1、Chapter 3 International Financial Markets Lecture Outline Motives for Using International Financial Markets Motives for Investing in Foreign Markets Motives for Providing Credit in Foreign Markets Motives for Borrowing in Foreign Markets Foreign Exchange Market History of Foreign Exchange Foreign Ex
2、change Transactions Interpreting Foreign Exchange Quotations Currency Futures and Options Markets International Money Market Origins and Development Standardizing Global Bank Regulations International Credit Market Syndicated Loans International Bond Market Eurobond Market Development of Other Bond
3、Markets Comparing Interest Rates Among Currencies International Stock Markets Issuance of Foreign Stock in the U.S. Issuance of Stock in Foreign Markets Comparison of International Financial Markets How Financial Markets Affect an MNCs Value Chapter Theme This chapter identifies and discusses the va
4、rious international financial markets used by MNCs. These markets facilitate day-to-day operations of MNCs, including foreign exchange transactions, investing in foreign markets, and borrowing in foreign markets. Topics to Stimulate Class Discussion 1. Why do international financial markets exist? 2
5、. How do banks serve international financial markets? 3. Which international financial markets are most important to a firm that consistently needs short-term funds? What about a firm that needs long-term funds? Critical debate Should firms that go public engage in international offerings? Propositi
6、on Yes. When a firm issues shares to the public for the first time in an initial public offering (IPO), it is naturally concerned about whether it can place all of its shares at a reasonable price. It will be able to issue its shares at a higher price by attracting more investors. It will increase i
7、ts demand by spreading the shares across countries. The higher the price at which it can issue shares, the lower is its cost of using equity capital. It can also establish a global name by spreading shares across countries. Opposing view No. If a firm spreads its shares across different countries at
8、 the time of the IPO, there will be less publicly traded shares in the home country. Thus, it will not have as much liquidity in the secondary market. Investors desire shares that they can easily sell in the secondary market, which means that they require that the shares have liquidity. To the exten
9、t that a firm reduces its liquidity in the home country by spreading its share across countries, it may not attract sufficient home demand for the shares. Thus, its efforts to create global name recognition may reduce its name recognition in the home country. With whom do you agree? State your reaso
10、ns. Use InfoTrac or some other search engine to learn more about this issue. Which argument do you support? Offer your own opinion on this issue. ANSWER: The key is that students recognize the tradeoff involved. A firm that engages in a relatively small IPO will have limited liquidity even when all
11、of the stock is issued in the home country. Thus, it should not consider issuing stock internationally. However, firms with larger stock offerings may be in a position to issue a portion of their shares outside the home country. They should not spread the stocks across several countries, but perhaps
12、 should target one or two countries where they conduct substantial business. They want to ensure sufficient liquidity in each of the foreign countries where they sell shares. Stock Markets are inefficient Proposition I cannot believe that if the value of the euro in terms of, say, the British pound
13、increases three days in a row, on the fourth day there is still a 50:50 chance that it will go up or down in value. I think that most investors will see a trend and will buy, therefore the price is more likely to go up. Also, if the forward market predicts a rise in value, on average, surely it is g
14、oing to rise in value. In other words, currency prices are predictable. And finally, if it were so unpredictable and therefore unprofitable to the speculator, how is it that there is such a vast sum of money being traded every day for speculative purposes there is no smoke without fire. Opposing vie
15、w The simple answer is that if that is what you believe, buy currencies that have increased three days in a row and on average you should make a profit, buy currencies where the forward market shows an increase in value. The fact is that there are a lot of investors with just your sort of views. The
16、 market traders know all about such beliefs and will price the currency so that such easy profit (their loss) cannot be made. Look at past currency rates for yourself, check all fourth day changes after three days of rises, any difference is going to be not enough to cover transaction costs or tradi
17、ng expenses and the slight inaccuracy in your figures which are likely to be closing day mid point of the bid/ask spread. No, all currency movements are related to information and no-one knows if tomorrows news will be better or worse than expected. With whom do you agree? Could there be undiscovere
