Chapter21 The Global Capital Market

1. Chapter21The Global Capital Market Performance and Policy Problems

2. The international Capital Market And The Gains From Trade • Three Types Of Gain From Trade • Trades of goods or services for goods or services • Trades of goods or services for assets • Trades of assets for assets

3. Goods and services Goods and services assets assets The international Capital Market And The Gains From Trade

4. The International Capital Market And The Gains From Trade • Risk-averse investors in foreign currency assets base their demand for a particular asset on its riskiness in addition to its expected return.This observation is basic to understanding why countries exchange assets.

5. The International Capital Market And The Gains From Trade • Portfolio diversification as a motive for international asset trade.When an economy is opened to the international capital market,it can reduce the riskiness of its wealth by placing some of its”eggs” in additional foreign “baskets”.

6. The international Capital Market And The Gains From Trade • The menu of international assets:debt versus equity • Debt instruments must repay a fixed value regardless of the economic circumstances.

7. The international Capital Market And The Gains From Trade • Equity instruments is a claim to a firm`s profits,rather than to a fixed payment,and its payoff will vary according to circumstances. • By choosing how to divide their portfolios between debt and equity instruments,individuals and nations can arrange to stay close to desired consumption and investment levels.

8. International Banking And The International Capital Market • The structure of the international capital market • Commercial banks:the center of the international capital market. • Corporations:finance their investments by drawing on foreign sources of funds. • Nonbank financial institutions:move into foreign assets to diversify their portfolios.

9. International Banking And The International Capital Market • Growth of the international capital market • An important reason for that development is related to exchange rate systems. • A country can`t have more than two items from the following list:

10. International Banking And The International Capital Market • Fixed exchange rate • Monetary policy oriented toward domestic goals • Freedom of international capital movements

11. International Banking And The International Capital Market • Offshore banking and offshore currency trading • Offshore banking isto describe the business that banks ` foreign offices conduct outside of their home countries.Bank may conduct foreign business through three types of institution:

12. International Banking And The International Capital Market • An agency office located abroad • A subsidiary bank located abroad • A foreign branch

13. Eurodollar And Other Eurocurrencies • How big is the eurocurrency market? • In the mid-1990s,the size of the currency market stood at around $8 trillion.

14. Eurodollar And Other Eurocurrencies • How eurocurrencies are created? • The typical eurocurrency deposit is a nonnegotiable time deposit with a fixed term to maturity ranging from overnight to five years. • Take a example to explain the creating process of eurocurrencies.

15. Eurodollar And Other Eurocurrencies • The growth of eurocurrency trading • The main reasons for the growth of offshore banking activities: • The growth of world trade • Government financial regulations(including taxes) • Political considerations

16. Eurodollar And Other Eurocurrencies • The importance of regulatory asymmetries • The major factor behind the continuing profitability of Eurocurrency trading is regulatory. • Freedom from reserve requirements is probably the most important regulatory factor that makes eurocurrency trading attractive to banks and their customers.

17. Eurodollar And Other Eurocurrencies • Eurocurrencies and macroeconomic stability • Eurocurrencies and World inflation:the possibility that creation of eurocurrencies has had some inflationary effect,but it has never set off the protracted inflation that some worried observers of the eurocurrency system seem to fear.

18. Eurodollar And Other Eurocurrencies • Eurocurrencies and monetary control:The fear that eurodollars can come “flooding back” into the United States is highly exaggerated.

19. Regulating International Banking 1.The Problem of Bank Failure The reason for bank failures Consequences of banking collapse Precautionary bank regulation measures Deposit insurance Reserve requirement Capital requirement Bank examination Lender of the last resort facilities The banking safeguards listed above are interdependent

20. Regulating International Banking 2.Difficuties in Regulating International Banking Why is an international banking system harder to regulate? • The absence of deposit insurance • The absence of reserve requirement • The difficulties of bank examination and enforcing capital requirement and asset restrictions

21. Regulating International Banking • Uncertainty over the central bank’s responsibility for providing LLR assistance 3.International Regulatory Cooperation • In 1974 , Basle Committee was set up. Its job was to achieve “ a better coordination of the surveillance exercised by national authorities over the international banking system ……”

22. Regulating International Banking • The failure of nonbank financial institutions also has serious consequences. It’s time to take actions to regulate the international activities of them. Case study :

23. Regulating International Banking It gives us an example of the nightmare that the global investment fund , Long Term Capital Management , nearly collapsed in September 1998. The near failure of this institution always haunts global regulator’s sleep.

