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The Global Capital Market Chapter 11

The Global Capital Market Chapter 11. Functions of a Generic Capital Market. Brings together: Those who want to invest: corporations, individuals, nonbank financial institutions. Those who want to borrow: individuals, companies, governments. Market makers:

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The Global Capital Market Chapter 11

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  1. The Global Capital Market Chapter 11

  2. Functions of a Generic Capital Market • Brings together: • Those who want to invest: • corporations, individuals, nonbank financial institutions. • Those who want to borrow: • individuals, companies, governments. • Market makers: • Commercial and investment banks that connect investors with borrowers. 11-1

  3. The Main Players in a Generic Capital Market Investors: Companies Individuals Institutions Borrowers: Individuals Companies Governments Market makers: Commercial bankers Investment bankers Figure 11.1 11-2

  4. Attraction of the Global Capital Market? • Increases the supply of funds available for borrowing. • Borrower’s perspective • Lowers the cost of capital. • Investor’s perspective • Provides a wider range of investment opportunities. 11-3

  5. Market Liquidity and the Cost of Capital D SS B SS 10% l 9 Cost of Capital D 0 1 2 D D Figure 11.2 Dollars 11-4

  6. Risk Reduction Through Portfolio Diversification (a) Risk reduction through domestic diversification 1.0 Variance of portfolio return Variance of return on typical stock U.S. Stocks 0.27 Total Risk Systematic Risk 1 10 20 30 40 50 Figure 11.3a Number of stocks 11-5

  7. Risk Reduction Through Portfolio Diversification (b)Risk reduction through domestic and international diversification 1.0 Variance of portfolio return Variance of return on typical stock U.S. Stocks 0.27 International Stocks 0.12 1 10 20 30 40 50 Figure 11.3b Number of stocks 11-6

  8. Net International Bank Lending Figure 11.4 11-7

  9. International Bond Issues and the US Dollar Exchange Rate Left-hand Scale (31 Dec 1993=100): Exchange Rate against US$ Right-handScale ($ Billion): announced Issues US Dollar European Currencies Yen Other 300 200 100 Figure 11.5 11-8

  10. International Equity Offerings and Equity Price Developments 80 Left-Hand Scale (US$) M.S.C.I. World Index 60 Right-hand Scale ($ Billions) US$ 40 Yen 20 Figure 11.6 11-9

  11. Why The Growth? • TECHNOLOGY. • Deregulation by governments of capital flows and financial services. • Risk: Nations may be more vulnerable to speculative capital flows. • Short term investing. 11-10

  12. Index of Capital Controls in Emerging Markets 0 = No Capital controls 1 = Tight Capital Controls Figure 11.7 11-11

  13. Eurocurrency • It’s not the Euro! • It is any currency banked outside its country of origin. • 1950s. Eastern Europeans afraid US would seize deposits to reimburse claims for business losses as a result of Communist takeover of Eastern Europe. 11-12

  14. Growth in Eurocurrency Funds 1.5 Trillion One Billion 11-13

  15. The Eurocurrency Market • Characterized by a lack of regulation compared to domestic financial markets. • This means that you don’t have to pay for the cost of regulation. • Hence, cheap (or cheaper) money. • Downside: • Banks could be more likely to fail (not probable) • Because you are getting foreign money, you have currency exchange risks. 11-14

  16. Interest Rate Spreads in Domestic and Eurocurrency Markets Rate of interest Domestic lending rate Eurocurrency lending rate Eurocurrency deposit rate Domestic deposit rate 0% Figure 11.8 11-15

  17. The International Bond 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. 11-16

  18. Euro vs Foreign Bonds(Billions of Dollars) 11-17

  19. Attraction of the Eurobond Market? • No government interference. • Few disclosure requirements. • Favorable tax status. 11-18

  20. Global Equity Markets • Where investors can buy/sell stocks. • Made up of many stock exchanges around the world. 11-19

  21. Trading in Non-US Stocks US Billions 11- 20

  22. 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. 11-21

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