16613709 International Financial Markets

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INTERNATIONAL FINANCIAL MARKETS

In economics, a financial market is a mechanism that allows people to buy and sell

(trade) financial securities (such as stocks and bonds), commodities (such as precious

metals or agricultural goods), and other fungible items of value at low transaction

costs and at prices that reflect the efficient-market hypothesis.

Both general markets (where many commodities are traded) and specialized markets

(where only one commodity is traded) exist. Markets work by placing many interested

buyers and sellers in one "place", thus making it easier for them to find each other. An

economy which relies primarily on interactions between buyers and sellers to allocate

resources is known as a market economy in contrast either to a command economy orto a non-market economy such as a gift economy.

In finance, financial markets facilitate:

The raising ofcapital (in the capital markets)

The transfer ofrisk(in the derivatives markets)

The transfer ofliquidity (in the money markets)

International trade (in the currency markets)

and are used to match those who wantcapital to those who have it.

Typically a borrower issues a receipt to the lender promising to pay back the capital.

These receipts aresecurities which may be freely bought or sold. In return for lending

money to the borrower, the lender will expect some compensation in the form of

interest ordividends.

In mathematical finance, the concept continuous-time Brownian motion stochastic

process is sometimes used as a model.

Definition

In economics, typically, the term marketmeans the aggregate of possible buyers and

sellers of a certain good or service and the transactions between them.
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The term "market" is sometimes used for what are more strictly exchanges,

organizations that facilitate the trade in financial securities, e.g., a stock exchange or

commodity exchange. This may be a physical location (like the NYSE) or an

electronic system (like NASDAQ). Much trading of stocks takes place on an

exchange; still, corporate actions (merger, spinoff) are outside an exchange, while any

two companies or people, for whatever reason, may agree to sell stock from the one to

the other without using an exchange.

Trading ofcurrencies andbonds is largely on a bilateral basis, although some bonds

trade on a stock exchange, and people are building electronic systems for these as

well, similar to stock exchanges.

Financial markets can be domestic or they can be international.

Types of financial markets

The financial markets can be divided into different subtypes:

Capital markets which consist of:

o Stock markets, which provide financing through the issuance of shares

orcommon stock, and enable the subsequent trading thereof.

o Bond markets, which provide financing through the issuance ofbonds,

and enable the subsequent trading thereof.

Commodity markets, which facilitate the trading of commodities.

Money markets, which provide short term debt financing and investment.

Derivatives markets, which provide instruments for the management of

financial risk.

Futures markets, which provide standardized forward contracts for trading

products at some future date; see also forward market.

Insurance markets, which facilitate the redistribution of various risks.

Foreign exchange markets, which facilitate the trading offoreign exchange.

The capital markets consist ofprimary markets and secondary markets. Newly formed

(issued) securities are bought or sold in primary markets. Secondary markets allow
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investors to sell securities that they hold or buy existing securities. The transaction in

primary market exist between investors and public while secondary market its

Raising the capital

To understand financial markets, let us look at what they are used for, i.e. what where

firms make the capital to invest

Without financial markets, borrowers would have difficulty finding lenders

themselves. Intermediaries such as banks help in this process. Banks take deposits

from those who have money to save. They can then lend money from this pool of

deposited money to those who seek to borrow. Banks popularly lend money in the

form ofloans and mortgages.

More complex transactions than a simple bank deposit require markets where lenders

and their agents can meet borrowers and their agents, and where existing borrowing or

lending commitments can be sold on to other parties. A good example of a financial

market is a stock exchange. A company can raise money by selling shares to investors

and its existing shares can be bought or sold.

The following table illustrates where financial markets fit in the relationship between

lenders and borrowers:

Relationship between lenders and borrowers

LendersFinancial

Intermediaries

Financial

MarketsBorrowers

Individuals

Companies

Banks

Insurance Companies

Pension Funds

Mutual Funds

Interbank

Stock Exchange

Money Market

Bond Market

Foreign

Exchange

Individuals

Companies

Central

Government

Municipalities

Public

Corporations

Lenders
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Who have enough money to Lend or to give someone money from own pocket at the

condition of getting back the principal amount or with some interest or charge, is the

Lender.

Individuals & Doubles

Many individuals are not aware that they are lenders, but almost everybody does lend

money in many ways. A person lends money when he or she:

puts money in a savings account at a bank;

contributes to a pension plan;

pays premiums to an insurance company;

invests in government bonds; or

invests in company shares.

Companies

Companies tend to be borrowers of capital. When companies have surplus cash that is

not needed for a short period of time, they may seek to make money from their cash

surplus by lending it via short term markets called money markets.

There are a few companies that have very strong cash flows. These companies tend to

be lenders rather than borrowers. Such companies may decide to return cash to lenders

(e.g. via a share buyback.) Alternatively, they may seek to make more money on their

cash by lending it (e.g. investing in bonds and stocks.)

Borrowers

Individuals borrow money via bankers' loans for short term needs or longer term

mortgages to help finance a house purchase.

Companies borrow money to aid short term or long term cash flows. They also

borrow to fund modernisation or future business expansion.

Governments often find their spending requirements exceed their tax revenues. To

make up this difference, they need to borrow. Governments also borrow on behalf ofnationalised industries, municipalities, local authorities and other public sector bodies.
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In the UK, the total borrowing requirement is often referred to as the Public sector net

cash requirement (PSNCR).

Governments borrow by issuingbonds. In the UK, the government also borrows from

individuals by offering bank accounts and Premium Bonds. Government debt seems

to be permanent. Indeed the debt seemingly expands rather than being paid off. One

strategy used by governments to reduce thevalue of the debt is to influence inflation.

Municipalities and local authorities may borrow in their own name as well as

receiving funding from national governments. In the UK, this would cover an

authority like Hampshire County Council.

Public Corporations typically include nationalised industries. These may include the

postal services, railway companies and utility companies.

Many borrowers have difficulty raising money locally. They need to borrow

internationally with the aid ofForeign exchange markets.

Borrower's having same need can form them into a group of borrowers. It can also

take an organizational form. just like Mutual Fund. They can provide mortgaze on

weight basis. The main advantage is that it lowers their cost of borrowings.

