-----Financial Markets -----Financial Institutions & Intermediaries ---Financial Products inancial markets are those markets, where the

smooth transaction of raising progress of funds or the investment of assets, hichever is chosen. They also assist equity lines in handling of various risks. The financial markets can be divided into the following ubtypes: 1. Capital Markets 2. Money Markets 3. Derivatives Markets 4. Futures Markets 5. Insurance Markets 6. Foreign xchange Markets ternational Financial Markets Foreign Exchange Market-----International Money Market----International Credit Market----ternational Bond Market------------International Stock Market ackground & Corporate Uses of International Forex Markets -----To describe the background and corporate use of the following ternational financial markets: ----Foreign Exchange Market-------Euro Currency Market----Euro Credit Market---Euro Bond Market oreign Exchange Market---------The foreign exchange market allows currencies to be exchanged in order to facilitate international rade or financial transactions. The system for establishing exchange rates has evolved over time.

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From 1876 to 1913, each currency was convertible into gold at a specified rate, as dictated by the gold standard. US (1879), Russia & Japan (1897) This was followed by a period of instability, as World War I began and the Great Depression followed.

In July 1944 Bretton Woods Agreement called for fixed currency exchange rates. By 1971, the U.S. dollar appeared to be overvalued. The Smithsonian Agreement devalued the U.S. dollar and widenedthe boundaries for exchange rate fluctuations from 1% to 2.25%. Due to this, the government had difficult in maintaining exchange rates within the stated boundaries. Finally, in 1973 the official boundaries for the more widely traded currencies were eliminated & floating exchange rate system came into effect. FOREX Transactions There is no specific building or location where traders exchange currencies. Trading also occurs around the clock. The market for immediate exchange is known as the Spot market. Forward market enables an MNC to lock in the exchange rate at which it will buy or sell a certain quantity of currency on a specified future date. Hundreds of banks facilitate foreign exchange transactions, though the top 20 among 100 banks handle about 50 of credit % transactions. At any point of time, arbitrage ensures that exchange rates are similar across banks. Trading between banks occurs in the Interbank market. Within this market, foreign exchange brokerage firms sometimes act as middlemen. Attributes of Banks that provide FOREX Competitiveness of quote---Special Relationship between the bank and its customer----------Speed of execution--Advice about urrent market conditions-----Forecasting advice The spread on currency quotations is positively influenced by order costs, inventory costs, currency risk and negatively infl enced u by competition and volume. The markets for heavy traded currencies like the $, , and are very liquid. uro Currency Market U.S Dollar or Japanese Yen deposits placed in banks of Europe and other EU are called Eurodollars. Ex: Japanese Co. borrowing U.S. dollars from a bank in France

accommodate increasing international business and to bypass strict U.S. regulations on banks in the U.S. The Eurocurrency market is made up of several large banks called Eurobanks that accept deposits and provide loans in various currencies. The Eurocurrency market focuses on large-volume transactions, because no single bank will be willing to lend the needed amount. Syndicate of Eurobanks may then be composed to underwrite the loans. Front-end management and commitment fees are usually charged for such syndicated Eurocurrency loans. The recent standardization of regulations around the world has promoted the globalization of the banking ind ustry. In particular, the Single European Act has opened up the European banking industry. The 988 Basel Accord signed by G-10 central banks outlined common capital standards, such as the structure of risk weights, for their banking industries. (Capital Adequacy, Assets Quality, Management, Earning Quality, Liquidity, Systems &Control) The Eurocurrency market in Europe will be called in Asia as Asian Euro market and for US as the Asian Dollar market. The primary function of banks in Asian dollar market is to channel funds from depositors to borrowers. Apart from this, they involve in interbank lending and borrowing. Eurocredit Market Loans of one year or longer are extended by Eurobanks to MNC s or government agencies in theEurocredit market. These loans are known as Eurocredit loans. Floating rates are commonly used, since the bank s asset and liability maturities may not match - Eurobanks accept short-term deposits but sometimes provide longer term loans. Eurobond Market There are two types of international bonds. Bonds denominated in a currency of a country where they are placed but issued by borrowers foreign to the country are called foreign bonds or parallel bonds. Bonds that are sold in countries other than the country represented by the currency denominating them are called Eurobonds. The emergence of the Eurobond market is partially due to the 1963 Interest Equalization Tax imposed in the U.S. The tax discouraged U.S. investors from investing in foreign securities, so non-U.S. borrowers looked elsewhere for funds. Then in 1984, the U.S. corporations allowed to issue bearer bonds directly to non-U.S. investors and withholding tax on bond purchases was abolished. Eurobonds are underwritten by a multinational syndicate of investment bank and simultaneously placed in many countries s through second-stage, and in many cases, third-stage, underwriters. Eurobonds are usually issued in bearer form, pay annual coupons, may be convertible, may have variable rates and typically ha ve few protective agreement. Interest rates for each currency and credit conditions in the Eurobond market change constantly, causing the popularity of th e market to vary among currencies. About 70% of the Eurobonds transactions are denominated in the U.S. dollar. International Money Market Local Corporations & Country Government needs to borrow short-term funds to support their operations & finance their budget deficits, respectively.

