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International International Financial MarketsFinancial Markets
Copyright © 2014 Pearson Education, Inc.
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9 - 2Copyright © 2014 Pearson Education, Inc.
Chapter ObjectivesChapter Objectives
• Discuss the purposes, development, and financial centers of the international capital market
• Describe the international bond, international equity, and Eurocurrency markets
• Discuss the four primary functions of the foreign exchange market
• Explain how currencies are quoted and the different rates that are given
• Identify the main instruments and institutions of the foreign exchange market
• Explain why and how governments restrict currency convertibility
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NintendoNintendo
• Exchange rates affect financial performance• Convert foreign earnings into home currency• Rising home currency means lower earnings
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Capital MarketCapital Market
System that allocates financial resourcesaccording to their most efficient uses
Debt: Repay principal plus interest Bond has timed principal & interest payments
Equity: Part ownership of a company Stock shares in financial gains or losses
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International Capital MarketInternational Capital Market
Network of people, firms, financial institutions, and governments borrowing and investing internationally
Borrowers Expands money supply Reduces cost of money
Borrowers Expands money supply Reduces cost of money
Lenders Spread / reduce risk Offset gains / losses
Lenders Spread / reduce risk Offset gains / losses
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International CapitalInternational CapitalMarket DriversMarket Drivers
Information technology
Deregulation
Financial instruments
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Country or territorywhose financial sector
features few regulationsand few, if any, taxes
Country or territorywhose financial sector
features few regulationsand few, if any, taxes
Operational centerExtensive financial activity
and currency trading
Operational centerExtensive financial activity
and currency trading
Booking centerMostly for bookkeeping
and tax purposes
Booking centerMostly for bookkeeping
and tax purposes
Offshore Financial CentersOffshore Financial Centers
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Discussion QuestionDiscussion Question
What key factors are driving growth of the international capital market?
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Answer to Discussion Answer to Discussion QuestionQuestion
Information technology is reducing the costs of global communication. Deregulation increases competition, lowers the cost of financial transactions, and opens national markets to global investing and borrowing. Innovative financial instruments expand the options available to lenders and borrowers.
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International Bond MarketInternational Bond Market
Foreign bond Interest ratesEurobond
Bond that is issued outside the country in whose currency the bond is denominated
Bond sold outside a borrower’s country and denominated in the currency of the country in which it is sold
Driving growth are differential interest rates between developed and developing nations
Market of bonds sold by issuing companies, governments, and others outside their own countries
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International Equity MarketInternational Equity Market
Market of stocks bought and sold outsidethe issuer’s home country
PrivatizationPrivatization
Investment banksInvestment banks
Emerging marketsEmerging markets
Electronic marketsElectronic markets
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Governments Commercial banks International companies Wealthy individuals
Eurocurrency MarketEurocurrency Market
Unregulated market of currencies banked outside
their countries of origin
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Foreign Exchange MarketForeign Exchange Market
Conversion: To facilitate transactions, invest directly abroad, or repatriate profits
Hedging: Insure against potential losses from adverse exchange-rate changes
Arbitrage: Instantaneous purchase and sale of a currency in different markets for profit
Speculation: Sequential purchase and sale (or vice-versa) of a currency for profit
Market in which currencies are bought and sold and their prices are determined
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Largest Currency MarketsLargest Currency Markets
UK:$1.33 trillion
US:$0.62 trillion
Japan:$0.24 trillion Source: */Kyodo/NewscomSource: */Kyodo/Newscom
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Discussion QuestionDiscussion Question
Using the foreign exchange market to insure against potential losses from adverse changes in exchange rates is called currency __________.
a. Arbitrage
b. Hedging
c. Speculation
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Answer to Discussion Answer to Discussion QuestionQuestion
Using the foreign exchange market to insure against potential losses from adverse changes in exchange rates is called currency __________.