Derivative products

During the 1980s and 1990s, a major growth sector in financial markets is the trade in

so called derivative products, orderivatives for short.

In the financial markets, stock prices, bond prices, currency rates, interest rates and

dividends go up and down, creating risk. Derivative products are financial products

which are used to control risk or paradoxically exploit risk. It is also called financial

economics.

Derivative products or instruments help the issuers to gain an unusual profit from

issuing the instruments. For using the help of these products a contract have to be

made. Derivative contracts are mainly 3 types: 1. Future Contracts 2. Forward

Contracts 3. Option Contracts.
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Currency markets

Main article: Foreign exchange market

Seemingly, the most obvious buyers and sellers of currency are importers and

exporters of goods. While this may have been true in the distant past, [when?] when

international trade created the demand for currency markets, importers and exporters

now represent only 1/32 of foreign exchange dealing, according to the Bank for

International Settlements.[1]

The picture of foreign currency transactions today shows:

Banks/Institutions

Speculators

Government spending (for example, military bases abroad)

Importers/Exporters

Tourists

Analysis of financial markets

See Statistical analysis of financial markets,statistical finance---

Much effort has gone into the study of financial markets and how prices vary with

time. Charles Dow, one of the founders of Dow Jones & Company and The Wall

Street Journal, enunciated a set of ideas on the subject which are now called Dow

Theory. This is the basis of the so-called technical analysis method of attempting to

predict future changes. One of the tenets of "technical analysis" is that market trends

give an indication of the future, at least in the short term. The claims of the technical

analysts are disputed by many academics, who claim that the evidence points rather to

the random walk hypothesis, which states that the next change is not correlated to the

last change.

The scale of changes in price over some unit of time is called the volatility. It was

discovered by Benot Mandelbrot that changes in prices do not follow a Gaussian

distribution, but are rather modeled better by Lvy stable distributions. The scale of

change, or volatility, depends on the length of the time unit to apowera bit more than
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1/2. Large changes up or down are more likely than what one would calculate using a

Gaussian distribution with an estimated standard deviation.

A new area of concern is the proper analysis of international market effects. As

connected as today's global financial markets are, it is important to realize that there

are both benefits and consequences to a global financial network. As new

opportunities appear due to integration, so do the possibilities of contagion. This

presents unique issues when attempting to analyze markets, as a problem can ripple

through the entire connected global network very quickly. For example, a bank failure

in one country can spread quickly to others, which makes proper analysis more

difficult.

Financial market slang

Poison pill, when a company issues more shares to prevent being bought out

by another company, thereby increasing the number of outstanding shares to

be bought by the hostile company making the bid to establish majority.

Quant, a quantitative analyst with a PhD[citation needed] (and above) level of

training in mathematics and statistical methods.

Rocket scientist, a financial consultant at the zenith of mathematical and

computer programming skill. They are able to invent derivatives of high

complexity and construct sophisticated pricing models. They generally handle

the most advanced computing techniques adopted by the financial markets

since the early 1980s. Typically, they are physicists and engineers by training;

rocket scientists do not necessarily build rockets for a living.

White Knight, a friendly party in a takeoverbid. Used to describe a party that

buys the shares of one organization to help prevent against a hostile takeover

of that organization by another party.

1. Distinction between Credit and Bond Market
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Both bonds and credit (currency) financing have their advantages anddisadvantages.

For a given company, under specific circumstances, one method of financing may be

preferred to the other. The major differences are:

1. Cost of borrowing

Bonds are issued in both fixed rate and floating rate forms. Fixed rate bonds are an

attractive exposure management tool since the known long-term currency inflows can

be offset by the known long-term outflows in the same currency. In contrast, currency

loans carry variable rates.

2. Maturity

Bonds have longer maturities while the period of borrowing in the currency market

has tended to lengthen over time.

3. Size of the issue

Earlier, the funds available for lending at any time have been much more in the inter-

bank market than in the bond market. But of late, this situation does not hold true.

Moreover, although in the past the flotation costs of a Euro currency loan have been

much lower than a Euro bond (about 0.5 % of the total loan amount versus about 2.25

% of the face value of a Euro bond issue), compensation has worked to lower Euro

bond flotation costs.

4. Flexibility

In a Euro bond issue, the funds must be drawn in one sum on a fixed date and repaid

according to a fixed schedule, unless the borrower pays a substantial prepayment


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penalty. By contrast, the drawdown in a floating rate loan can be staggered to suit the

borrowers needs and can be repaid in whole or in part at any time, often without

penalty. Moreover, a Euro currency loan with a multi-currency clause enables the

borrower to switch currencies on any roll-over date, whereas switching the

denomination of a Euro bond from currency A to currency B would require a costly,

combined, refunding and reissuing operation.

5. Speed

Funds can be raised by a known borrower very quickly in the Euro currency market.

Often, a period of two to three weeks should suffice. A Euro bond financing generally

takes more time, though the difference is becoming less significant.

2. Credit Market

Credit or Loans are the loans extended for one year or longer. The market that deals in

such loans is called Credit Market.

The common maturity for credit loans is 5 years. Since banks accept short-term

deposits and provide long-term loans, it is likely that asset liability mismatch may

arise. To avoid this banks often extend floating rate credit loans fixed to some market

interest rate. The London Inter Bank Offer Rate (LIBOR) is the most commonly used

interest rate. It is the rate charged for loans between Banks.

Participants in credit Market

The major lending banks in the credit market are banks, American, Japanese, British,

Swiss, French, German and Asian (specially that of Singapore) banks, Chemical


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Bank, JP Morgan, Citicorp, Bankers Trust, Chase Manhattan Bank, First National

Bank of Chicago, Barclay's Bank, National Westminster, BNP, etc. Among the

borrowers, there are banks, multinational groups, public utilities, government

agencies, local authorities, etc.

Dealing with credits

When a borrower approaches a bank for credit, a formal document is prepared on

behalf of potential borrowers. This document contains the principal terms and

conditions of loan, objectives of loan and details of the borrower.