18、d patterns? Could some movements not be related to information? Could some private news be leaking out? ANSWER: Clearly there are no obvious patterns. Discussion on the impossibility of obvious patterns is worth emphasizing. However, does market inefficiency necessarily involve patterns, could marke
19、t manipulation be occasional. There is worrying evidence from share price movements that there is unusual movement before announcements on many occasions, so the ideathat traders do not occasionally collude and move the price without supporting economic evidence is not an unreasonable view. Proof is
20、 however difficult as we have to separate anticipation from prior knowledge, the lucky speculator from the speculator who was in the know. Answers to End of Chapter Questions 1. Motives for Investing in Foreign Money Markets. Explain why an MNC may invest funds in a financial market outside its own
21、country. ANSWER: The MNC may be able to earn a higher interest rate on funds invested in a financial market outside of its own country. In addition, the exchange rate of the currency involved may be expected to appreciate. 2. Motives for Providing Credit in Foreign Markets. Explain why some financia
22、l institutions prefer to provide credit in financial markets outside their own country. ANSWER: Financial institutions may believe that they can earn a higher return by providing credit in foreign financial markets if interest rate levels are higher and if the economic conditions are strong so that
23、the risk of default on credit provided is low. The institutions may also want to diversity their credit so that they are not too exposed to the economic conditions in any single country. 3. Exchange Rate Effects on Investing. Explain how the appreciation of the Australian dollar against the euro wou
24、ld affect the return to a French firm that invested in an Australian money market security. ANSWER: If the Australian dollar appreciates over the investment period, this implies that the French firm purchased the Australian dollars to make its investment at a lower exchange rate than the rate at whi
25、ch it will convert A$ to euros when the investment period is over. Thus, it benefits from the appreciation. Its return will be higher as a result of this appreciation. 4. Exchange Rate Effects on Borrowing. Explain how the appreciation of the Japanese yen against the UK pound would affect the return
26、 to a UK firm that borrowed Japanese yen and used the proceeds for a UK project. ANSWER: If the Japanese yen appreciates over the borrowing period, this implies that the UK firm converted yen to pounds at a lower exchange rate than the rate at which it paid for yen at the time it would repay the loa
27、n. Thus, it is adversely affected by the appreciation. Its cost of borrowing will be higher as a result of this appreciation. 5. Bank Services. List some of the important characteristics of bank foreign exchange services that MNCs should consider. ANSWER: The important characteristics are (1) compet
28、itiveness of the quote, (2) the firms relationship with the bank, (3) speed of execution, (4) advice about current market conditions, and (5) forecasting advice. 6. Bid/ask Spread. Delay Banks bid price for US dollars is 0.53 and its ask price is 0.55. What is the bid/ask percentage spread? ANSWER:
29、(0.55 0.53)/0.55 = .036 or 3.6% 7. Bid/ask Spread. Compute the bid/ask percentage spread for Mexican peso in which the ask rate is 20.6 New peso to the dollar and the bid rate is 21.5 New peso to the dollar. ANSWER: direct rates are 1/20.6 = $0.485:1 peso as the ask rate and 1/21.5 = $0.465:1 peso a
30、s the bid rate so the spread is ($0.485 $0.465)/$0.485 = .041, or 4.1%. Note that the spread is fro the Mexiccan peso not the dollar. 8. Forward Contract. The Wolfpack ltd is a UK exporter that invoices its exports to the United States in dollars. If it expects that the dollar will appreciate agains
31、t the pound in the future, should it hedge its exports with a forward contract? Explain. . ANSWER: The forward contract can hedge future receivables or payables in foreign currencies to insulate the firm against exchange rate risk. Yet, in this case, the Wolfpack Corporation should not hedge because
32、 it would benefit from appreciation of the dollar when it converts the dollars to pounds. 9. Euro. Explain the foreign exchange situation for countries that use the euro when they engage in international trade among themselves. ANSWER: There is no foreign exchange. Euros are used as the medium of ex
33、change. 10. Indirect Exchange Rate. If the direct exchange rate of the euro is worth 0.685, what is the indirect rate of the euro? That is, what is the value of a pound in euros? ANSWER: 1/0.685 = 1.46 euros. 11. Cross Exchange Rate. Assume Polands currency (the zloty) is worth 0.17 and the Japanese
