International Financial Markets

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International Financial Markets

Text of International Financial Markets

International financial marketsThis chapter provided a general profile of the markets and instruments that currently exist for facilitating financial capital flows among nations. International bank lending and international transactions in bonds and stocks are now of huge size and take place in financial centers worldwide. Within these markets, a wide variety of specific instruments, including many different kinds of derivatives, has emerged. These instruments enable international investors, particularly in eurocurrency markets, to unbundle the various aspects of risk associated with the instruments in order to better distribute and hedge the risks. A key aspect of modern lending technology is the ability to separate the currency of denomination of a particular financial instrument from its respective jurisdiction. Thus, the characteristics of a eurocurrency instrument can be separated or unbundled and repackaged in a manner that is more profitable and/or contains a risk profile that is more suitable to the individual investor. The wide array of instruments for dealing with the risk associated with exchange rates, interest rates, and equity prices clearly appears to be playing an important role in improving the efficiency of rapidly globalizing international financial markets.

Types of financial markets[edit]Within the financial sector, the term "financial markets" is often used to refer just to the markets that are used to raise finance: for long term finance, theCapital markets; for short term finance, theMoney markets. Another common use of the term is as a catchall for all the markets in the financial sector, as per examples in the breakdown below. Capital marketswhich consist of: Stock markets, which provide financing through the issuance of shares orcommon stock, and enable the subsequent trading thereof. 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 offinancialrisk. Futures markets, which provide standardizedforward contractsfor trading products at some future date; see alsoforward market. Insurance markets, which facilitate the redistribution of various risks. Foreign exchange markets, which facilitate the trading offoreign exchange.Thecapital marketsmay also be divided intoprimary marketsandsecondary markets. Newly formed (issued) securities are bought or sold in primary markets, such as duringinitial public offerings. Secondary markets allow investors to buy and sell existing securities. The transactions in primary markets exist between issuers and investors, while in secondary market transactions exist among investors.Liquidity is a crucial aspect of securities that are traded in secondary markets. Liquidity refers to the ease with which a security can be sold without a loss of value. Securities with an active secondary market mean that there are many buyers and sellers at a given point in time. Investors benefit fromliquid securitiesbecause they can sell their assets whenever they want; an illiquid security may force the seller to get rid of their asset at a large discount.

Paris Europlace,International Financial Forum in Tokyo 27 november 2007Globalisation of capital marketsSpeech by Christian NoyerGovernor of the Banque de FranceLadies and gentlemen,It is a great honour and a pleasure for me to speak before such a distinguished audience and I amdelighted to be in Tokyo today. In the last decades, global economic growth, financial innovation andfinancial globalisation have progressed hand in hand. This does not exclude, of course, challengingepisodes of stress, such as the current one.Financial globalisation is not a new phenomenon, but the scale and speed of the current phase ofglobalisation is unprecedented; cross-border and cross-market links are deeper than ever before.Events are still unfolding, but the dynamics of the current crisis has been a live experiment of howglobalisation has modified the reaction of the financial system to shocks. The magnitude of possiblelosses is, in many respects, contained. Current estimates put the direct cost of subprime defaults ataround 250 billions USD. It is significant but bearable, especially starting from a point of veryfavourable economic conditions and high profitability.Still, what began as a sound correction of the undervaluation of risks in the subprime market unravelsas one of the major financial crisis of the past 10 years. Some scenarios considered as very remotecrystallised on a large scale, while widely expected break-up points held up well. Hedge funds, onceconsidered as a source of systemic risk, fared better than regulated institutions. The inter-bank market,traditionally the most liquid and efficient of all markets, has experienced serious dislocation, whileequity markets were relatively unscathed. The spreading of defiant expectations from the subprime USmarket to other segments, other institutions and other regions has been unexpected, asymmetric and2/5disconnected from the magnitude of the initial shock. It invites us to revisit our reading ofglobalisation and contagion in the light of current events.The ongoing financial globalisation is underpinned by three main drivers, each of them strengtheningthe two others.The first driver, and probably the strongest, is financial innovation. Supported by technologicalprogress, financial innovation has fostered the emergence of new financial products and services,resulting in more complete financial markets. Thanks to advances in financial technology, it is nowpossible to break up the risk of an asset into its constituent parts and to recombine them as wished, tofit a specific investors risk profile. The emergence of derivatives, combined with the appropriatemathematical tools to price them, has greatly expanded the range of tradable risks, opening up newand vast horizons for hedging strategies. Financial institutions are able to actively manage theirexposures and reallocate certain risks to those players that are most able to bear them. Overall,investors are more willing to invest across borders, knowing that they can reach an improved riskreturntrade-off.Simultaneously, economies are becoming more open financially, especially in the emergingworld. The growth of international capital flows is the consequence both of domestic policies andglobal factors. Domestically, financial liberalisation and deregulation have relaxed investmentrestrictions. More flexible exchange rate policies, liberalisation of capital accounts, the opening ofdomestic stock markets to foreign investors as well as investor-friendly policies help to attractforeign investors. Global factors have also played a role, with the abundant global liquidityenvironment as well as the decrease in home bias. By way of example, non-residents currently hold46% of French market capitalisation and slightly more than 50% of French government bonds.A third driver is the emergence of global financial players, such as large banks, hedge funds,private equity funds and more recently sovereign wealth funds. They all share common characteristics:- They play an important role in fostering market efficiency, and provide liquidity to capitalmarkets;- They use sophisticated investment strategies;- They implement advanced risk management practices, and help to spread them across marketsand countries.3/5However, because of their sheer size and potential impact on market equilibria, they raise someconcerns of transparency as well as questions about their role in fostering, or not, financial stability.Those issues warrant being debated.What are the consequences of the financial globalisation currently underway for global capitalmarkets? They are well known, so I will just highlight two of them.First, globalisation increases the efficiency of financial markets.Thanks to financial globalisation and technological progress, informational efficiency of capitalmarkets has increased over the past few decades. Any new available information is accuratelyprocessed and impounded in asset prices, leading to more accurate pricing of assets and risks. And thepermanent quest for arbitrage opportunities has fostered cross-market and cross-border strategies alsoleading to more consistent pricing.Allocative efficiency, that is the markets ability to allocate resources in a way that maximises thewelfare attained through their use, has also improved: for a given investor, there is a wider and morediversified range of investment opportunities than ever before.Operational efficiency has so far gained from globalisation, since the cost of financial operations hasquickly fallen, due to productivity gains in the financial sector stemming from the scale and scope ofeconomies and the intense competition between markets and intermediaries.Nevertheless, this overall trend towards efficiency occasionally bumps into puzzles that are not readilyexplained by economic theory. For instance, the longstanding question as to why capital does not flow,in net terms, from rich to poor countries has not yet been clarified since it was first addressed byRobert Lucas. It has recently been supplemented by the so-called allocation puzzle, highlighting thefact that capital seems to flow toward economies with relatively low investment rates. Convincingexplanations for these puzzles certainly require taking into account market imperfections (such ascredit constraints), differences in financial infrastructures as well as growth externalities (such ashuman capital).Another salient feature of financial globalisation is the rapid maturing of emerging economiesand markets. In 2007 and 2008, the IMF expects emerging countries to account for more than half ofworld economic growth. The same positive trend is reflected in their financ