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    Chapter 3

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    Feriel El Ilmi
    The chapter describes the major international financial markets: foreign exchange, money, credit, bond and stock markets. It discusses the evolution of foreign exchange from the gold standard to floating rates. The key aspects of the foreign exchange market include currency quotations, spot and forward markets. The international money market facilitates short-term borrowing across borders. The credit market includes syndicated loans and the Eurocredit market. International bonds include foreign bonds and Eurobonds. Finally, international stock markets allow firms to issue equity abroad through ADRs or foreign listings.

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    Chapter 3

    Uploaded by

    Feriel El Ilmi
    73 views22 pages
    The chapter describes the major international financial markets: foreign exchange, money, credit, bond and stock markets. It discusses the evolution of foreign exchange from the gold standard to floating rates. The key aspects of the foreign exchange market include currency quotations, spot and forward markets. The international money market facilitates short-term borrowing across borders. The credit market includes syndicated loans and the Eurocredit market. International bonds include foreign bonds and Eurobonds. Finally, international stock markets allow firms to issue equity abroad through ADRs or foreign listings.

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    The chapter describes the major international financial markets: foreign exchange, money, credit, bond and stock markets. It discusses the evolution of foreign exchange from the gold standard to floating rates. The key aspects of the foreign exchange market include currency quotations, spot and forward markets. The international money market facilitates short-term borrowing across borders. The credit market includes syndicated loans and the Eurocredit market. International bonds include foreign bonds and Eurobonds. Finally, international stock markets allow firms to issue equity abroad through ADRs or foreign listings.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    73 views22 pages

    Chapter 3

    Uploaded by

    Feriel El Ilmi
    The chapter describes the major international financial markets: foreign exchange, money, credit, bond and stock markets. It discusses the evolution of foreign exchange from the gold standard to floating rates. The key aspects of the foreign exchange market include currency quotations, spot and forward markets. The international money market facilitates short-term borrowing across borders. The credit market includes syndicated loans and the Eurocredit market. International bonds include foreign bonds and Eurobonds. Finally, international stock markets allow firms to issue equity abroad through ADRs or foreign listings.

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    You are on page 1of 22

    International Financial

    Markets
    Chapter 3
    Chapter Objectives
    This chapter will describe the:
    A. Foreign exchange market
    B. International money market
    C. International credit market
    D. International bond market
    E. International stock markets
    Foreign Exchange Market
    1. Allows for the exchange of one currency
    for another
    2. Exchange rate specifies the rate at which
    one currency can be exchanged for another
    History of Foreign Exchange
     The system used for exchanging foreign currencies has
    evolved:
    1. Gold Standard (1876 – 1913): each currency was
    convertible into gold at a specified rate
    2. Agreements on Fixed Exchange Rates: fixed exchange
    rate between currencies. Governments would intervene
    to prevent exchange rates from moving more than 1%
    above or below the fixed rate
    a. Bretton Woods Agreement 1944
    b. Smithsonian Agreement 1971
    3. Floating Exchange Rate System: boundaries were
    removed and exchange rates were allowed to fluctuate
    in accordance with market forces
    Foreign Exchange Transactions
     The average daily transaction volume in the
    foreign exchange market is about $4 trillion, with
    the $US involved in about 40% of the transactions
     Historical data could be downloaded from :
    http://www.oanda.com/currency/historical-rates
    /

    1. Over the counter market


    2. Foreign exchange dealers serve as intermediaries
    3. Spot Market: transaction for immediate exchange
    at the spot rate
    Spot Market
    1. Spot market structure: electronic
    2. Use of the Dollar in the spot market:
    commonly accepted medium of exchange
    in countries with weak currency
    3. Spot market time zones
    4. Spot market liquidity: more buyers and
    sellers means more liquidity
    Attributes of Banks That Provide
    Foreign Exchange
    1. Competitiveness of quote
    2. Special relationship with the bank
    3. Speed of execution
    4. Advice about current market conditions
    5. Forecasting advice
     Refer to p. 64
    Foreign Exchange Quotations
     Spot market interaction among banks: the
    exchange rate between two currencies should
    be similar across various banks. Otherwise,
    an arbitrage opportunity arises
     A bank’s bid (buy) is always lower than a

    bank’s ask(sell). Refer to the example p. 65


    (at the bottom)
     The bid-ask spread represents the difference

    between the bid and the ask quotes


    Foreign Exchange Quotations
     The differential between ask and bid quotes
    could be standardized by measuring it as a
    percentage of the spot rate:

    Ask Rate  Bid Rate


    Bid / ask spread in % 
    Ask Rate

     Refer to Exhibit 3.1. p. 65


    Factors That Affect the Spread
    1. Order costs: costs of processing orders
    (e.g., clearing costs and the costs of
    recording transactions)
    2. Inventory costs: costs of maintaining an
    inventory of a particular currency
    (opportunity costs)
    3. Competition: the more intense the
    competition, the narrower the spread
    4. Volume: liquidity
    5. Currency risk: exchange rate volatility
    Interpreting Foreign Exchange
    Quotations
     http://online.wsj.com/mdc/public/page/mdc_currencies.ht
    ml?mod=mdc_topnav_2_3002_europe

    1. Direct Quotation represents the value of a foreign currency


    in dollars (number of dollars per currency)
    Example: $1.031 per Euro
    2. Indirect quotation represents the number of units of a
    foreign currency per dollar
    Example: €0.97 per Dollar
    3. Cross Exchange Rates: exchange rate between two nondollar
    currencies. If the peso is worth $ 0.1 and the C$ is worth
    $0.7, what is the exchange rate between C$ and the peso?
     Refer to Exhibit 3.3 p. 69
     http://finance.yahoo.com/currency
    Forward, Futures, and Option Markets
    1. Forward Contracts: agreements between a foreign
    exchange dealer and an MNC that specifies the
    currencies to be exchanged, the exchange rate,
    and the date at which the transaction will occur
    2. Futures Contracts: similar to forward contracts but
    sold on an exchange
    3. Option Contracts
    a. Currency Call Option: provides the right to buy currency
    at a specified strike price within a specified period of time
    (importers)
    b. Currency Put Option: provides the right to sell currency at
    specified strike price within a specified period of time
    (exporters)
    International Money Market
    1. Corporations or governments in a particular
    country need for short-term funds denominated in
    a currency different from their home currency.
    2. Reasons for international money market:
    a. Need to borrow funds to pay for imports denominated in
    a foreign currency
    b. Borrowing in a currency in which the interest rate is lower
    Origins and Development
    1. European Money Market: Dollar deposits in
    banks in Europe and other continents are
    called Eurodollars or Eurocurrency.
    2. Asian Money Market: centered in Hong
    Kong and Singapore
    Standardized Global Bank Regulations
    1. Single European Act
    2. Basel Accord: standardized capital
    standards imposed on banks
    3. Basel II Accord: correct some Basel I
    accord’s inconsistencies (controlling
    operational risk, providing more
    information to shareholders, …)
    International Credit Market
    1. Eurocredit Market: loans denominated in
    dollars or other currencies often maturities
    of 5 years.
    2. London Interbank Offer Rate (LIBOR): rate
    charged for loans between banks
    3. Syndicated Loans: one single bank is
    unwilling or unable to lend the total
    amount to a company or a government
    International Bond Market
    1. Foreign bonds: issued by borrower foreign
    to the country where the bond is placed
    2. Eurobonds: bonds sold in countries other
    than the country of the currency
    denominating the bond
    Eurobonds
    1. Features:
    a. Bearer bonds
    b. Annual coupon payments
    c. Convertible or callable
    2. Denominations
    3. Underwriting Process
    a. multinational syndicate of investment banks
    4. Secondary Market
    International Stock Markets
    1. Issuance of Stock in Foreign Markets
    2. Issuance of Foreign Stock in the U.S.
    a. Yankee stock offerings ( stock issues by non-US firms on
    US markets)
    b. American Depository Receipts (ADR) (conversion ratio and
    ADR price in $, refer to p. 82-86)
    ◦Why do US investors invest in foreign stocks?
    ◦What are the advantages in buying ADRs?
    Exhibit 3.5 Comparison of Stock Exchanges
    (as of 2008)
    Exhibit 3.6 Impact of Governance on Stock
    Market Participation and Trading Activity
    Exhibit 3.7 Foreign Cash Flow Chart of an MNC

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