34、 yen is worth 0.005. What is the cross (implied) rate of the zloty with respect to yen? ANSWER: 0.17/0.005 = 34 zloty:1 yen 12. Syndicated Loans. Explain how syndicated loans are used in international markets. ANSWER: A large MNC may want to obtain a large loan that no single bank wants to accommoda
35、te by itself. Thus, a bank may create a syndicate whereby several other banks also participate in the loan. 13. Loan Rates. Explain the process used by banks in the Eurocredit market to determine the rate to charge on loans. ANSWER: Banks set the loan rate based on the prevailing LIBOR, and allow th
36、e loan rate to float (change every 6 months) in accordance with changes in LIBOR. 14. International Markets. What is the function of the international money market? Briefly describe the reasons for the development and growth of the European money market. Explain how the international money, credit,
37、and bond markets differ from one another. ANSWER: The function of the international money market is to efficiently facilitate the flow of international funds from firms or governments with excess funds to those in need of funds. Growth of the European money market was largely due to (1) regulations
38、in the U.S. that limited foreign lending by U.S. banks; and (2) regulated ceilings placed on interest rates of dollar deposits in the U.S. that encouraged deposits to be placed in the Eurocurrency market where ceilings were nonexistent. The international money market focuses on short-term deposits a
39、nd loans, while the international credit market is used to tap medium-term loans, and the international bond market is used to obtain long-term funds (by issuing long-term bonds). 15. Evolution of Floating Rates. Briefly describe the historical developments that led to floating exchange rates as of
40、1973. ANSWER: Country governments had difficulty in maintaining fixed exchange rates. In 1971, the bands were widened. Yet, the difficulty of controlling exchange rates even within these wider bands continued. As of 1973, the bands were eliminated so that rates could respond to market forces without
41、 limits (although governments still did intervene periodically). 16. International Diversification. Explain how the Asian crisis would have affected the returns to a UK. firm investing in the Asian stock markets as a means of international diversification. See the chapter appendix. ANSWER: The retur
42、ns to the UK firm would have been reduced substantially as a result of the Asian crisis because of both declines in the Asian stock markets and because of currency depreciation. For example, the Indonesian stock market declined by about 27% from June 1997 to June 1998. Furthermore, the Indonesian ru
43、piah declined against the U.S. dollar by 84%. 17. Eurocredit Loans. a. With regard to Eurocredit loans, who are the borrowers? b. Why would a bank desire to participate in syndicated Eurocredit loans? c. What is LIBOR and how is it used in the Eurocredit market? ANSWER: a. Large corporations and som
44、e government agencies commonly request Eurocredit loans. b. With a Eurocredit loan, no single bank would be totally exposed to the risk that the borrower may fail to repay the loan. The risk is spread among all lending banks within the syndicate. c. LIBOR (London interbank offer rate) is the rate of
45、 interest at which banks in Europe lend to each other. It is used as a base from which loan rates on other loans are determined in the Eurocredit market. 18. Foreign Exchange. You just came back from Canada, where the Canadian dollar was worth 0.43. You still have C$200 from your trip and could exch
46、ange them for pounds at the airport, but the airport foreign exchange desk will only buy them for 0.40. Next week, you will be going to Mexico and will need pesos. The airport foreign exchange desk will sell you pesos for 0.055 per peso. You met a tourist at the airport who is from Mexico and is on
47、his way to Canada. He is willing to buy your C$200 for 1500 New Pesos. Should you accept the offer or cash the Canadian dollars in at the airport? Explain. ANSWER: Exchange with the tourist. If you exchange the C$ for pesos at the foreign exchange desk, the C$200 is multiplied by 0.40 and then divid
48、ed by 0.055 ie a ratio of 0.40/0.055 = 7.27 pesos to the C$. The total pesos would be 200 x 7.27 = 1454 pesos, a little less than is being offered by the tourist. 19. Foreign Stock Markets. Explain why firms may issue stock in foreign markets. Why might MNCs issue more stock in Europe since the conv
49、ersion to a single currency in 1999? ANSWER: Firms may issue stock in foreign markets when they are concerned that their home market may be unable to absorb the entire issue. In addition, these firms may have foreign currency inflows in the foreign country that can be used to pay dividends on foreign-issued stock. They may also desire to enhance their global image. Since the euro can be used in several countries, firms may need a large amount of euros if they are expanding across Europe. 20. Stock Market Integration. Bullet plc a UK firm, is planning to issue