Before launching syndication, the approached bank decides primarily, in consultation

with the borrower, on a strategy to be adopted, i.e. whether to approach a large market

or a restricted number of banks to form the syndicate. Each of the banks in syndicate

lends a part of the loan. The duration of this operation is normally about 6 to 8 weeks.

Several clauses may be introduced in the contract of debt:

Pari-passu clause that prevents the borrower from contracting new debts thatsubordinate the interest of lenders;

Exchange option clause that allows the withdrawal of a part or totality of loan in

another currency;

Negative guarantee clause that commits the borrower not to contract other debts

that subordinate the interest of lenders.


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Characteristics of credit

A major part (more than 80 %) of the debts is made in US dollars. The second (but far

behind) is Pound Sterling followed by Deutsch mark, Japanese yen, Swiss franc and

others.

Most of the syndicated debts are of the order of $50 million. As far as the upper limits

are concerned, amounts involved are of as high magnitude as $5 billion and more. In

1990, Euro tunnel borrowed $6.8 billion.

On an average, maturity periods are of about five years (in some cases it is about 20

years). The reimbursement of the loan may take place in one go (bullet) or in several

installments.

The interest rate on Euro debt is calculated with respect to a rate of reference,

increased by a margin (or spread). The rates are available and generally renewable

(roll over credit)every six months, fixed with reference to LIBOR. The LIBOR is the

rate of money market applicable to short-term credits among the banks of London.

The reference rate can equally be PIBOR at Paris and FIBOR at Frankfurt, etc. It is

revised regularly.

The margin depends on the supply and demand of the capital as also on the degreeof

the risk of these credits and the rating of borrowers. Financial institutions are in

vigorous competition. There is an active secondary market of Euro debts. Numerous

techniques allowbanks to sell their titles in this market.

3. Bond Market


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Euro Bond issue is one denominated in a particular currency but sold to investors in

national capital markets other than the country that issued the denominating currency.

An example is a Dutch borrower issuing DM-denominated bonds to investors in the

UK, Switzerland and the Netherlands.

The Eurobond market is the largest international bond market, which is said to have

originated in 1963 with an issue of Eurodollar bonds by Autos trade, an Italian

borrower. The market has since grown enormously in size and was worth about $ 428

billion in 1994.

bond markets in all currencies except the Japanese Yen are quite free from any

regulation by the respective governments. Straight bonds are priced with reference to

a benchmark, typically treasury issues. Thus a dollar bond will be priced to a yield a

YTM (Yield-to-Maturity) somewhat above the US treasury bonds of similar maturity,

the spread depending upon the borrowers ratings and market conditions.

Floatation costs of the bond are comparatively higher than costs indicated with

syndicated credits.

4. Commercial paper(CPs)

Commercial paper is a corporate short-term, unsecured promissory note issued on a

discount to yield basis. Commercial paper maturities generally do not exceed 270

days. Commercial paper represents a cheap and flexible source of funds While CPsare negotiable, secondary markets tend to be not very active since most investors hold

the paper to maturity.

The emergence of the Euro Commercial Paper (ECP) is much more recent. It evolved

as a natural culmination of the Note Issuance Facility and developed rapidly in an

environment of securitisation and disintermediation of traditional banking. CP has

also developed in the domestic segments of some European countries offering

attractive funding opportunities to resident entities.


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5. Certificate of Deposit (CDs)

A Certificate of Deposit (CD) is a negotiable instrument evidencing a deposit with a

bank. A CD is a marketable instrument so that the investor can dispose it off in the

secondary market whenever cash is needed. The final holder is paid the face value on

maturity along with the interest. It is used by the commercial banks as short- term

funding instruments.

Euro CDs are mainly issued in London by banks. Interest on CDs with maturity more

than a year is paid annually than semi-annually.

6. International Capital Markets

International Capital Markets have come into existence to cater to the need of

international financing by economies in the form of short, medium or long-term

securities or credits. These markets also called markets, are the markets on which

currencies, bonds, shares and bills are traded/exchanged. Over the years, there has

been a phenomenal growth both in volume and types of financial instruments

transacted in these markets. currency deposits are the deposits made in a bank,

situated outside the territory of the origin of currency. For example, dollar is a deposit

made in US dollars in a bank located outside the USA; banks are the banks in which

currencies are deposited. They have term deposits in currencies and offer credits in a

currency other than that of the country in which they are located.

A distinctive feature of the financial strategy of multinational companies is the wide

range of external services of funds that they use on an ongoing basis. British

Telecommunication offers stock in London, New York and Tokyo, while Swiss Bank

Corporation-, aided by Italian, Belgian, Canadian and German banks- helps


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corporations sell Swiss franc bonds in Europe and then swap the proceeds back into

US dollars.

Firms have three general sources of funds available: (i) internally generatedcash, (ii)

short-term external funds, and (iii) long-term external funds. External investment

comes in the form of debt or equity, which are generally negotiable (tradable)

instruments. The pattern of financing varies from country to country. Companies in

the UK get an average of 60-70% of their funds from internal sources. German

companies get about 40-50% of their funds from external suppliers. In 1975, Japanese

companies got more than 70% of their money from outside sources, but this patternhas since reversed; major chunks of finances come from internal sources.

Another significant aspect of financing behaviour is that debt accounts for the

overwhelming share of external finance. Industry sources of external finance also

differ widely from country to country. German and Japanese companies have relied

heavily on bank borrowing, while the US and British industry raised much more

money directly from financial markets by the sale of securities. However, in all

countries, bank borrowing is on a decline. There is a growing tendency for corporate

borrowing to take the form of negotiable securities issued in the public capital markets

rather than in the form of commercial bank loans. This process known as

securitisation is most pronounced among the Japanese companies.

7. Petro DollarDuring the oil crises of 1973, the Capital markets have played a very important role.

They accepted the dollar deposits from oil exporters and channeled the funds to the

borrowers in other countries. This is called recycling the petrodollars.