Besides, corporations & local government may issue short-term securities to the local investors Therefore, a domestic money market in each country serves to transfer short-term funds denominated in local currency from local surplus units (savers) to deficit units (borrowers) The growth in international business has caused the corporations & government to invest in short term funds denominated in foreign currency for the following reasons; The local country need to borrow funds to pay for imports denominated in foreign currency To support local operations, they may consider borrowing in currency where the interest rate is low. The local country may consider borrowing in a foreign currency that will depreciate against their home currency, Apart from this, they can repay the loan at more favorable exchange rate over time. International Credit Market MNC & Domestic firms sometimes obtain or issue medium-term funds through term loans from local institutions or foreign markets. Loans for one year or longer period extended by banks to MNC or government agencies in Europe are commonly called Eurocredits or Eurocredit loans. The loans can be denominated in dollars or many other currencies and commonly have a maturity of 5 years. In case of exchange between one bank to another, LIBOR loan rate can be considered to be the common interest rate. Here the loan rate will be adjusted every 6 months and is set at LIBOR plus 3 percent. International Bond Market NC or domestic firms can obtain or issue long-term bonds in their local market. MNC may choose to issue bonds in the international ond markets for three reasons; they are Issuing country may attract a strong demand by issuing their bonds in international market rather than domestc market. Some i countries have limited investor base, so MNC s in those case seeks financing elsewhere. MNC may prefer to finance a specific project in a particular currency & therefore attempt to obtain funds of the particular country because of their currency widely used. Financing in a foreign currency with lower interest rate may enable MNC to reduce its cost of financing, although it may exposed to FOREX risk. Institutional investors such as Commercial banks, Mutual funds, Insurance company and Pensi n funds from many o ountries are the major investors in the International Bond market. ternational Stock Markets In addition to issuing stock locally, MNCs can also obtain funds by issuing stock in international markets. Therefore, this will enhance the firm s image, name recognition, and diversify the shareholder base. Apart from this, the stock offering may be easily digested when it is issued in several markets. Stock issued in the U.S. by non-U.S. firms or governments are called Yankee Stock offerings. Many of such recent stock offerings resulted from privatization programs in Latin America and Europe. Non-U.S. firms may also issue ADR, which are certificates representing bundles of stock. ADRs are less strictly regulated. The locations of MNC s operations can influence the decision about where to place stock, in view of this, cash flows needed to cover dividend payments.