a. Arbitrage
b. Hedging
c. Speculation
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Quoting CurrenciesQuoting Currencies
Quoted currency = numeratorBase currency = denominatorQuoted currency = numeratorBase currency = denominator
(¥/$) = Japanese yen needed to buy one U.S. dollar(¥/$) = Japanese yen needed to buy one U.S. dollar
Yen is quoted currency, dollar is base currencyYen is quoted currency, dollar is base currency
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Currency ValuesCurrency Values
Change in U.S. dollar against Norwegian
krone
February 1: NOK 5/$ March 1: NOK 4/$
%change = [(4-5)/5] x 100 = -20%
U.S. dollar fell 20%
Change in Norwegian krone against U.S. dollar
Make krone base currency (1÷ NOK/$) February 1: $.20/NOK March 1: $.25/NOK
%change = [(.25-.20)/.20] x 100 = 25%
Norwegian krone rose 25%
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Cross RateCross Rate
• Exchange rate calculated using two other exchange rates• Use direct or indirect exchange rates against a third currency
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Cross Rate ExampleCross Rate Example
Direct quote method
1) Quote on euro = € 0.7883/$2) Quote on yen = ¥ 84.3770/$3) € 0.7883/$ ÷ ¥ 84.3770/$ = € 0.0093/¥4) Costs 0.0093 euros to buy 1 yen
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Spot RateSpot Rate
Exchange rate requiring deliveryExchange rate requiring deliveryof traded currency within two business daysof traded currency within two business days
Repatriate incomeRepatriate incomefrom sales abroadfrom sales abroad
Invest in anotherInvest in anothernational marketnational market
Pay supplier inPay supplier inits own currencyits own currency
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Forward RateForward Rate
Rate at which two parties will exchangecurrencies on a specified future date
Forward Contracts
Reduce exchange-rate risk
30, 90, 180 days or custom lengths
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Currency swapSimultaneous purchase and sale of foreign exchange
for two different dates
Currency swapSimultaneous purchase and sale of foreign exchange
for two different dates
Currency optionOption to exchange a specified amount of currency on a
specified date at a specified rate
Currency optionOption to exchange a specified amount of currency on a
specified date at a specified rate
Currency futures contractContract requiring the exchange of a specified amount of a currency
on a specified date at a specified exchange rate, with allconditions fixed and not adjustable
Currency futures contractContract requiring the exchange of a specified amount of a currency
on a specified date at a specified exchange rate, with allconditions fixed and not adjustable
Swaps, Options, and FuturesSwaps, Options, and Futures
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Discussion QuestionDiscussion Question
Why is exchange rate risk important to companies involved in international business?
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Answer to Discussion Answer to Discussion QuestionQuestion
Exchange-rate risk is important because it can jeopardize profits from current and future international transactions.
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Key Market InstitutionsKey Market Institutions
Interbankmarket
Securitiesexchange
Market in whichthe world’s largestbanks exchangecurrencies at spotand forward rates
Market in whichthe world’s largestbanks exchangecurrencies at spotand forward rates
Exchange that specializes in currency futures and options transactions
Exchange that specializes in currency futures and options transactions
Global computer network of foreignexchange tradersand other marketparticipants
Global computer network of foreignexchange tradersand other marketparticipants
Over-the-Counter(OTC) market
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Manager’s Briefcase:Manager’s Briefcase:Managing Foreign ExchangeManaging Foreign Exchange
1. Match Needs to Providers
2. Work with the Major Banks
3. Consolidate Multiple Transactions
4. Get the Best Rate Possible
5. Embrace Information Technology
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Goals of Currency RestrictionGoals of Currency RestrictionGoals of Currency RestrictionGoals of Currency Restriction
Protect a currencyfrom speculators
Constrain individualsand companies from
investing abroad
Preserve hard currencyto repay debts owed
to other nations
Preserve hard currencyto pay for imports andfinance trade deficits
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Currency Restriction PoliciesCurrency Restriction Policies
Multiple exchange rate system
Import deposit requirements
What’s a firm to do?
Countertrade
Quantity restrictions
Import licenses
Central bank approval
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Discussion QuestionDiscussion Question
A currency that trades freely in the foreign exchange market is called a __________ currency.
a. Cross
b. Vehicle
c. Convertible
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Answer to Discussion Answer to Discussion QuestionQuestion
A currency that trades freely in the foreign exchange market is called a __________ currency.
a. Cross
b. Vehicle
c. Convertible
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any
means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher.
Printed in the United States of America.
Copyright © 2014 Pearson Education, Inc.
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