8. Junk Bonds


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A junk bond is issued by a corporation or municipality with a bad credit rating. In

exchange for the risk of lending money to a bond issuer with bad credit, the

issuer pays the investor a higher interest rate. "High-yield bond" is a nicer

name for junk bond The credit rating of a high yield bond is considered

"speculative" grade or below "investment grade". This means that the chance

of default with high yield bonds is higher than for other bonds. Their higher

credit risk means that "junk" bond yields are higher than bonds of better credit

quality. Studies have demonstrated that portfolios of high yield bonds have

higher returns than other bond portfolios, suggesting that the higher yields

more than compensate for their additional default risk.

Junk bonds became a common means for raising business capital in the 1980s, when

they were used to help finance the purchase of companies, especially by leveraged

buyouts, the sale of junk bonds continued to be used in the 1990s to generate capital

9. Samurai Bonds

They are publicly issued yen denominated bonds. They are issued by non-Japanese

entities.

The Japanese Ministry of Finance lays down the eligibility guidelines for potential

foreign borrowers. These specify the minimum rating, size of issue, maturity and so

forth. Floatation costs tend to be high. Pricing is done with respect to Long-term

Prime Rate.

Shibosai Bonds

They are private placement bonds with distribution limited to banks and institutions.

The eligibility criteria are less stringent but the MOF still maintains control.

Shogun / Geisha Bonds


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They are publicly floated bonds in a foreign currency while Geisha are their private

counterparts.

10. Yankee Bonds

These are dollar denominated bonds issued by foreign borrowers. It is the largest and

most active market in the world but potential borrowers must meet very stringent

disclosure, dual rating and other listing requirements, options like call and put can be

incorporated and there are no restrictions on size of the issue, maturity and so forth.

Yankee bonds can be offered under rule 144a of Sec. These issues are exempt from

elaborate registration and disclosure requirements but rating, while not mandatory is

helpful. Finally low rated or unrated borrowers can make private placements. Higher

yields have to be offered and the secondary market is very limited.

DESCRIPTIVE

1. Trace the development of the International Capital Markets

The financial revolution has been characterized by both a tremendous quantitative

expansion and an extraordinary qualitative transformation in the institutions,

instruments and regulatory structures.

Global financial markets are a relatively recent phenomenon. Prior to 1980, national

markets were largely independent of each other and financial intermediaries in each

country operated principally in that country. The foreign exchange market and the

Eurocurrency and Eurobond markets based in London were the only markets that

were truly global in their operations.


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Financial markets everywhere serve to facilitate transfer of resources from surplus

units (savers) to deficit units (borrowers), the former attempting to maximize the

return on their savings while the latter looking to minimize their borrowing costs. An

efficient financial market thus achieves an optimal allocation of surplus funds

between alternative uses. Healthy financial markets also offer the savers a range of

instruments enabling them to diversify their portfolios.

Globalization of financial markets during the eighties has been driven by two

underlying forces. Growing (and continually shifting) imbalance between savings and

investment within individual countries, reflected in their current account balances, has

necessitated massive cross-border financial flows. For instance, during the late

seventies, the massive surpluses of the OPEC countries had to be recycled, i.e. fed

back into the economies of oil importing nations. During the eighties, the large current

account deficits of the US had to be financed primarily from the mounting surpluses

in Japan and Germany. During the nineties, developing countries as a group have

experienced huge current account deficits and have also had to resort to international

financial markets to bridge the gap between incomes and expenditures, as the volume

of concessional aidfrom official bilateral and multilateral sources has fallen far short

of their perceived needs.

The other motive force is the increasing preference on the part of investors for

international diversification of their asset portfolios. This would result in gross cross-

border financial flows. Investigators have established that significant risk reduction is

possible via global diversification of portfolios.

These demand-side forces accompanied by liberalization and geographical

integration of financial markets has led to enormous growth in cross-border financial

transactions. In virtually all major industrial economies, significant deregulation of


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the financial markets has already been effected or is under way. Functional and

geographic restrictions on financial institutions, restrictions on the kind of securities

they can issue and hold in their portfolios, interest rate ceilings, barriers to foreign

entities accessing national markets as borrowers and lenders and to foreign financial

intermediaries offering various types of financial services have been already

dismantled or are being gradually eased away. Finally, the markets themselves have

proved to be highly innovative, responding rapidly to changing investor preferences

and increasingly complex needs of the borrowers by designing new instruments and

highly flexible risk management products.

The result of these processes has been the emergence of a vast, seamless global

financial market transcending national boundaries. But control and government

intervention have not entirely disappeared. E.g. South East Asia- Korea, Taiwan, etc-

permit only limited access to foreign investors. However, despite these reservations,

the dominant trend is towards globalization of financial markets.

International financial markets can develop anywhere, provided that local regulations

permit the market and potential users are attracted to it. The most important

international financial centers are London, Tokyo and New York. All the major

industrial countries have important domestic financial markets as well but only some

such as Germany and France are also important international financial centers. On the

other hand, even though some countries have relatively unimportant domestic

financial markets, they are important world financial centers such as Switzerland,Luxembourg, Singapore and Hong Kong.

International Capital Markets, also called Euro markets, are the markets on which

Euro currencies; Euro bonds, Euro equity and Euro bills are exchanged. International

financing in the form of short-, medium- or long-term securities or credits has become

necessary for the international economy. Financing techniques have diversified,

volumes dealt have increased and the process is continuing to grow.


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Notable developments in international capital markets can be traced to the end of

1950s. There are several reasons for their growth. The significant ones are:

Transfer of assets of erstwhile Soviet Union to Europe. In the 1950s and early

1960s, the former Soviet Union and Soviet-bloc countries sold gold and commodities

to raise hard currency. Because of anti-Soviet sentiment, these Communist countries

were afraid of depositing their US dollars in US banks for fear that the deposits could

be frozen or taken. Instead they deposited their dollars in a French Bank whose telex

address was Euro-Bank. Since that time, dollar deposits outside the US have been

called Eurodollars and banks accepting Eurocurrency deposits have been called Euro

banks. International capital markets subsequently came to be known as Euro markets.