24. How Well Has the International Capital Market Performed ? 1.The Extent of International Portfolio Diversification • Though the extent of international portfolio diversification is low at present time , the world capital market has certainly contributed to a rise in the diversification since the early 1970s.

25. How Well Has the International Capital Market Performed ? 2.The Extent of Intertemporal Trade • Martin Feldtein and Charles Horioka suggested an alternative way of evaluating the performance of the world capital market : in a smoothly working international capital market , countries’ domestic investment rates can widely diverge from their saving rates .

26. How Well Has the International Capital Market Performed ? • For many countries , differences between national saving and domestic investment rates (that is , current account balances ) have not been large since world war Ⅱ . • However , in industrialized countries such as United States , Germany and Japan , the external imbalances have been historically high recently .

27. How Well Has the International Capital Market Performed ? 3.Onshore-Offshore Interest Differentials • A quite different barometer of the international capital market’s performance is the relationship between onshore and offshore interest rates on similar assets denominated in the same currency .

28. How Well Has the International Capital Market Performed ? • If the world capital market is doing its job of communicating information about global investment opportunities , these interest rates should move closely together and not differ too greatly. • Countries with long-standing open capital market show an approximate equality between onshore and offshore interest rates.

29. How Well Has the International Capital Market Performed ? 4.The Efficiency of the Foreign Exchange Market Studies of the foreign exchange market’s use of available information are potentially important in judging whether the international capital market is sending the right signals to markets .

30. How Well Has the International Capital Market Performed ? • Studies based on interest parity The interest parity condition is :Rt– Rt* = (Et+1e– Et)/Et Ι Statistical studies of the relationship between interest rate differences and actual depreciation rates show that the interest difference has been a very bad predictor .

31. How Well Has the International Capital Market Performed ? Ⅱ Forecast error in predicting depreciation , ut+1 , can be expressed as : ut+1 = (Et+1– Et)/Et - (Et+1e– Et)/Et = (Et+1– Et)/Et – (Rt – Rt* ) A number of researches have shown that forecast errors , defined above , can be predicted . These two tests prove that the foreign exchange market is not doing a good job of using current information to forecast exchange rates.

32. How Well Has the International Capital Market Performed ? • The role of risk premiums If the people are risk-adverse and bonds denominated in different currencies are imperfect substitutes , the interest rate difference equals expected currency depreciation plus a risk premium , ρt , Rt– Rt* = (Et+1e– Et)/Et+ ρt

33. How Well Has the International Capital Market Performed ? The reasons for why the interest difference has been a very bad predictor: ΙRisk premiums are important in exchange rate determination . ( It awaits solid statistical confirmation. ) ⅡThe foreign exchange market has been ignoring the opportunity to profit from easily available information . ( It seems unlikely in the light of foreign exchange traders’ powerful incentives to make profits.)

34. How Well Has the International Capital Market Performed ? • Tests for excessive volatility Exchange rates have been excessively volatile perhaps because the foreign exchange market overreacts to events . How volatile must an exchange rate be before its volatility becomes excessive?

35. How Well Has the International Capital Market Performed ? There are some underlying factors that move exchange rates – such as money supplies , national outputs and fiscal variables . Attempts to compare exchange rates’ volatilities with those of their underlying determinants have produced inconclusive results . It is very hard to test the excessive volatility .

36. How Well Has the International Capital Market Performed ? • The bottom line The ambiguous evidence on the foreign exchange market’s performance warrants an open-minded view . The stakes are high , and more researches and experience are needed before a firm conclusion can be reached .

37. Question

38. Thanks