7-1 The Global Capital Market

7-2 The Global Capital Market Introduction: Globalization of capital market facilitates the free flow of money around the world, enabling individuals and institutions based in one nation to invest in corporations based elsewhere with relative ease. In the past, substantial regulatory barriers separated national capital market from each other. It was often difficult to take capital out of a country and invest it elsewhere.

7-3 Moreover, corporations lacked the ability to list their shares on stock markets outside of their home nations. These regulatory barriers made it difficult for corporations to attract significant capital from foreign investors. Global capital market enabled firms to attract capital from international investors, to list their stock on multiple exchanges and to raise funds by issuing equity or debt around the world. Three important segments of the global capital market: the eurocurrency market, the international bond market and the international equity market. The Global Capital Market

A capital market brings together those who want to invest money and those who want to borrow money. 2. Capital market loans to corporations are either equity loans or debt loans. 3. Provides liquidity of financial assets 4. Determines cost of money Functions of Global Capital Market

7-5 A global capital market benefits both borrowers and investors. It benefits borrowers by increasing the supply of funds available for borrowing and by lowering the cost of capital. It benefits investors by providing a wider range of investment opportunities, thereby allowing them to build portfolios of international investments that diversify their risks. Attractions of the Global Capital Market

7-6 Global Capital Market Risks Some analysts are concerned that due to deregulation and reduced controls on cross-boarder capital flows, individual nations are becoming more vulnerable to speculative capital flows. A lack of information about the fundamental quality of foreign investments may encourage speculative flows in the global capital market. Faced with a lack of quality information, investors may react to dramatic news events in foreign nations and pull their money out too quickly. Despite advances in information technology, it is still difficult for an investor to

7-7 get access to the same quantity and quality of information about foreign investment opportunities that he can get about domestic investment opportunities. This information gap is exacerbated by different accounting conventions in different countries, which makes the direct comparison of cross-boarder investment opportunities difficult for all but the most sophisticated investor. Given the problems created by differences in the quantity and quality of information, many investors have yet to Global Capital Market Risks

7-8 venture into the world of cross-boarder investing, and those that do are prone to reverse their decision on the basis of limited information. However, if the international capital market continues to grow, financial intermediaries likely will increasingly provide quality information about foreign investment opportunities. Better information should increase the sophistication of investment decisions and reduce the frequency and size of speculative capital flows. Global Capital Market Risks

7-9 A eurocurrency is any currency banked outside of its country of origin. Eurodollars, which account for about two-thirds of all eurocurrencies, are dollars banked outside of the US. Other important eurocurrencies include the euroyen, and the europound. The term eurocurrency is actually a misnomer because a eurocurrency can be created anywhere in the world; the persistent euro-prefix reflects the European origin of the market. The eurocurrency market has been an important and relatively low-cost source of funds for international business. The Eurocurrency Market

7-10 Bonds are an important means of financing of many other companies. The most common kind of bond is a fixed-rate bond. The investor who purchases a fixed-rate bond receives a fixed set of cash payoffs. Each year until the bond matures, the investor gets an interest payment and then at maturity he gets back the face value of the bond. The Global Bond Market

7-11 International bonds are of two types: foreign bonds and eurobonds. Foreign bonds are sold outside of the borrower’s country and are denominated in the currency of the country in which they are issued. Eurobonds are normally underwritten by an international syndicate of banks and placed in countries other than one in whose currency the bond is denominated. The Global Bond Market

7-12 The world equity market is that companies with historic roots in one nation are broadening their ownership by listing their stock in the equity markets of other nations. The reasons are primarily financial. Listing stock on a foreign market is often a prelude to issuing stock in that market to raise capital. The Global Equity Market

7-13 It is emphasized that a firm can borrow funds at a lower cost on the global capital market than on the domestic capital market. However, it is mentioned that under a floating exchange rate regime, foreign exchange risk complicates this picture. Adverse movements in foreign exchange rates can substantially increase the cost of foreign currency loans. Foreign Exchange Risk & the Cost of Capital

7-14 Unpredictable movements in exchange rates can inject risk into foreign currency’s borrowing, making something that initially seems less expensive ultimately much more expensive. The borrower can hedge against such a possibility by entering into a forward contract to purchase the required amount of the currency being borrowed at a predetermined exchange rate when the loan comes due. Foreign Exchange Risk & the Cost of Capital

7-15 When a firm borrows funds from the global capital market, it must weigh the benefits of a lower interest rate against the risks of an increase in the real cost of capital due to adverse exchange rate movements. Although using forward exchange markets may lower foreign exchange risk with short-term borrowings, it cannot remove the risk. Most importantly, the forward exchange market does not provide adequate coverage for long- term borrowings. Foreign Exchange Risk & the Cost of Capital