Chapter The Global Capital Market 11

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Case: China Mobile Largest provider of wireless telephone service in the world In 2000 China was wrapping up negotiations to join the World Trade organization Direct consequence: China will have to open up its telecommunication market to foreign service providers As a preemptive strategy China mobile Increased geographic coverage Raised capital through Issuance of new shares Selling 2% stake in company to Vodafone Selling ADRs

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Functions of a generic capital market Brings together: Those who want to invest: Corporations, individuals, non bank financial institutions Those who want to borrow: Individuals, companies, governments Market makers: Commercial and investment banks that connect investors with borrowers

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved The main players in a generic capital market Fig 11.1

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Attractions of the global capital market Increases the supply of funds available Benefits both borrowers and investors Borrower’s perspective Lowers the cost of capital Investor’s perspective Provides a wider range of investment opportunities

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Market liquidity and the cost of capital Fig 11.2

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Risk reduction through portfolio diversification Fig 11.3

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved International portfolio risk reduction Some common perceptions Global capital market has increased the correlation between different stock markets reducing the benefit of international diversification In fact, movements of stock prices across countries are not perfectly correlated Reflects two factors: Countries pursue different macroeconomic policies and face different economic conditions Different stock markets are segmented by capital controls. Perception that markets are integrating, but not as rapidly as thought Home bias puzzle

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Growth of the global capital market Information technology Diminishing costs of sharing information Internet Computer power Deregulation Response to: Eurocurrency market Increasing acceptance a ‘free market’ concept Dismantling of national capital controls Less restrictions on inward/outward capital flows

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Global capital market risks Nations more vulnerable to speculative capital flows because of lack of knowledge Potential destabilization of economies (Mexico) Capital pursuing short term gains Hot money Long term patient money Lack of quality information Investors react to quickly to news events Differing accounting conventions

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved The Eurocurrency market Euro-currency is any currency banked outside its country of origin Eurodollars are dollars banked outside the United States Growth 1950s. Eastern Europeans, afraid US would seize deposits to reimburse claims for business losses as a result of Communist takeover of Eastern Europe Other events: Britain – 1957 U.S. – 1960s Failure of Bretton Woods Oil crisis – 1970s

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved The Eurocurrency market Attractions Gave opportunity to those who wanted to deposit or borrow dollars (later, other currencies, as well). Lack of government regulations makes the Eurocurrency attractive Banks offer higher interest rates Drawbacks Unregulated system could result in loss of deposits Borrowing funds internationally can expose a company to foreign exchange risk

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Interest rate spreads in domestic and Eurocurrency markets Fig 11.4

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved The global bond market Attractions of the Eurobonds market Bonds tend to be fixed rate Foreign bonds Sold outside the borrower’s country and in currency of country where issued Eurobonds Underwritten by an international syndicate Issued by large corporations, international institutions and governments Placed in country other than country of currency and its residents

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Global equity markets Where investors can buy/sell stocks Made up of many Stock exchanges around the world

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Who uses these markets? Investors seeking to diversify their portfolios. Companies seeking to Issue stock in the country Use stock and options as a form of employee incentives Satisfy local ownership requirements Create funding for future acquisitions Increase the visibility of the company

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Foreign exchange risk and the cost of capital When a firm borrows from the global capital market it must Weigh benefits of lower interest rates against risks of an increase in the real cost of capital due to adverse exchange rate movements Unpredictable movements in exchange rates, inject risk into foreign currency borrowing, making something less expensive more expensive Borrower can hedge by entering into a forward contract

McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved Managerial implications Growth of Global capital markets provide opportunities for firms wishing to borrow or invest money. Firms can borrow funds at lower costs Perhaps the emergence of a unified capital market in the EU? Opportunities to diversify investments FX risk is a complicating factor