rate and proportion of individual Vs institutional share ownership. Electronic communications networks (ECNs) have been created to match orders between buyers & seller in recent years. Due to popularity in ECN s over time, they may ultimately be merged with one another or with other exchanges to create a single global stock exchange. omparing Interest Rates Among Currencies Interest rates vary substantially for different countries ranging from about 1% in Japan to about 60% in Russia. Interest rates are crucial because they affect the MNC s cost of financing. The interest rate for a specific currency is determined by the demand and supply of funds in that currency. As the demand & supply schedules change over time for a specific currency, the equilibrium interest rate for that currency will also change. The freedom to transfer funds across countries causes the demand & supply conditions for fund to somewhat integrated, such that interest rate movements become integrated too. otives for Investing & Borrowing in Foreign Markets actors: Tax disparity, tariffs, quotas, labor immobility, cultural differences, financial reporting differences, & costs of communicating formation across countries otives for Investing in Foreign Markets----Economic Conditions--------Exchange Rate Expectations-------International Diversification otives for Providing Credit in Foreign Markets------High Foreign Interest Rates----Exchange Rate Expectations-----International iversification otives for Borrowing in Foreign Markets----Low Interest Rates----Exchange Rate Expectations

ow Financial Markets Affect an MNC s Value

ince interest rates commonly vary among countries, an MNC may use the international financial markets to reduce its cost of apital, thereby achieving a higher valuation. Volatility in the Currency between the parent country and the subsidiary country. Investors Sentiment towards MNC s symmetric news and leverage effect

CHANGING GLOBAL FINANCIAL ENVIRONMENT

Evolution of the International Monetary System-----Bimetallism : Before 1875-------Classical Gold Standard: 1875 1914---------Inter war period: 1915 1944-------Bretton Woods System: 1945 1972-------Flexible Exchange Rates Regime: Since 1973 Bimetallism (Before 1875) Bimetallism in the sense that both Gold & Silver were used as international means of payment and the exchange rate among countries were determined by either gold or silver contents. Exchange Rates Under the Bimetal System: Exchange rates was determined by metal content of the currencies being exchanged. Gold & Silver had a universal price and currencies were exchanged at the value of metal. This worked well if the currency being exchanged was of the same metal but different countries maintained different metal systems. Bimetallism refers to the use of noble metals Gold & Silver as currency. Prior to 1875 this was the predominant monetary system in major countries.

the gold standard. France maintained the bimetal system from the French revolution in 1878. Other Countries such as China, India, Germany & Holland were on Silver Standard. The United States operated under bimetal form 1792 to 1873 when it stopped producing the silver dollar. The U.S, Russia & Austria - Hungary had alternative currencies from 1848 - 79, it is mainly due to political turmoil. Till 1870 s IMS was not followed systematically by the countries. resham s Law: Bad (Abundant) money drives out Good (Scare) money. This law dictated the three currency used to trade. xchange rate between gold and silver was fixed by French Officials ither gold or silver could be used to settle debts. ore abundant metal would be used to transact and the scare metal will fall out of circulation During the Gold Rush Era (1850 s) gold flooded the market & the intrinsic value of gold fell relative to silver. However he exchange rate in France remained constant at 15.5:1 silver to gold francs. Since the price of gold was still set people elected to ay debts in the over valued currency (gold) and silver fell out of circulation. This effectively put France on the gold standard. lassical Gold Standard (1875 1914) The first full-fledged Gold Standard was introduced in 1821 at England when notes issued by the Bank of England for gold standard. France, unofficially on the gold standard since 1850, officially adopted the gold standard in 1878. Germany converted in 1875 after receiving a large endowment from France. The united states adopted the gold standard in 1879 Finally, Russia and Japan followed the gold standard in the year 1897 Historically speaking, the international gold standard existed as a historical reality during the period 1875 - 1914. Due o World War I many countries got off from gold standard in 1914. The CGS as an IMS lasted for about 40 years. During the period, ondon became the centre for International Financial System, reflecting Britain s advanced economy & top position in Internatonal i rade. lassical Gold Standard International Gold Standard can prevailed in most of the countries by followed reasons; they are Gold alone is assured of unrestricted coinage. There is two-way convertibility between gold & national currencies at a stable ratio Gold may be freely exported or imported In Gold standard, the exchange rates between two currencies will be determined by the respective currencies gold content. Auto correction under the gold standard: Buying pressure will increase on the pound Buying pressure will decrease on the franc xcess demand for pound will cause the price of pound to increase relative to the franc & the miss pricing will be corrected.

