Chapter

12

The Global Capital Market

 Learning Objectives
12-1 Describe the benefits of the global capital market.
12-2 Identify why the global capital market has grown so
rapidly.
12-3 Understand the risks associated with the globalization
of capital markets.
12-4 Compare and contrast the benefits and risks associated
with the Eurocurrency market, the global bond market,
and the global equity market.
12-5 Understand how foreign exchange risks affect the cost of
capital.
1. Benefits of the Global Capital Market 1

vThe Functions of a Generic Capital

Market
vMarket makers are the financial service
companies that connect investors and
borrowers, either directly or indirectly.
vCommercial banks perform an indirect
connection function.
vInvestment banks perform a direct connection
function.
 Why Do We Have
Capital Markets?
vCapital markets bring together investors and
borrowers
vinvestors - corporations with surplus cash, individuals,
and non-bank financial institutions
vborrowers - individuals, companies, and governments
vmarkets makers - the financial service companies that
connect investors and borrowers, either directly
(investment banks) or indirectly (commercial banks)
vcapital market loans can be equity or debt

11-4
Figure 11.1 The main players in the generic
capital market

v Access the text alternative for slide

images
Checking your knowledge

5-6
________ perform a direct connection
function in capital markets.

vA) Insurance brokers

vB) Investment banks
vC) Pension fund managers
vD) Commercial banks
v

7
v________ requires a corporation to repay a
predetermined portion of the loan amount at
regular intervals regardless of how much
profit it is making.

vA) An equity loan

vB) A stock loan
vC) A debt loan
vD) A bonded loan
v

8
The liquidity of the market is ________
in a purely domestic capital market.

vA) held in reserves

vB) unlimited
vC) based upon the stock market
vD) limited

9
The cost of capital is

vA) higher in a purely domestic capital market

than in a global market.
vB) lower in a domestic capital market than in
an international market.
vC) higher in a global market than in a purely
domestic capital market.
vD) the same in either a global market or a
purely domestic capital market.
v

10
The risk associated with a portfolio

vA) declines exponentially as the number of

stocks purchased increases and continues to
decline until a point of zero risk is reached.
vB) decreases as the investor increases the
number of stocks in her portfolio.
vC) grows exponentially with the number of
stocks purchased.
vD) increases as the investor increases the
number of stocks in her portfolio.
v
11
The systematic risk of the stock
market is the
vA) movement in a stock portfolio's value that
is attributable to the individual selections
made for that portfolio.
vB) level of diversifiable risk in an economy.
vC) movement of the economy of a country.
vD) level of nondiversifiable risk in an
economy.
v

12
vA ________ brings together those who want to
invest money and those who want to borrow
money.

vA) consumer market

vB) value chain
vC) supply chain
vD) capital market

13
An equity loan is made when

vA) a corporation pledge equities or other

assets to borrow money.
vB) corporations avail cash loans from
individuals.
vC) a corporation sells stock to investors.
vD) corporations issue bonds to individual
investors.
v

14
Which of the following statements is true
of debt loans?
vA) Management has the discretion in paying
the amount to investors.
vB) Debt loans should be repaid at regular
intervals.
vC) Returns from debt loans are variable in
nature.
vD) Corporations need not pay back the debt
loans if they incur losses.
v

15
 When an investor purchases a corporate
bond, he purchases the right to receive a

vA) share of the overall revenues that the

company generates.
vB) part of the title for the assets that the
corporate holds.
vC) specified fixed stream of income from the
corporation.
vD) share of the profits that the company
generates through operations.
v
16
2. Benefits of the Global Capital Market 1

vThe Functions of a Generic Capital

Market
vMarket makers are the financial service
companies that connect investors and
borrowers, either directly or indirectly.
vCommercial banks perform an indirect
connection function.
vInvestment banks perform a direct connection
function.
 Benefits of the Global Capital Market 3

