Chapter 3

International Financial Markets

 Foreign Exchange Market

• The foreign exchange market allows for the exchange

of one currency for another in order to facilitate
international trade or financial transactions.
• Large commercial banks serve this market by holding
inventories of each currency so that they can
accommodate requests by individuals or MNCs.
• For one currency to be exchanged for another
currency, an exchange rate is needed that specifies
the rate at which one currency can be exchanged for
another.
 Foreign Exchange Market

• History of foreign exchange:

– Gold standard
– Agreements on fixed exchange rates
– Floating exchange rate system
 Foreign Exchange Market

• Foreign Exchange Transactions:

– Foreign exchange dealers serve as intermediaries in the
foreign exchange market by exchanging currencies desired
by MNCs or individuals.
– The most common type of foreign exchange transaction is
for immediate exchange. The market where these
transactions occur is known as the spot market.
– The exchange rate at which one currency is traded for
another in the spot market is known as the spot rate.
– If a bank begins to experience a shortage of a particular
foreign currency, it can purchase that currency from other
banks. This trading between banks occurs in what is often
referred to as the interbank market.
 Foreign Exchange Market

– The spot market for each currency is characterized

by its liquidity, which reflects the level of trading
activity.
– Attributes of banks that provide foreign exchange:
▪ Competitiveness of quote
▪ Special relationship with the bank
▪ Speed of execution
▪ Advice about current market conditions
▪ Forecasting advice
 Foreign Exchange Market

• Foreign Exchange Quotations:

– Bid/ask spread: the difference between the bid
and ask prices (buy and sell quotes respectively)
– This spread is meant to cover the costs associated
with fulfilling requests to exchange currencies.
– Normally expressed as a percentage of the ask
quote:

– Factors that affect the spread:

 Foreign Exchange Market

• Interpreting Foreign Exchange Quotations:

– Direct quotation: the number of domestic
currency’s units per unit of foreign currency
– Indirect quotation: the number of foreign
currency’s units per unit of domestic currency
– Cross exchange rate: between two foreign
currencies
 International Money Market

• Composed of several large banks that accept

deposits and provide short-term loans in various
currencies.
• Used primarily by governments and large
corporations.
• Origins and development
– Eurodollars
– London Interbank Offer Rate (LIBOR)
• Money market interest rates among currencies
 International Credit Market

• Composed of the same commercial banks that serve

the international money market.
• These banks convert some of the deposits received
into loans (for medium-term periods) to
governments and large corporations.
• Syndicated loans in the credit market
• Regulations in the credit market
• Impact of the credit crisis
 International Bond Market

• The international bond markets facilitate

international transfers of long-term credit, thereby
enabling governments and large corporations to
borrow funds from various countries.
• Facilitated by multinational syndicates of investment
banks.
• A foreign bond is issued by a borrower foreign to the
country where the bond is placed.
• Eurobonds are bonds that are sold in countries other
than the country whose currency is used to
denominate the bonds.
 International Bond Market

• Eurobond market
• Development of other bond markets
• Risk of international bonds
– Interest rate risk
– Exchange rate risk
– Liquidity risk
– Credit risk
– International integration of credit risk
• Impact of the Greek Crisis
 International Stock Markets

• Enable firms to obtain equity financing in foreign

countries, thus help MNCs finance their international
expansion.
• Issuance of stock in foreign markets
• Issuance of foreign stock in the U.S.
• Non-U.S. firms listing on U.S. exchanges
• Investing in foreign stock markets
• How market characteristics vary among countries
• Integration of stock markets
• Integration of international stock markets and credit
markets
International Stock Markets
How Financial Markets
Serve MNCs