Restrictive measures taken by the administration. Several regulatory measures

(initiated particularly in the USA) also contributed (in an indirect manner) to the

development of International capital markets. The important ones are as follows:

Regulation 'Q'. In 1960, Regulation 'Q' in the USA fixed a ceiling on interest rates

offered by American banks on term deposits and prohibited them to remunerate the

deposits whose term was less than 30 days. Besides, at the end of the 1960s, the

Federal Reserve reduced the growth of total monetary mass. The money market ratewent up. American banks borrowed on the Euro dollar market, which resulted in:

The increase of indebtedness of these banks on the Euro dollar market;

The flight of American Capital, attracted by the interest rate on Euro market.


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Tax of interest equalization. In 1963, tax was imposed on the purchase of foreign

securities (portfolio investments) by American residents. The objective was to reduce

the deficit of BOP of the USA and to establish equilibrium in international structure of

interest rates. In fact, in order to avoid tax payment, some companies launched the

issue of dollar bonds outside the USA. This contributed to the growth of Euro dollar

market. Realizing its adverse effects, subsequently, the tax was withdrawn in 1974.

Program of voluntary restrictions on investments. The USA initiated/imposed various

restrictions on its financial system to tackle BOP problems. For instance, banks were

directed not to lend or invest in foreign operations beyond the limits of thepreviousyear(s). As a result, the business community felt a scarcity of funds. This in turn led

them to take recourse to the Euro dollar market.

Differential of American lending and borrowing rates. The interest rate paid by

American banks was low, vis--vis, the expected rate from borrowers. European

banks availed of this opportunity; they offered higher rates of interest at the cost of

contenting themselves with smaller margins than those offered by American banks, to

attract investors. They could do so by operating on Euro dollar markets, which were

not subject to interest-rate and other regulations. For instance, banks were neither

constrained to respect a certain compulsory reserve ratio on their deposits in Euro

dollars nor constrained to maintain their interest rates below a certain ceiling.

There may be other reasons as well for development of Euro dollars. Globalization of

big multinationals has further boosted this development. The financing system

practiced hitherto also was not able to respond to capital needs of the international

economy.

Indian entities began accessing external capital markets towards the end of the

seventies as gradually the amount of concessional assistance became inadequate to


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meet the increasing needs of the economy. The initial forays were low-key. The pace

accelerated around mid-eighties, but even the authorities adopted a selective approach

and permitted only a few select banks, all India financial institutions and large public

and private sector companies to access the market. After liberalization, during 1993-

94 there was a sharp increase in the amount of funds raised by corporate entities form

the global debt and equity markets.

Indias borrowings have mainly been by way of syndicated bank loans, buyers credits

and lines of credits. Other instruments such as foreign and Euro bonds have been

employed less frequently though a number of companies made issues of Euroconvertible bonds after 1993. Prior to that only apex financial institutions and the

public sector giant ONGC had tapped the German, Swiss, Japanese, and Euro dollar

bond markets. Throughout the eighties, there was a steady improvement in the

markets perception of the creditworthiness of Indian borrowers (manifested in the

steady decline in the spreads they had to pay over LIBOR in the case of Euro loans).

The 1990-91 crisis sent Indias sovereign rating below investment grade and the

foreign debt markets virtually dried up to be opened up again after 1993.

2. Describe the mechanism of the Euro Bond Market.

Bond: issue is one denominated in a particular currency but sold to investors in


An example is a Dutch borrower issuing DM-denominated bonds to investors in theUK, Switzerland and the Netherlands.

The bond market is the largest international bond market, which is said to have

originated in 1963 with an issue of Eurodollar bonds by Autostrade, an Italian

borrower. The market has since grown enormously in size and was worth about $ 428

billion in 1994.


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bond markets in all currencies except the Japanese Yen are quite free from any

regulation by the respective governments.

Straight bonds are priced with reference to a benchmark, typically treasury issues.

Thus a Eurodollar bond will be priced to a yield a YTM (Yield-to-Maturity)

somewhat above the US treasury bonds of similar maturity, the spread depending

upon the borrowers ratings and market conditions.

Floatation costs of the Eurobond are comparatively higher than costs indicated with

syndicated Eurocredits.

Primary market: A borrower desiring to raise funds by issuing Euro bonds to the

investing public will contact an investment banker and ask it to serve as

lead manager of an underwriting syndicate that will bring the bonds to

market. The underwriting syndicate is a group of investment banks,

merchant banks, and the merchant banking arms of commercial banks

that specialize in some phase of public issuance. The lead manager will

usually invite co managers to form a managing group to help negotiate

terms with the borrower, ascertain market conditions and manage the

issuance.

The managing group along with other banks, will serve as underwriters for the issue,

that is, they will commit their own capital to buy the issue from the borrower at a

discount from the issue price, if they are unable to place the bonds with investors. The

discount or the underwriting spread is typically in the 2 or 2.5% range. Most of the


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underwriters along with other banks will be a part of the placement or selling group

that sells the bonds to the investing public.

The total elapsed time from the decision date of the borrower to issue Eurobonds until

net proceeds from the sale are received is typically 5 to 6 weeks.

The lead manager prepares a preliminary prospectus focusing on economic and

financial characteristics of the project and financial standing of the borrower.

After having consulted a certain number of banks, the lead manager decides on the

interest rate. Subsequently, the issue price is fixed. Clauses of reimbursement before

maturity are provided for. After, the issue advertising is done in International Press in

the form of tombstone. This tombstone indicates the lead manager, co-lead managers

and members of the guarantee syndicate.

Secondary Market: bonds purchased in the primary market can be resold before their

maturities in the secondary market. The secondary market is an over the counter

market with principal trading in London. However, important trading is also done in

other major European cities. The bonds are quoted in percentage of their value,

without taking into account the coupon already running.

The secondary market comprises of market makers and brokers. Market makers stand

ready to buy or sell for their own account by quoting a two way bid and ask prices.

Market traders trade directly with one another, through a broker, or with retail

customers. The bid-ask is their only profit. Brokers accept buy or sell orders from

market makers and then attempt to find a matching party for the other side of the


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trade; they may also trade for their own account. Brokers charge a small commission

to the market makers that engaged them. They do not deal directly with retail clients.

Extra Information

What is a bond?