Attractions of the Global Capital Market

vThe Borrower’s Perspective: Lower Cost of
Capital.
vDomestic capital market – higher cost of
capital.
vGlobal capital market – lower cost of capital.
vCost of capital refers to the price of borrowing money.
Figure 12.2 Market liquidity and the cost of
capital

v Access the text alternative for slide

images
Benefits of the Global Capital
Market 4

Risk Reduction through Portfolio Diversification

11-20
 Benefits of the Global Capital Market 4

Attractions of the Global Capital Market continued

vThe Investor’s Perspective: Portfolio Diversification.

vMore investment opportunities.
vInvestors can diversify their portfolios internationally, reducing
risk.
v Systematic risk—movement in a stock’s portfolio’s value that are
attributable to macroeconomic forces affecting all firms in an economy.
 Benefits of the Global Capital Market 5

Attractions of the Global Capital Market continued

vThe Investor’s Perspective: Portfolio Diversification continued

vRelatively low correlation between movement of stock markets in
different countries.
vGrowing perception that the global economy has
increased correlation between different stock markets.
vRisk-reducing effects of international portfolio
diversification would be greater except for the volatile
exchange rates associated with the floating exchange
rate regime.
 Benefits of the Global Capital Market 6

vGrowth of the Global Capital Market

vInformation Technology.
vAdvances have created instantaneous communication.
vAllows market makers to absorb and process large volumes of
information from around the world.
v24-hour a day trading.
v “Shocks” spread quickly.
 Benefits of the Global Capital Market 7

vGrowth of the Global Capital Market continued

vDeregulation.
vResponse to the Eurocurrency market.
vIncreasing acceptance of the free market ideology.
vMany countries started to dismantle capital controls
in the 1970s.
v Financial crisis of 2008 to 2009 caused experts to question if deregulation
had gone too far.

vHedge funds are private investment funds that position

themselves to make “long bets” on assets that they
think will increase in value and “short bets” on assets
that they think will decline in value.
Checking your knowledge

5-25
An important drawback of a purely
domestic capital market is that the
vA) investment does not receive protection
from governments.
vB) investments are riskier than in global
capital markets.
vC) market lacks a strong regulatory
mechanism.
vD) cost of capital tends to be higher than it is
in a global market.

26
A purely domestic capital market faces
the problem of

vA) foreign exchange risk.

vB) limited liquidity.
vC) lack of regulation.
vD) deregulated markets.

27
The cost of capital is the

vA) interest received on investments made by

the company.
vB) price of borrowing money.
vC) difference between cost of inputs and
outputs.
vD) total value of raw materials that a
company uses.
v

28
As investors increase the number of
stocks in their portfolio, the portfolio's
risk

vA) increases initially and declines later.

vB) declines slowly and steadily.
vC) increases exponentially.
vD) declines rapidly in the beginning.

29
Systematic risk refers to movements in a
stock portfolio's value that are
vA) attributable to macroeconomic forces
affecting an economy.
vB) specific to the firm or individuals who
invest in a portfolio.
vC) attributable to factors pertaining to an
individual firm.
vD) specific to the company that facilitates the
investment portfolio.
v

30
vThe relatively low correlation between the
movement of stock markets in different
countries indicates that
vA) diversifying a portfolio will increase the
risk of investing.
vB) most countries face similar economic
conditions.
vC) countries pursue different macroeconomic
policies.
vD) most stock markets are highly segmented
from each other.
v
31
vThe element of risk into investing in foreign
assets is greater with ________ exchange rates.

vA) floating
vB) pegged
vC) fixed
vD) managed

32
v________ is made when a corporation sells
stock to investors.
vA) A corporate bond sale
vB) A debt loan
vC) A Eurobond investment
vD) An equity loan
v

33
vIn ________, the limited pool of investors
implies that borrowers must pay more to
persuade investors to lend them their money.

