Chapter The Global Capital Market 11. McGraw-Hill/Irwin International Business, 5/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 11-2.

Chapter

The Global Capital Market

11

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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

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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

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The main players in a generic capital market

Fig 11.1

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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

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Market liquidity and the cost of capital

Fig 11.2

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Risk reduction through portfolio diversification

Fig 11.3

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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

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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

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Global capital market risks

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

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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

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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

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Interest rate spreads in domestic and Eurocurrency markets

Fig 11.4

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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

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Global equity markets

Where investors can buy/sell stocks

Made up of many

Stock exchanges

around the world

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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

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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

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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