A bond is a loan and you are the lender. The borrower is usually the government, a

state, a local municipality or a big company like General Motors. All of these entities

need money to operate -- to fund the federal deficit, for instance, or to build roads and

finance factories -- so they borrow capital from the public by issuing bonds.

When a bond is issued, the price you pay is known as its "face value." Once you buy

it, the issuer promises to pay you back on a particular day -- the "maturity date" -- at a

predetermined rate of interest -- the "coupon." Say, for instance, you buy a bond with

a $1,000 face value, a 5% coupon and a 10-year maturity. You would collect interest

payments totaling $50 in each of those 10 years. When the decade was up, you'd get

back your $1,000 and walk away.

A key difference between stocks and bonds is that stocks make no promises about

dividends or returns. General Electric's dividend may be as regular as a heartbeat, but

the company is under no obligation to pay it. And while GE stock spends most of its

time moving upward, it has been known to spend months -- even years -- going the

other way.

When GE issues a bond, however, the company guarantees to pay back your principal

(the face value) plus interest. If you buy the bond and hold it to maturity, you know

exactly how much you're going to get back (in most cases, anyway). That's why bondsare also known as "fixed-income" investments -- they assure you a steady payout or


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yearly income. And although they can carry plenty of risk, this regular income is what

makes them inherently less volatile than stocks.

Global Bond: They have a minimum value of $1 billion and are effected

simultaneously in Europe, America and Asia. The salient features of these bonds are

that they permit to raise very high amounts. They offer very high liquidity since they

are quoted on several exchanges while secondary market functions round the clock,

with uniform price all over the world. They are especially used by governments,

public enterprises, international organisations and private financial institutions.

External Bond Market: The external bond market refers to bond trading activity

wherein the bonds are underwritten by an international syndicate, are offered in

several countries simultaneously, are issued outside any country's jurisdiction, and are

not registered. The Eurobond market is a major external bond market. The external

bond market combined with the internal bond market comprises the global bond

market. Examples of an external bond are the "global bond," issued by the World

Bank, and Eurodollar bonds.

Internal Bond Market: The internal bond market refers to all bond trading activity in a

given country and is comprised of both a domestic bond market and a foreign bond

market. Also referred to as the "national bond market." The internal and external bond

markets comprise the global bond market

Bulldog Bonds: A sterling denominated foreign bond, priced with reference to the UK

gilts.

Rembrandt Bond: Denominated in the Dutch guilder.

(For more information, please refer to page 504-505 in P G Apte)


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3. What are the different international financial markets?

The international financial markets consist of the credit market, money market, bond

market and equity market.

The international credit market, also called Euro credit market, is the market that deals

in medium term Euro credit or Euro loans.

International banks and their clients comprise the Eurocurrency market and form the

core of the international money market. There are several other money market

instruments such as the Euro Commercial Paper (ECP) and the Euro Certificate of

Deposit (ECD).

Foreign bonds and Eurobonds comprise the international bond market. There are

several types of bonds such as floating rate bonds, zero coupon bonds, deep discount

bonds, etc.

The international equity market tells us how ownership in publicly owned

corporations is traded throughout the world. This comprises both, the primary sale of

new common stock by corporations to initial investors and how previously issued

common stock is traded between investors in the secondary markets.

International Financial Market- (general- can be used in any)


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The last two decades have witnessed the emergence of a vast financial market across

national boundaries enabling massive cross-border capital flows from those who have

surplus funds and a search of high returns to those seeking low-cost funding. The

degree of mobility of capital, the global dispersal of the finance industry and the

enormous diversity of markets and instruments, which a firm seeking funds can tap, is

something new.

Major OECD (Organization for Economic Co-operation and Development) countries

had began deregulating and liberalizing their financial markets towards the end of

seventies. While the process was far from smooth, the overall trend was in thedirection ofrelaxation of controls, which till then had compartmentalized the global

financial markets. Exchange and capital controls were gradually removed, non-

residents were allowed freer access to national capital markets and foreign banks and

financial institutions were permitted to establish their presence in the various national

markets.

While opening up of the domestic markets began only around the end of seventies, a

truly international financial market had already been born in the mid-fifties and

gradually grown in size and scope during sixties and seventies. This refers to the Euro

currencies Marketwhere borrower (investor) from country A could raise (place) funds

from (with) financial institutions located in country B, denominated in the currency of

country C. During the eighties and nineties, this market grew further in size,

geographical scope and diversity of funding instruments. It is no more a "euro" marketbut a part of the general category called offshore markets.

Alongside liberalization, other qualitative changes have been taking place in the

global financial markets. Removal of restrictions has resulted into geographical

integration of the major financial markets in the OECD countries. Gradually this trend

is spreading to developing countries many of which have opened up their markets-at

least partially-to non-resident investors, borrowers and financial institutions.


28/40

Another noticeable trend is functional integration. The traditional distinctions

between different financial institutions-commercial banks, investment banks, finance

companies, etc.- are giving way to diversified entities that offer the full range of

financial services. The early part of eighties saw the process of disintermediation get

underway. Highly rated issuers began approaching investors directly rather than going

through the bank loan route.

On the other side, debt crisis in the developing countries, adoption of capital adequacy

norms and intense competition, forced commercial banks to realize that their

traditional business of accepting deposits and making loans was not enough to

guarantee their long-term survival and growth. They began looking for new products

and markets. Concurrently, the international financial environment was becoming

more volatile- there were fluctuations in interest and exchange rates. These forces

gave rise to innovative forms of funding instruments and tremendous advances in risk

management. The decade saw increasing activity in and sophistication of the

derivatives market, whichhad begun emerging in the seventies.

Taken together, these developments have given rise to a globally integrated financial

marketplace in which entities in need of short- or long-term funding have a much

wider choice than before in terms of market segment, maturity, currency of

denomination, interest rate basis, incorporating special features and so forth. The same

flexibility is available to investors to structure their portfolios in line with their risk-

return tradeoffs and expectations regarding interest rates, exchange rates, stock

markets andcommodity prices.

4. List out the growth and functions of currency markets


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While opening up of the domestic markets began only around the end of seventies, a

truly international financial market had already been born in the mid-fifties and

gradually grown in size and scope during sixties and seventies. This refers to the well-

known Eurocurrencies Market. It is the largest offshore market.