vA) a purely domestic market

vB) a mixed market
vC) an international market
vD) a purely Euro market

34
 3. Global Capital Market Risks
vIndividual nations may be more vulnerable to speculative
capital flows.
vCould destabilize national economies.
vEconomist Martin Feldstein:
v“Hot money” refers to short-term capital.
v“Patient money” supports long-term cross-border
capital flows.
vInvestors need better information about foreign
assets to make the global capital market work more
efficiently.
 Global Capital Market Risks
vLack of information about the quality of
foreign investments may encourage
speculative flows.
vCauses investors to react to dramatic
events in foreign nations and move their
money too quickly.
vDifferent accounting methods make it
difficult to compare.
Checking your knowledge

5-37
vInvestors are able to reduce risks by
diversifying an investment portfolio
internationally, and the risk reduction effects
would be greater if not for
vA) volatile exchange rates associated with the
current floating exchange risk regime.
vB) the different kinds of tax regimes in
different countries.
vC) the inaccessibility of foreign stock
exchanges to most investors.
vD) the poor quality of many stocks in
international start-up firms.
v 38
v Analysts who believe globalization of capital
has serious risks argue that
vA) capital does not shift in and out of
countries as quickly as conditions change.
vB) individual nations are becoming more
vulnerable to speculative capital flows.
vC) deregulation of trade is helpful for the
economic growth in a country.
vD) most of the capital that moves
internationally is pursuing long-term gains.
v
39
What is a disadvantage of the global
capital market?
vA) Foreign investments may be driven by
speculative flows in the market.
vB) A truly global market reduces the liquidity
of investments.
vC) The availability of capital is low in a global
capital market.
vD) The cost of capital is more in a global
market than a domestic market.
v

40
vWhat is a disadvantage of the integration of
the international capital market facilitated
by technology?
vA) Segregated international capital markets
will emerge as a result of technology.
vB) Complexity in processing large volumes
of data will increase.
vC) Shocks that occur in one financial center
will spread globally.
vD) Systems integration hinders real-time
data transfer across different countries.
v
11-41
vAccording to some analysts, deregulation and
reduced controls on cross-border capital
flows are
vA) having a stabilizing effect on national
economies.
vB) making individual nations more
vulnerable to speculative capital flows.
vC) making investors nervous and causing
them to pull their money out of foreign
nations.
vD) allowing undeveloped nations to enter the
global market.
42
Harvard economist Martin Feldstein
argues that the lack of patient money is
due to
vA) the flood of information, due to the
Internet, that investors receive about current
events in other countries.
vB) money owners and managers preferring
to keep their money "home."
vC) the relative scarcity of information that
investors have about foreign investments.
vD) money owners and managers preferring
to place their money in foreign investments.
v 43
 4. How Have Global Capital
Markets Changed Since 1990?
vGlobal capital markets have grown
rapidly
vthe stock of cross-border bank loans was
just $3,600 billion in 1990, but $24,566 in
2008
vthe international bond market has grown
from $3,515 billion in 1997 to $22,734 in
2008

11-44
 5. Why Is The Global Capital
Market Growing?
v Two factors are responsible for the growth
of capital markets
v 1 Advances in information technology –
the growth of international
communications technology and advances
in data processing capabilities
v 24-hour-day trading
v so, shocks that occur in one financial market
spread around the globe very quickly

11-45
 Why Is The Global Capital
Market Growing?
2 Deregulation by governments – has facilitated
growth in international capital markets
v governments have traditionally limited foreign
investment in domestic companies, and the amount of
foreign investment citizens could make
v since the 1980s, these restrictions have been falling
v deregulation began in the United States, then moved
to other countries - Great Britain, Japan, and France
v many countries have dismantled capital controls
making it easier for both inward and outward
investment to occur

11-46
Checking your knowledge

5-47
v A ________ market benefits investors by
providing a wider range of investment
opportunities, thereby allowing them to build
portfolios of international investments that
diversify their risks.