. The supply of newly minted gold is so restricted that the growth of world trade and investment can be seriously affected because of insufficient monetary reserves. . The supply of gold is limited and countries are required to maintain a pegged ratio, which means a country s money supply is limited and regulated by the trade imbalance self correction. The restriction of a countries money supply can seriously impair economic growth. . The gold standard works well if all countries adhere to the rules however, nothing binds countries to follow the gold standar d. Therefore, it can be abandoned at any time as it was in WW I Inter War Period (1915 1944) After World War I ended the classical gold standard was abandon in August 1914, there was no global cooperation between the major countries and restricted gold exports. Great Britain, France, Germany & Russia were suffered huge hyperinflation In 1923, the Wholesale Price Index in Germany was more than 1 trillion times as high as the prewar level. Due to fluctuation in exchange rate, many countries predatory depreciated their currency value to gain advantage in world exp ort market & trying to rebuild their economy by attempting to restore the gold standard. Ex: Predatory depreciation is a country can increase its money, supply which will cause the price of its currency to decrease. Goods manufactured in this country then become less expensive on the world market, which attracts foreign investment. Finally, many countries returned to the gold standard from 1919 & 1928. The U.S, which replaced Great Britain as the dominant financial power, spearheaded efforts to restore the gold standard. In 1919, the U.S was able to lift restrictions on gold exports with mild inflation. In Great Britain, Winston Churchill played a key role in restoring the gold standard in 1925. Besides Great Britain, the countries like Switzerland, France & Scandinavian countries restored the gold standard by 1928. The International gold standard was not much popularized after World War I, because most of the countries gave priority to stabilization of gold by matching inflows with outflows of gold by reduction & increases in domestic money and credit. Federal Reserve Bank & Bank of England also followed the policy of keeping gold outside the domestic market. Due to this policy, countries not having gold Standard & political support has been ruled out and gold standard was unable to work properly.

THE GREAT DEPRESSION The restored gold standard was destroyed in the wake of Great Depression & accompanying financial crisis. In 1929 after the stock market crash banks in Austria, England ,and The United States experienced large declines in portfolio values, touching off runs on the banks. Britain experienced a massive outflow of gold reserves & chronic BOP , which made to lose confidence in pound, which ended its use from international lev el. Despite coordinated international efforts to rescue to pound, British gold reserves continued to fall and impossible to maintain gold standard in Britain. Bretton Woods System (1945 1972)

olicy The agreement was subsequently approved in 1945 by majority of the countries to launch a chief esponsible institutions for financial individual development projects; they are he International Monetary Fund (IMF) he International Bank of Reconstruction Development (IBRD) popularly known as World Bank In designing Bretton Woods System, representatives were mainly concerned with how to prevent the conomic nationalism with destructive policy and how to addre ss the interwar years ritish & American Solution British Delegates led by ohn Maynard Keynes proposed an international clearing union that would create an international reserve asset called Bancor People Bank of China governor considered SDR because of recent turmoil. Countries would accept payments in bancor to settle international transaction, without limit. Apart from this, countries are allowed to acquire bancor by using overdraft facilities with clearing union. On the other hand, American delegat es headed by Harry Dexter White proposed a currency group to member countries would make contribution and borrow to short -term Balance of Payment deficits. Finally, both the delegates desired exchange rate stability without restoring an international gold standard. So the American proposal was largely incorporated into the Article of Agreement of the IMF. Advantages of Bretton Woods Countries can use both gold and foreign exchanges as means of payment. Countries can earn interest on foreign exchange reserve s where gold dose not earn interest. Transactions costs associated with the transportation of gold was eliminated. Foreign exchange rates where very stable Ample supply of International Monetary Reserves coupled with stable exchange rates provide an cond ucive environment growth of international trade & investment throughout 1950 to 1960. Collapse of Bretton Wood System Gold - Exchange System was programmed to collapse in the long -run. To avoid this, the U. S had to run balance of payment deficit (Trade d eficit) continuously for expansion of international trade and global expansion. In case of permanent BOP deficit in U. S, the trade deficit persistence would eventually impact the public confidence in dollar because total dollar value will exceed total gol d value. Due to short-run BOP deficit in U. S, can lead to crisis of confidence in currency reserves and cause downfall of the system.