Prior to 1980, Eurocurrencies market was the only truly international financial market

of any significance. It is mainly an inter-bank market trading in time deposits and

various debt instruments. What matters is the location of the bank neither the

ownership of the bank nor ownership of the deposit. The prefix "Euro" is now

outdated since such deposits and loans are regularly traded outside Europe.

Over the years, these markets have evolved a variety of instruments other than time

deposits and short-term loans, e.g. certificates of deposit (CDs), euro commercial

paper (ECP), medium- to long- term floating rate loans, eurobonds, floating rate notes

and euro medium-term notes (EMTNs).

The difference between markets and their domestic counterparts is one of regulation.

Eurobonds are free from rating and a disclosure requirement applicable to many

domestic issues as well as registration with securities exchange authorities.

Emergence of Euro markets:

1. During the 1950s, the erstwhile USSR was earning dollars from the sale of gold

and other commodities and wanted to use them to buy grain and other products

from the West, mainly from the US. However, they did not want to keep these

dollars on deposit with banks in New York, as they were apprehensive that the USgovernment might freeze the deposits if the cold war intensified. They approached


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banks in Britain and France who accepted these dollar deposits and invested them

partly in US.

2. Domestic banks in US (as in many other countries) were subjected to reserve

requirements, which meant that a part of their deposits were locked up in

relatively low yielding assets.

3. The importance of the dollar as a vehicle currency in international trade and

finance increased, so many European corporations had cash flows in dollars and

hence temporary dollar surpluses. Due to distance and time zone problems as well

as their greater familiarity with European banks, these companies preferred to

keep their surplus dollars in European banks, a choice made more attractive by thehigher rates offered by Euro banks.

The mainfactors behind the emergence and strong growth of the Eurodollar markets

were the regulations on borrowers and lenders imposed by the US authorities which

motivated both banks and borrowers to evolve Eurodollar deposits and loans. Added

to this are the considerations mentioned above, viz. the ability of Euro banks to offer

better rates both to the depositors and the borrowers and convenience of dealing with

a bank that is closer to home, who is familiar with business culture and practices in

Europe.

SHORT NOTES

1. Participants in International Project Financing a) Sponsors b) Lenders

Sponsors


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These are partners in the project who bring in the equity capital or risk capital. Being

so, they are keenly interested in the successful completion of the project and shoulder

major responsibilities as regards its execution. The fact that they bring in the equity

capital is an indication of their interest. Also the amount of equity that they bring has

a marked bearing on the extent of debt that can be raised for the project.

Sometimes people who bring in the equity capital are just the initiators of the project.

Included in this category are multinational firms, future buyers of products or services

of the project, the public or private investors, international organisations, development

banks etc.

Lenders

They bring in the debt capital. Financing of a big project necessitates intervention of a

banking pool consortium composed of banks, national or international financial

institutions, export financing institutions etc.

Guarantors

Guarantees maybe provided by banks, public financing organisations, international

financial institutions, private insurance companies etc.

Project Operators

An operating company intervenes in the erection of the project. It brings its

organisational know-how to manage the project.


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2. Risks associated with international projects- financial, political, others

1. Financial risk

In general, international projects are prone to greater financial risk as a bulk of finance

is in the form of debt. The major factors affecting financial risk are degree of

indebtedness, the terms and conditions of repayment of debt and currency used.

Some projects will have expenses and revenues that involve several currencies. As aresult the exchange rate risk is very high.

Projects maybe financed with floating rates. In view of the volatility observed on the

rates like LIBOR, the interest rate risk is also significant. Therefore it is

necessary to plan the coverage of all these risks.

2. Foreign Exchange Risk

As corporations expand their international activities, they begin to acquire foreign

assets and foreign liabilities. As exchange rates change, the values of these foreign

assets and liabilities change accordingly. For a corporation, exchange rate risk is the

sensitivity of the value of the corporation when the exchange rates change. Obviously,

the change in the corporation value is related to the net change in the values of the

foreign assets and foreign liabilities. (E.g. foreign direct investment, foreign exchange

loss, sales and income from foreign sources.)

3. Economic Risk

Economic risk is risk created by changes in the economy. Typically, it is related to

technological changes, the actions of competitors, shifts in consumer preferences, etc.


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Ideally, a pure domestic firm is affected only by domestic economic conditions - the

domestic economic risk. However, in today's integrated world economy, the concept

of a pure domestic firm has less practical relevance. Many firms that appear strictly

pure domestic confront foreign economic risk indirectly. (E.g.: local restaurant/dept

store, real estate agent)

4. Political Risk

Political risk is risk created by political changes or instability in a country. These

factors include, but are not limited to, nationalization, confiscation, price controls,

foreign exchange and capital controls, administrative hurdles, uncertain property

rights, discriminative or arbitrary regulations on business practices (hiring, contract

negotiation), civil wars, riots, terrorism, etc. Each country in the world presents a

different political profile and represents a unique source of political risk that firms

must assess and manage when they make foreign investments.

In order to minimize this risk, local investors or the local government may be

associated with the project. Insurance against political risk is another useful technique

recommended for the purpose.

What constitutes political risk and how to measure it?

The political risk management typically involves:

- Identifying political risk and its likely consequences

- Developing policies in advance to cope with the possibility of political risk

- Strengthening a firm's bargaining position

- Devising measures to maximize compensation in the event of expropriation


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Country Risk: It refers to elements of risk inherent in doing business in the economic,

social, and political environment of another country.

5. Counter party Risk - The risk that a counter party will default on a financial

obligation.

6. Liquidity Risk -The risk that a financial position cannot be sold quickly at

prevailing prices.

7. Delivery Risk - The risk that a buyer will not deliver payment of funds after a

seller has delivered securities or foreign exchange that were purchased.

8. Rollover Risk - The risk of being closed out from a financial market and unable

to renew (or roll over) a short-term contract.

9. Other risks - Other risks relate to the risk of cost overruns and bad management.

3. Financing of MNCs in local or international market


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Project financing may be defined as financing of an economic unit, legally

independent, created with a view to setting up of a big project, which is commercially

profitable and financially viable.