vA) foreign exchange

vB) global capital
vC) domestic exchange
vD) domestic capital
v
48
vWhich of the following statements is true of
the use of information technology in
financial services?
vA) Information technology prevents the
spread of financial crises.
vB) Financial services are an information-
intensive industry.
vC) Financial services do not use decision-
making systems.
vD) It does not require the processing of
large volumes of information.
v 11-49
vHedge funds position themselves to make
________ bets on assets that they think will
________.

vA) long; weather a volatile market

vB) long; increase in value
vC) short; weather a volatile market
vD) short; increase in value
v

11-50
Which of the following statements is
true of the deregulation of the financial
industry?
vA) Countries can strengthen the global
capital market by encouraging strict
regulations.
vB) Financial services have historically been
the most deregulated of all industries.
vC) Deregulation helped the development of
an international capital market.
vD) Deregulation compels financial services
companies to remain as domestic
companies. 11-51
 Hedge funds

vA) are public investment funds that invest

in corporate bonds and shares.
vB) make long bets rather than short bets.
vC) are investment funds managed by the
government.
vD) make short bets on assets that they think
will decline in value.
v

11-52
 5. The Eurocurrency Market 1

vEurocurrency is any currency banked outside its

country of origin.
vEurodollars account for two-thirds of all
Eurocurrencies.
vCan be created anywhere in the world.
vImportant and relatively low-cost source of funds
for international businesses.
 The Eurocurrency Market 2

Genesis and Growth of the Market

vEastern European holders of dollars were afraid to
deposit their money in the U.S.
vBritish government prohibited British banks from lending
British pounds to finance non-British trade in 1957.
vU.S. government enacted regulations that discouraged
U.S. banks from lending to non-U.S. residents in 1960s.
vOil price increases engineered by OPEC created huge
amounts of dollars that were deposited in banks in
London.
 The Eurocurrency Market 3

Attractions of the Eurocurrency Market

vLack of government regulation.
vAllows banks to offer higher interest rates on Eurocurrency
deposits than on deposits made in the home currency, and charge
borrowers a lower interest rate.
vBanks have more freedom in their dealings in foreign
currency.
vCompanies receive a higher interest rate on deposits and pay less
for loans.
Figure 12.3 Interest rate spreads in domestic
and Eurocurrency markets
 The Eurocurrency Market 4

Drawbacks of the Eurocurrency

Market
vIn a regulated system, the chance of
bank failure is lower.
vBorrowing funds internationally can
expose a company to foreign exchange
risk.
Checking your knowledge

5-58
A Eurocurrency is any currency

vA) banked outside of its country of origin.

vB) that is traded in European countries.
vC) that originates in European countries.
vD) used to buy gold and related
commodities.

11-59
A Eurocurrency is

vA) the currency used by the countries of the

European Union.
vB) the currency formerly used in many
European countries before the formation of
the European Union and the institution of
the euro.
vC) any currency banked outside of its
country of origin.
vD) any currency banked within a European
country. 11-60
________ is characterized by a
lack of government regulation.

vA) The Eurocurrency market

vB) A money market fund
vC) The New Your Stock Exchange
vD) A hedge fund

11-61
________ deposits are regulated in all
industrialized countries.

vA) U.S. currency

vB) Domestic currency
vC) Foreign currency
vD) Eurocurrency
v

11-62
Companies receive ________ when
using the Eurocurrency market.

vA) a lower interest rate on deposits and pay

more for loans
vB) tax incentives
vC) a higher interest rate on deposits and pay
less for loans
vD) liquid asset reserve waiver
v

11-63
Investors who purchase a fixed-
rate bond receive

vA) incremental payouts until the bonded

money runs out.
vB) cash payoffs only at maturity.
vC) a full cash payoff on demand.
vD) a fixed set of cash payoffs.

11-64
Foreign bonds sold in the
United States are
vA) Yankee bonds.
vB) Uncle Sam's bonds.
vC) Bulldogs.
vD) Eagles.

