sale of stock worldwide by
bringing together sellers and large potential buyers.
Investment
- Becoming more common than listing a company’s shares on
Banks another country’s stock exchange.

Advent of - Stock markets that have no central geographic location, but

consist of online global trading activities that allow listing of
Cybermarkets stocks worldwide for electronic 24-hour trading.
 COMPONENTS – Eurocurrency Market

 All the world’s currencies banked outside their countries of origin are called Eurocurrency and trade
on the Eurocurrency market (e.g., U.S. dollars in Tokyo are called Eurodollars. British pounds in New
York are called Euro pounds)
 Characterized by large transactions involving only the largest companies, banks, and governments.
 Four Sources of Deposits:
 Governments with excess funds from prolonged trade surplus
 Commercial banks with excess currency
 International companies with excess cash
 Extremely wealthy individuals
 Eurocurrency market is valued at around $6 trillion, with London accounting for about 20 percent of
all deposits.
FOREIGN EXCHANGE MARKET

Market in which currencies are bought and sold and in

which currency prices are determined

Exchange rates reflect the size of the transaction, the trader

conducting it, general economic conditions, and sometimes,
government mandate.
FUNCTIONS - Foreign Exchange Market

Currency Hedging
Currency Conversion
Insuring against potential
Companies use the
losses that result from
foreign exchange
adverse changes in
market to convert
exchange rates.
currencies
Companies use it to:

Reduce exposure in
transactions where a
Lessen the risk of
time lag exists between
international transfers
billing and receipt of
payment
FUNCTIONS - Foreign Exchange Market

Currency Speculation
Currency Arbitrage
Purchase or sale of a currency
Instantaneous purchase and
with the expectation that its
sale of a currency in different
value will change and
markets for profit
generate a profit

Common among Interest arbitrage - profit-

experienced foreign motivated purchase and Much riskier than arbitrage
exchange traders, large sale of interest-paying because the value, or price,
investors, and firms in securities denominated in of currencies is quite volatile
arbitrage business different currencies

Companies – use to find higher

interest rates abroad in government
treasury bills, corporate and
government bonds, and even bank
deposits.
 FOREIGN EXCHANGE MARKET – HOW IT WORKS

 Quoting Currencies
 Two components to every quoted exchange rate: the quoted currency and the base
currency.
 In (¥/$), the yen is the quoted currency, the dollar is the base currency. The quoted currency is
always the numerator, and the base currency is always the denominator.

 Direct and Indirect Rate Quotes

 In ¥ 117/$, the yen is the quoted currency - called a direct quote on the yen and an indirect quote
on the dollar
 In $0.0085/¥, the dollar is the quoted currency - called a direct quote on the dollar and an indirect
quote on the yen
FOREIGN EXCHANGE MARKET – HOW IT WORKS

 This formula derives a direct quote from an indirect quote:

Direct Quote = 1
Indirect Quote
 And, for deriving an indirect quote from a direct quote, use:
Indirect Quote = 1
Direct Quote
 FOREIGN EXCHANGE MARKET – HOW IT WORKS

Quoting Currencies
 Cross Rates
 Exchange rate calculated using two other exchange rates
 Used when no access to the exchange rate between two nation’s currencies, but have exchange
rates for each nation’s currency with that of a third nation
Forward Rate
 Exchange rate at which two parties agree to exchange currencies on a specified future date
 Represent traders’ and bankers’ expectations of a currency’s future spot rate. Used to insure
against unfavorable changes in exchange rates
 FOREIGN EXCHANGE MARKET – HOW IT WORKS

Spot Rate
 Exchange rate that requires delivery of a traded currency within two business days.
 The spot market helps companies to:
 Convert income from sales abroad into the home-country currency
 Convert funds into the currency of an international supplier
 Convert funds into the currency of a country in which it will invest
FOREIGN EXCHANGE MARKET – HOW IT WORKS

Swaps, Options and Futures

• Currency Swap
• Simultaneous purchase and sale of foreign exchange for two different dates

• Currency Option Right, or option,

• To exchange a specific amount of a currency on a specific date at a specific rate

• Currency Futures Contract

• Requiring the exchange of a specific amount of currency on a specific date at a specific
exchange rate, with all conditions fixed and not adjustable
 MARKET INSTRUMENTS & INSTITUTIONS

 Electronic network of foreign exchange traders, currency trading banks, and

investment firms among major financial centers
 Trading Centers
 Important Currencies
 A vehicle currency is used as an intermediary to convert funds between two
other currencies
 Currencies most often involved in currency transactions are the U.S. dollar, British
pound, Japanese yen, and European Union euro
 MARKET INSTRUMENTS & INSTITUTIONS

 Interbank Market
 Market where the world’s largest banks exchange currencies at spot and forward
rates
 Banks act as agents for clients and turn to foreign exchange brokers, who
maintain networks to obtain seldom traded currencies
 Securities Exchanges
 Specialize in currency futures and options transactions
 Securities brokers facilitate currency transactions on securities exchanges
 Transactions on securities exchanges are much smaller than those in the
interbank market and vary with each currency
 MARKET INSTRUMENTS & INSTITUTIONS

 Over-the-Counter (OTC) Market

 Consists of a global computer network of foreign exchange traders and other
market participants, but with no central trading location
 Major players in the OTC market are large financial institutions and investment
banks
 The OTC market has grown because of several benefits:
 Business people search for the institution that provides the best (lowest) price
for transactions
 Offers greater opportunities for designing customized transactions
 CURRENCY CONVERTIBILITY

A convertible (hard) currency is one that trades freely in the foreign exchange
market, with its price determined by the forces of supply and demand

But some countries do not permit the free convertibility of their currencies

Goals of Currency Restriction

Preserve nation’s hard Preserve hard currencies Keep individuals and

Protect a currency from
currencies to repay debts to pay for imports and businesses from investing
speculators
owed to other nations finance trade deficits in other nations
CONCLUSION
Key components of
international financial markets
are the international bond,
equity, and Eurocurrency
markets.
Continued growth in the
international capital market is
expected
Its crucial to understand the
fundamentals of exchange
rates and how the foreign
exchange market is structured
THANK YOU
SHIVANI SHARMA