responsible for the collapse of the dollar based gold exchange system in the early 1970 mithsonian Agreement (1971) n December 1971, 10 major countries popularly known as G - 10 met at the Smithsonian Institution in Washington, D.C to discuss and attempt to save the Bretton Wood System Price of gold increased to $38 per ounce Each country reevaluated its currency against U.S $ upto 10 % and for exchange rate were allowed to move was expanded from 1 % to 2.25% in either direction he Smithsonian agreeme nt lasted for a year before it was replaced. It is due to the following reasons; they are Devaluation in U.S $ was not sufficient to stabilize the situation. In February 1973, the selling pressure in U.S $ was heavy, which prompting central banks around th e world to buy Dollars The price of gold was further raised from $ 38 to $ 42 per ounce. y March 1973, European & Japanese currencies were allowed to float, so it lead to complete fall in Bretton Woods System.Finally, the exchange rates among major currencies like Dollar, Mark, Pound &Yen have been fluctuating against each other lexible Exchange Rates Regime: Since 1973 n 1976, the IMF members joined in Jamaica & agreed to a new set of rules for IMS. The key elements of amaican Agreement include; IMF member countries and Central banks were declared and allowed to maintain floating exchange rate policies Gold was officially abandoned as the international asset. Half of the IMF s gold holding were returned to the members and other half were sold to help the poor nations Non - oil exporting countries and less - developing countries were given greater access to IMF loans Apart from this, IMF extended assistance & loans to the member countries. The loans & assistance were provided to those countries follow the IMF s macroeconomic policy prescriptions. ouvre Accord he government of major industrial countries began to worry that the dollar may fall too far o address the problem of exchange rate volatility and other related issues, the G -7 economics (France, Japan, ermany, U.K, U.S, Italy and Canada) summit meeting was convened in Paris in 1987. The meeting produced the ouvre Accord, according to which; -7 countries would cooperate to achieve stability in exchange rates -7 countries agreed to move closely consult and coordinate their macroeconomic policies

ointly involve in correcting the exchange rate of their currencies. ince the Louvre Accord, exchange rates became relatively more stable for a while. uring the period 1996 - 2001, the U.S Dollar generally appreciated, reflecting a robust performance of the U.S conomy fueled by technology boom uring this period, foreigners invested heavily in the U.S to participate in the booming U.S economy and stock arket. This helped the dollar to appreciate. urrent Exchange Rate System xchange Agreements with no Separate Legal Tender: Countries have no domestic currency but use foreign urrency to trade. Ex: Ecuador, Panama using $ & France, Germany & Italy using common currency as Euro. urrency Board Agreements: Countries peg their currency to that of anoth er country. Ex: Hong Kong fixed to $ ther Conventional fixed Pegged Arrangements: The currency is peg its currency with basket of currency & llowed to fluctuate with in - 1%. Ex: China, Malaysia, India & S. Arabia egged Exchange Rates with Horizontal Bands: The exchange rate was fixed with bands greater than 1% Ex: gypt & Denmark uropean Monetary System ccording to Smithsonian Agreement (1971) the band of exchange rate movements was expanded from +1 or -1 to 1 to 2.25% in either direction. owever, the members of European Economic Community (EEC) decided to narrow down the exchange rate and to + 1.125 or -1.125 % for the currencies inally, the snake arrangement was replaced by the European Monetary System (EMS) in 1979, which was riginally proposed by German Chancellor Helmut Schmidt with the following objectives; they are o establish a Zone of Monetary Stability in Europe o coordinate exchange rate policies with the non EMS currencies. inally, the EEC member countries, except the U.K and Greece joined the EMS and their main instruments of the MS are; uropean Currency Units: CU is a basket of currency constructed on the average weight of European Union countries. Where, the weights re based on GNP and Share in intra-EU trade. xchange Rate Mechanism: RM refers to the procedure by which EMS member countries collectively manage their exchange rates aastricht Treaty n December 1991, the turbulence period in EMS, which motivated the European Union countries to met in etherland and sign ed the Maastricht Treaty

