International Financial Market
International Financial Market | Assignment – 01 V. Prabaseelan S/07/735 introduction to international financial market Background to international finance International finance as a subject is not new in the area of financial management, it has been widely covered earlier in international economics and it is only the fast growth of international business in the post-world war II and the associated complexities in the international transactions that made the subject as an independent area of study.
With growing operation of multinational corporations, a number of complexities arose in the area of their financial decisions. Apart from the considerations of where, when and how to invest, the decision concerning the management of working capital among their different subsidiaries and the parent units became more complex, especially because the basic policies varied from one MNC to another. Those MNCs that were more interested in maximizing the value of global wealth adopted a centralized approach while those not interfering much with their subsidiaries believed in a decentralized approach.
Normally there is a mix of the two approaches in varying proportions, for which the study of international finance has come to be more relevant. The second half of the twentieth century has also experienced a vast magnitude of lending by international and regional development banks (e. g. City bank, Barclays, African development Bank, Standard Chartered bank etc) and different governmental and non-governmental agencies. The movement of funds in form of interest and amortization payments needed proper management.
Besides, there were big changes in the character of the international financial market with the emergence of euro banks and offshore banking centers and of various instruments, such as Euro bonds, euro notes and euro commercial papers. The nature of the movement of funds became so complex that proper management became a necessity and the study of international finance became highly of important. Definition of international finance International finance is the branch of economics that studies the dynamics of foreign exchange, foreign direct investment and how these affect international trade.
Also studies the international projects, international investment and the international capital flow. International Finance can be broadly defined, as the study of the financial decisions taken by a multinational corporation in the area of international business i. e. global corporate finance. International finance draws much of its background from the preliminary studies in the topics of corporate finance such as capital budgeting, portfolio theory and cost of capital but now viewed in the international dimension. International finance versus domestic finance
International finance is to a great extent, similar to domestic corporate finance. A domestic company takes up a project for investment only when the net present value of cash flows is positive and it shapes the working capital policy in a way that maximizes profitability and ensures desired liquidity. It is not different in case of international finance. Again, the financing decisions in respect of whether a domestic or an international company aims at minimizing the overall cost of capital and providing optimum liquidity.
Domestic financial management is concerned with the costs of financing sources and the payoffs from investment. In domestic arena, movements in exchange rates are substantially ignored. But when we move outside of this purely domestic field, there is no way that we can analyze international financing and investment opportunities without an understanding of the impact of foreign exchange rates upon the basic model of financial management. However, international finance has a wider scope than domestic corporate finance and it is designed to cope with greater range of complexities than the domestic finance.
The reasons are as follows:- * The MNCs operate in different economic, political, legal, cultural and tax environments * They operate across and within varied ranges of product and factor markets which vary in regard to competition and efficiency. * They trade in a large number of currencies as a result of which their dependence on the foreign exchange market is quite substantial. * They have easy access not only to varying domestic capital markets but also to unregulated international capital markets which differ in terms of efficiency and competitiveness.
THE INTERNATIONAL MONETARY SYSTEM (IMS) Simply, the international monetary system refers primarily to the set of policies, institutions, practices, regulations and mechanisms that determine the rate at which one currency is exchanged for another. The international monetary system which prevails today has evolved over a period of more than150 years. In the process of evolution, several monetary systems came into existence, which either collapsed due to their inherent weakness or were modified to cope with the changing international economic order.
An international monetary system is required to facilitate international trade, business, travel, investment, foreign aid, etc. IMS has evolved over time as international trade, finance, and business have changed, as technology has improved, as political dynamics change, etc. Example: evolution of the European Union and the Euro currency impacts the IMS. International Financial Markets A financial market is much like any other market you may be very familiar with, like a farmer’s market, but instead of apples and flowers, you have stocks, bonds, derivatives, and other financial products that change hands between individuals and institutions.
If you purchase a stock through your stock broker, he’s accessing the financial markets to make that purchase for you. “International” just refers to the idea that financial marketing carried out by companies overseas or across national borderlines. This strategy uses an extension of the techniques used in the home country of a firm. It refers to the firm-level and country-level marketing practices across the border. The following kinds of international financial markets are generally identified. * (1)Foreign exchange market * (2)International money market * (3)International capital market (3. 1) International stock market * (3. 2) International dept/bond market * (4)Derivatives market (01)Foreign exchange market 1. EXCHANGE RATE An exchange rate is the rate at which one currency can be exchanged for another. In other words, it is the value of another country’s currency compared to that of our own. Foreign exchange is one of the most exciting, fast-paced markets around the world. Until recently, trading in the Foreign exchange market had been the domain of large financial institutions, corporations, central banks, hedge funds and extremely wealthy individuals.
The foreign exchange market is the “place” or “a situation” where currencies are traded. Currencies are important to most people around the world, whether they realize it or not, because currencies need to be exchanged in order to conduct foreign trade and business. 2. GEOGRAPHICAL EXTENT OF FOREIGN EXCHANGE MARKET Geographically the foreign exchange market ps the globe, with prices moving and currencies traded somewhere every hour of every business day.