11-65
________ are normally underwritten by
an international syndicate of banks.
vA) Samurai bonds
vB) Eurobonds
vC) Yankee bonds
vD) Foreign bonds
v

11-66
Eurodollars are

vA) the exchange value of the dollar with the

euro.
vB) used to pay for imports from Europe.
vC) dollars banked outside of the United
States.
vD) the exchange buffer that the euro has
against dollar.
v

11-67
Which of the following statements
is true of Eurocurrency?
vA) The Eurocurrency market is a relatively
high-cost source of funds.
vB) It is produced and banked within
European countries.
vC) Eurocurrency can be created anywhere
in the world.
vD) It is used only for internal transactions
within European Union.
v
11-68
vThe main factor that makes the
Eurocurrency market attractive to both
depositors and borrowers is that it

vA) is separated from the foreign exchange

market.
vB) lacks government regulation.
vC) is associated with low risk.
vD) gives high levels of investor protection.

11-69
v Banks offer higher interest rates on
Eurocurrency deposits than on deposits
made in the home currency because
Eurocurrency deposits

vA) are funded by the European union.

vB) lack government regulations.
vC) are associated with low risk.
vD) have minimum foreign exchange risk.

11-70
What is an advantage that banks have
when they deal with foreign
currencies?
vA) Interest payments to customers are low
when dealing with foreign currencies.
vB) Accounts need not be maintained when
dealing with foreign currencies.
vC) Risks that investors face are low when
dealing with foreign currencies.
vD) Governments give banks more freedom
when dealing with foreign currencies.
v 11-71
When using the Euromarkets,
companies
vA) have funds that lack liquidity.
vB) pay less for loans.
vC) attract low interest rates.
vD) are secured from foreign exchange risks.
v

11-72
One drawback of the
Eurocurrency market is

vA) increased governmental controls.

vB) high reserve ratio requirements.
vC) low interest rates on deposits.
vD) exposure to foreign exchange risk.
v

11-73
 6. The Global Bond Market 1

Bonds are an important means of financing.

vMost common is fixed-rate bond – receives a
fixed set of cash payoffs.
vInternational bonds:
vForeign bonds are sold outside the borrower’s
country and are denominated in the currency
of country where they are issued.
vEurobonds are placed in countries other than
the one in whose currency the bonds are
denominated.
 The Global Bond Market 2

Attractions of the Eurobond Market

vAn absence of regulatory interference.
vFall outside of the regulatory domain of any
single nation.
vLess stringent disclosure requirements than in
most domestic bond markets.
vA favorable tax status.
vU.S. laws revised in 1984 to exempt any
withholding tax for holders of bonds issues by
U.S. corporations.
 The Global Equity Market 1

National equity markets historically separated

by regulatory barriers.
vDifficult to take capital out of a country and
invest it elsewhere.
vCorporations frequently lacked the ability to list
their shares on stock markets outside their home
nations.
vDifficult to attract equity capital from
foreign investors.
 The Global Equity Market 2

Consequences of international equity

investment:
1. Internationalization of corporate
ownership.
2. Companies historically rooted in one
nation are listing stock in equity
markets of other nations.
Checking your knowledge

5-78
v________ are sold outside of the borrower's
country and are denominated in the
currency of the country in which they are
issued.

vA) Micro bonds

vB) Eurobonds
vC) Foreign bonds
vD) Regulatory bonds
v

11-79
vThe United States sells bonds that are
denominated in dollars in Europe. This is an
example of a

vA) foreign bond.

vB) Eurobond.
vC) micro bond.
vD) regulatory bond.