Project is considered as a distinct legal entity and is financed, to a marked extent, by

debt (65 to 75 percent). Therefore the risk to be borne is substantial.

There are two major methods of financing international projects:

1. Financing with total risk borne by lenders where only the future cashflows ensure

the reimbursement of the loan. This method of financing was used in petroleum

and gas industry in the USA and Canada. Due to increased level of risks, this

method of project financing is generally not preferred.

2. In another type of financing, both the lender and the promoter share the risk. The

problem sometimes encountered in this method is to decide the proportion in

which the risk is to be shared between two parties.

Domestic v/s offshore markets

Financial assets and liabilities denominated in a particular currency - say the Swiss

Franc - are traded are primarily in the national financial markets of that country.

These financial markets are known as Domestic Markets.


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In case of many convertible currencies they are traded in the financial markets outside

the country of that currency. These financial markets are known as Offshore

Markets.

While it is true that neither both markets will offer both the financing options nor any

entity can access all segments of a particular market, it is true generally that a given

entity has an access to both the segments of the markets for placing as well as raising

funds.

There are theories by experts that suggest that there are no two types of financial

markets (viz. Domestic and offshore markets) but everything is a part of single

Global Financial Market.

Similarity

Experts suggest that arbitrage will ensure that both these markets will be closely

linked together in terms ofcosts of funding and returns on assets.

Differences

Both of these markets significantly differ on the Regulatory dimension. Major

segments of the domestic markets are subject to strict supervision by the relevant

authorities such as SEC in US, Ministry of Finance in Japan and the Swiss National

Bank in Switzerland. These authorities regulate foreign (non-resident) entities access

to the public capital markets in their countries by laying down eligibility criteria,

disclosure & accounting norms and registration & rating requirements (similarly for

domestic banks, reserve requirements and deposit insurance).


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Over the years, these markets have evolved a variety of instruments other than time

deposits and short-term loans, e.g. certificates of deposit (CDs), euro commercial

paper (ECP), medium- to long- term floating rate loans, eurobonds, floating rate notes

and euro medium-term notes (EMTNs).

The mainfactors behind the emergence and strong growth of the Eurodollar markets

were the regulations on borrowers and lenders imposed by the US authorities which

motivated both banks and borrowers to evolve Eurodollar deposits and loans. Added

to this are the considerations mentioned above, viz. the ability of euro banks to offer

better rates both to the depositors and the borrowers and convenience of dealing witha bank that is closer to home, who is familiar with business culture and practices in

Europe.

5. External Bond Market

The external bond market refers to bond trading activity wherein the bonds are

underwritten by an international syndicate, are offered in several countries

simultaneously, are issued outside any country's jurisdiction, and are not registered.

The Eurobond market is a major external bond market. The external bond market

combined with the internal bond market comprises the global bond market. Examples

of an external bond are the "global bond," issued by the World Bank, and Eurodollar

bonds.

The External Bond Market comprises of the :

Foreign Bond Market and

Bond Market


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Foreign Bond: issue is one offered by a foreign borrower to the investors in a national

capital market and denominated in that nations currency. An example is German

MNC issuing dollar denominated bonds to the U.S. investors.

Bond: issue is one denominated in a particular currency but sold to investors in


An example is a Dutch borrower issuing DM-denominated bonds to investors in the

UK, Switzerland and the Netherlands.


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References

T.E. Copeland, J.F. Weston (1988): Financial Theory and Corporate Policy,

Addison-Wesley, West Sussex (ISBN 978-0321223531)

E.J. Elton, M.J. Gruber, S.J. Brown, W.N. Goetzmann (2003): Modern

Portfolio Theory and Investment Analysis, John Wiley & Sons, New York

(ISBN 978-0470050828)

E.F. Fama (1976): Foundations of Finance, Basic Books Inc., New York

(ISBN 978-0465024995)

Marc M. Groz (2009): Forbes Guide to the Markets, John Wiley & Sons, Inc.,

New York (ISBN 978-0470463383)

R.C. Merton (1992): Continuous-Time Finance, Blackwell Publishers Inc.

(ISBN 978-0631185086)

Keith Pilbeam (2010) Finance and Financial Markets, Palgrave (ISBN 978-

0230233218)

Steven Valdez, An Introduction To Global Financial Markets, Macmillan

Press Ltd. (ISBN 0-333-76447-1)

The Business Finance Market: A Survey, Industrial Systems Research

Publications, Manchester (UK), new edition 2002 (ISBN 978-0-906321-19-5)

Notes

1. ^ Steven Valdez,An Introduction To Global Financial Markets
http://en.wikipedia.org/wiki/Special:BookSources/9780321223531http://en.wikipedia.org/wiki/Special:BookSources/9780470050828http://en.wikipedia.org/wiki/Special:BookSources/9780465024995http://en.wikipedia.org/wiki/Special:BookSources/9780470463383http://en.wikipedia.org/wiki/Special:BookSources/9780631185086http://en.wikipedia.org/wiki/Special:BookSources/9780230233218http://en.wikipedia.org/wiki/Special:BookSources/9780230233218http://en.wikipedia.org/wiki/Special:BookSources/0333764471http://en.wikipedia.org/wiki/Special:BookSources/9780906321195http://en.wikipedia.org/wiki/Financial_market#cite_ref-0http://en.wikipedia.org/wiki/Special:BookSources/9780321223531http://en.wikipedia.org/wiki/Special:BookSources/9780470050828http://en.wikipedia.org/wiki/Special:BookSources/9780465024995http://en.wikipedia.org/wiki/Special:BookSources/9780470463383http://en.wikipedia.org/wiki/Special:BookSources/9780631185086http://en.wikipedia.org/wiki/Special:BookSources/9780230233218http://en.wikipedia.org/wiki/Special:BookSources/9780230233218http://en.wikipedia.org/wiki/Special:BookSources/0333764471http://en.wikipedia.org/wiki/Special:BookSources/9780906321195http://en.wikipedia.org/wiki/Financial_market#cite_ref-0

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16613709 International Financial Markets