Lecture No.
International Financial Markets
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Chapter Outline
• Introduction
• Motives for Using International Financial
Markets
• Foreign Exchange Market
• International Money Market
• International Credit Market
• International Bond Market
• International Stock Market
• How Financial Markets Serve MNCs
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Lecture Outline
• Introduction
• Motives for Using International Financial
Markets
¤ Investors’ Motives
¤ Creditors’ Motives
¤ Borrowers’ Motives
• Foreign Exchange Market
¤ History of Foreign Exchange
¤ Foreign Exchange Transactions
¤ Forex Quotations
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International Financial Markets
• Introduction
¤ Growth in international business over the
last 30 years led to the development of
international financial markets
¤ Financial managers of MNCs must
understand the available international
financial markets so they can be used to
facilitate the international business of
MNCs
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Motives for Using
International Financial Markets
• Investors invest in foreign markets:
¤ to take advantage of favorable economic
conditions;
¤ when they expect foreign currencies to
appreciate against their own; and
¤ to reap the benefits of international
diversification.
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Motives for Using
International Financial Markets
• Creditors provide credit in foreign
markets:
¤ to capitalize on higher foreign interest
rates;
¤ when they expect foreign currencies to
appreciate against their own; and
¤ to reap the benefits of international
diversification.
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Motives for Using
International Financial Markets
• Borrowers borrow in foreign markets:
¤ to capitalize on lower foreign interest rates;
and
¤ when they expect foreign currencies to
depreciate against their own.
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Foreign Exchange Market:
History
• The foreign exchange market allows
currencies to be exchanged in order to
facilitate international trade or financial
transactions.
• The system for establishing exchange
rates has evolved over time.
¤ From 1876 to 1913, each currency was
convertible into gold at a specified rate, as
dictated by the gold standard.
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Foreign Exchange Market:
History
¤ This was followed by a period of instability,
as World War I began and the Great
Depression followed.
¤ The 1944 Bretton Woods Agreement called
for fixed currency exchange rates (±1%).
¤ By 1971, the U.S. dollar appeared to be
overvalued. The Smithsonian Agreement
devalued the U.S. dollar and widened the
boundaries for exchange rate fluctuations
from ±1% to ±2.25%.
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Foreign Exchange Market:
History
¤ Even then, governments still had difficulties
maintaining exchange rates within the
stated boundaries. In 1973, the official
boundaries for the more widely traded
currencies were eliminated and the floating
exchange rate system came into effect.
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Foreign Exchange
Transactions
• There is no specific building or location
where traders exchange currencies.
Trading also occurs round the clock.
• The market for immediate exchange is
known as the spot market.
• The 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.
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Foreign Exchange
Transactions
• Spot Market Structure
¤ Hundreds of banks facilitate foreign
exchange transactions.
¤ At any point in 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.
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Foreign Exchange
Transactions
• Spot Market Time Zones
¤ Forex trading hours vary among locations
because of different time zones.
¤ Thus, at any given weekday time, a bank
located somewhere in the world is open
and ready to accommodate foreign
exchange requests by MNCs.
¤ US forex market rate is influenced by UK
forex market rate as it opens prior to US
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Foreign Exchange
Transactions
• Spot Market Liquidity
¤ The spot market for each currency is
characterized by its liquidity, which reflects the
level of trading activity.
¤ The more buyers and sellers there are for a
currency, the more liquid the market for that
currency is.
¤ The spot markets for heavily traded currencies
such as the euro, the pound, and the yen are
extremely liquid and those for currencies of
less developed countries are much less liquid.
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Foreign Exchange
Transactions
• The following attributes of banks are
important to foreign exchange customers:
¤ competitiveness of quote
¤ special relationship between the bank and
its customer
¤ speed of execution
¤ advice about current market conditions
¤ forecasting advice
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Foreign Exchange
Transactions
• Banks provide foreign exchange services
for a fee: the bank’s bid (buy) quote for a
foreign currency will be less than its ask
(sell) quote. This is the bid/ask spread.
• bid/ask % spread = ask rate – bid rate
ask rate
• Example: Suppose bid price for £ = $1.52,
ask price = $1.60.
bid/ask % spread = (1.60–1.52)/1.60 = 5%
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Foreign Exchange
Transactions
• The bid/ask spread is normally larger for
those currencies that are less frequently
traded.
• The spread is also larger for “retail”
transactions than for “wholesale”
transactions between banks or large
corporations.
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Interpreting
Foreign Exchange Quotations
• Exchange rate quotations for widely
traded currencies are frequently listed in
the news media on a daily basis. Forward
rates may be quoted too.
• The quotations normally reflect the ask
prices for large transactions.
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Interpreting
Foreign Exchange Quotations
• Direct quotations represent the value of a
foreign currency in rupees, while indirect
quotations represent the number of units
of a foreign currency per dollar.
• Note that exchange rate quotations
sometimes include IMF’s special drawing
rights (SDRs).
• The same currency may also be used by
more than one country.
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Interpreting
Foreign Exchange Quotations
• A cross exchange rate reflects the amount
of one foreign currency per unit of another
foreign currency.
• Value of 1 unit of currency A in units of
currency B = value of currency A in Rs
value of currency B in Rs
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