11-80
 What Makes The Eurobond
Market Attractive?
v The eurobond market is attractive because
1. It lacks regulatory interference – since
companies do not have to adhere to strict
regulations, the cost of issuing bonds is lower
2. It has less stringent disclosure requirements
than domestic bond markets – it can be
cheaper and less time consuming to offer
eurobonds than dollar-denominated bonds
3. It is more favorable from a tax perspective –
eurobonds can be sold directly to foreign
investors

11-81
v________ are international bonds, normally
underwritten by an international syndicate
of banks and placed in countries other than
the one in whose currency the bond is
denominated.
vA) Micro bonds
vB) Foreign bonds
vC) Eurobonds
vD) Regulatory bonds
v

11-82
Eurobonds are

vA) denominated in the currency of the

country in which they are issued.
vB) normally underwritten by an
international syndicate of banks.
vC) denominated in a currency that is
accepted by the European Union.
vD) sold outside the borrower's county with
reference to the originating currency.
v
11-83
vAn Italian corporation issues a bond
denominated in dollars that has no
regulatory interference. This is an example
of a
vA) foreign bond.
vB) Eurobond.
vC) micro bond.
vD) regulatory bond.

11-84
vWhat makes Eurobonds more attractive
than most major domestic bonds?

vA) presence of regulatory interference

vB) strong disclosure requirements
vC) favorable tax status
vD) protection from exchange risks

11-85
Historically, ________ separated
national equity markets from each
other.

vA) substantial regulatory barriers

vB) fixed exchange rates
vC) financial similarities
vD) desire for high levels of profit
v

11-86
Entering into a forward contract will

vA) increase the risk involved in a

transaction.
vB) lower the borrower's cost of capital.
vC) benefit the borrower because the interest
rate will be lower.
vD) raise the borrower's cost of capital.

11-87
 Assignment 7

Please submit your answer sheet to:

ib503exam@zhumingxia.com

11-88
 Review Question
1.Which of the following are market makers?

a) commercial banks
b) pension funds
c) insurance companies
d) governments

11-89
 Review Question
2.Which of the following is not true of global
capital markets

a) they benefit borrowers

b) they benefit sellers
c) they raise the cost of capital
d) they provide a wider range of investment
opportunities

11-90
 Review Question
3.Compared to developed nations, less
developed nations have

a) smaller capital markets

b) more investment opportunities
c) similar costs of capital
d) greater liquidity

11-91
 Review Question
4.Historically, the most tightly regulated
industry has been

a) agriculture
b) consumer electronics
c) automotives
d) financial services

11-92
 Review Question
5. The term eurocurrency refers to

a) the currency used by the European Union

countries
b) any currency banked outside its country of origin
c) currencies purchased in the international equities
market
d) bonds sold outside the borrower’s country that
are denominated in the currency of the country in
which they are issued

11-93
6. Approximately two-thirds of
all Eurocurrencies are

vA) Euro-yen.
vB) Euro-pound.
vC) Euro-euro.
vD) Euro-dollars.
v

11-94
7. Which of the following is a drawback
of the Eurocurrency market?
vA) Borrowing funds within its home country can
expose a company to foreign exchange risk.
vB) There is a greater probability of a bank failure
that would cause depositors to lose their money.
vC) The system is overregulated and, therefore,
more costly.
vD) The higher interest rate received on home-
country deposits reflects the costs of insuring
against bank failure.
v
11-95
8.Which of the following is true
of the Eurobond market?
vA) There are many regulations that protect
investors.
vB) Government limitations are generally
more stringent for securities denominated
in foreign currencies.
vC) There are less stringent disclosure
requirements than in most domestic bond
markets.
vD) They have an unfavorable tax status.
11-96
9.________ can inject risk into
foreign currency borrowing.
vA) Movements in exchange rates
vB) Use of fixed-exchange rates
vC) Issue of domestic bonds
vD) Use of pegged exchange rates

11-97
v10. Borrowers can hedge against foreign
exchange risks by entering into a ________
contract.

vA) hedge fund insurance

vB) prevailing exchange rate
vC) forward
vD) global capital market
v

11-98
Q/A

Thanks

11-99