ubsequently introduced a common currency by replacing individual national currencies. he European Central Bank to be located in F rankfurt, Germany will be solely responsible for common currency nd conducting monetary policy uropean Monetary Union dvantages of a Common Currency: educed in transaction costs and elimination of Forex risk reate a continental capital market with inc reased liquidity isadvantages of a Common Currency: oss of Independent Monetary & Exchange Rate Policy: Member countries can no longer stimulate their conomies by depreciating their currency. This severely limits the action a country can take in times of recession. isk of Asymmetric News: The success of any common currency will depend on how well member countries deal ith economic shocks that effect only one country. Therefore, in times of recession the limitations of a common urrency will not serve the benefit. So, there is a risk of recession for common currency. he Mexican Peso Crisis n 20th Dec. 1994, the Mexican government under new President Ernesto Zedillo announced its decision to evaluate the peso against $ by 14 % ue to this, there was a sudden stampede to sell pesos as well as Mexican stocks & Bonds n early January 1995 the peso fell against the U.S$ by 40 %. So, the Mexican government forced to float the eso. he international investors reduced their holdings of emerging market sec urities, the peso crisis rapidly spillover o other Latin America & Asian financial markets. t the verge of global meltdown, the Mexican Govt. was supported by Clinton administration contributed ($20 illion) with IMF & BIS ($17.8 & $10 Billion), put toge ther $ 53 billion package to bail out Mexico. inally, 31 st January 1995, the world & Mexico Financial market began stabilized essons Emerged in Mexican Peso Crisis irst, it is essential to have a multinational safety net in place to safeguard the world financial system from the eso-type crisis, where No single currency or institution can handle a potentially global crisis alone . econd, the Mexico excessively depends on foreign portfolio capital to finance its economic development. Due to his, there was a high domestic inflation and overvalued the peso, which hurt Mexico s trade balances. sian Currency Crisis he Asian crisis has a similar story on a larger scale oreign investors were attracted to the diversification benefits offered by developing Asian economies arge portfolio capital inflows from private investors spurred easy credit in these countries.

ith Forex risk. n increase in the real exchange rate means that Asian good became more expensive relative to good produced n other countries. Demand for Asian goods decreased and the economy slowed. n Thailand, as the Baht weakened against the dollar foreign investors began selling off positions. he Thai government intervened with massive dollar infusions (buying Baht with USD) to stabilize the exchange ate. Due to this Thailand devalued their cu rrency against the dollar ixed Vs. Floating Rates orrection of Trade Deficits: urrently the United State is supporting a large trade deficit especially with respect to China. This means there is n excess supply of dollars on the world market. loating Rate System: nder floating rate system the excess supply of dollars on the market cause a depreciation in the value of dollar. s the value of the dollar declines foreign imports to the US become more expensive and US exports become ess expensive thereby reducing the trade imbalance. ixed Rate System: nder the fixed rate system China would be required to maintain its par ratio to the USD. In this case, China ould have to buy up the excess supply of dollars on the Forex market or depreciate their o wn currency by ncreasing the supply of Yuan on the global market. The forced maintenance of the Forex ratio would cause rices to correct and the trade imbalance to resolve. urrency Board Agreement o avoid the Peso/Asian currency crisis is to implemen t a Currency Board Agreement. This is a strictly fixed xchange rates in which a countries currency is fully backed by the US dollar. he idea is that both prices & exchange rates are stable. Therefore, there would be no advantage to operating in rgentina as opposed to the US. rgentina: aintained a currency board agreement though 2002 ue to dot com boom the USD strengthened relative to other currencies his means that the Argentinean Peso also strengthened relative to other currencies. This reduced dema nd for rgentinean exports. rgentina abandon the currency board agreement leading to soaring inflation and unemployment around 20%. aving borrowed heavily against the dollar, eventually Argentina s government defaulted on its internal and xternal debt.