Major world trading starts each morning in Sidney and Tokyo, moves to Hong Kong and Singapore, passes on to Bahrain, shifts to the main European markets of Frankfurt, Zurich and London, jumps the Atlantic to New York, goes west to Chicago and ends up in Francisco and Los Angeles. The market is deepest, or most liquid, early in the European afternoon, when the market of both Europe and the US east cost are open. This period is regarded as the best time to ensure the smooth execution of a very order. 3. ORGANIZATION OF THE FOREIGN MARKET
If there were a single international currency, there would be no need for a foreign exchange market. The foreign exchange market is not a physical place; rather it is electronically linked networks of banks, foreign exchange brokers and dealers whose main function is to bring together buyers and sellers of foreign exchange. It is not confined to any one country but is dispersed throughout the leading financial centers of the world: London, New York city, Paris, Zurich, Amsterdam, Tokyo, Toronto, Milan, Frankfurt and other cities. Trading is generally done by telephone or telex machine.
Foreign exchange traders in each bank usually operate out of a separate foreign exchange trading room. Each trader has several telephones and surrounded by display monitors and telex and fax machines feeding up-to- the minute information. The Foreign exchange market provides plenty of opportunity for investors. However, in order to be successful, a currency trader has to understand the basics behind currency movements. TYPES OF Currency Markets 1. Spot Market * It is the market for currency for immediate delivery. The price of foreign exchange in the spot market is referred to as the spot exchange rate or simply the spot rate. . Forward Market * It is the market for the exchange of foreign currencies at a future date. 3. Futures Market * Although the futures market trading is similar to forward market trading in that all transactions are to be settled at a future date, futures markets are actual physical locations where anonymous participants trade standard quantities of foreign currency for delivery at standard future dates. (02)International money market Each central bank usually holds some form of reserve that is acceptable in settling international transactions.
International monetary reserves are mainly gold, or “money market assets” in some country whose currency is widely used, such as the United States dollar. Because world trade continually gives rise to various needs for payment in various currencies, an international money market must exist so that traders with an excess of one currency can use it to buy another currency for which they have a need. Within the scope of convertibility arrangements, this trading in currencies is carried out by skilled intermediaries, usually banks or specialized foreign exchange brokers and dealers.
Changes in a country’s balance of payments may affect the usefulness or prestige of its currency. A sustained and substantial balance of payments deficit (out payments larger than in payments), for example, will result in continuous large increases in the world supply of its currency, possibly leading to some decline in its acceptability abroad and to a loss of international monetary reserves. At the same time, an outward drain may reduce the reserves of the commercial banks (the base for the domestic money supply), unless the central bank takes offsetting action.
The internal money markets of a surprisingly high proportion of the countries of the world are quite rudimentary. The work of the money market in these countries is done largely by transfers of deposit balances, government securities, or foreign exchange among a few banks and between them and the central bank. But in nearly all such cases there is genuine discontent with the rigidity of these limited facilities and a desire to develop a structure, as well as instruments and procedures, which would provide the open-market attributes of the arrangements that have evolved in the leading countries. 03)International capital market International capital market is that financial market or world financial center where shares, bonds, debentures, currencies, hedge funds, mutual funds and other long term securities are purchased and sold. International capital market is the group of different country’s capital market. They associate with each other with Internet. They provide the place to international companies and investors to deal in shares and bonds of different countries.
After invention of computer and Internet and revolution of financial market in 2010, almost all financial markets are converted in international capital markets. We can give the example of Hong Kong, Singapore and New York world trade centre. International capital market was started with dealing of foreign exchange. International capital market’s daily turnover has crossed $ 5 trillion. International capital market is very helpful for reducing the risk of small company because in international market, you can buy different countries companies’ shares, debentures and mutual funds.
Different countries have different business environment, so if any country is facing loss and due to financial crisis, your investment in that country may suffer losses but you can fulfill this loss from other country’s investment. So, overall risk will be reduced by this technique. Suppose, a company wants to invest his money, then it is good option, that ‘A’ company must invest it in international market. He can invest with following way and make his best portfolio: a) ‘A’ company can buy 10000 shares of USA Company. b) ‘A’ company can buy 10000 shares of Indian company. ) ‘A’ company can buy 10000 bonds of UK Company. d) ‘A’ company can also invest in the mutual funds of Pakistan or USA or Canada. (3. 1)International stock market A study on the international stock market gives comprehensive information on the various stock markets of the world. A stock market is typically a market where the trading of company stocks and derivatives is carried out. In order to be traded in the stock market, the securities need to be listed in the stock exchange. The international stock markets are the main sources for the corporations, companies and governments to collect money.
The corporations and governments issue their securities in the stock market thus going public and raising additional capital for their business or further development. The liquidity nature of the stock markets ensures the investors to sell their securities easily and quickly. The international stock markets play an important part to control and regulate the course of international finance. It has been seen that the economic activity of a country is most importantly affected by the price of shares and other assets. For example, the rising trend of shares may interpret that the business investment in the country is in the growing stage.
The prices of the shares also invariably affect the household wealth. Hence, the central bank of each country makes it a point to keep an eye on the activities and behavior of the stock markets. The stock markets also share the responsibility of carrying out the security transaction in a smooth way. The functioning of the international stock markets also construes the economic growth of a particular country. The international stock market is influenced by the trading of some of the major stock exchanges of the world like NASDAQ, NYSE Euronext, Bombay Stock Exchange and London Stock Exchange. 3. 2)International debt market International debt markets are primarily markets for ‘bonds issued’ outside the nation. The government and corporations borrow money by issuing bonds. International bonds offer investors an opportunity to earn better returns than from their country issued fixed income investments. There is no single international bond market as such. The international bond market is divided into three separate types of bond markets: Domestic Bonds, Foreign Bonds, and Eurobonds. (a)Domestic Bonds The market for domestic bonds is a part of the international bond market.
Domestic bonds are brought out on a local basis and domestic borrowers are responsible for issuing the local bonds. Domestic bonds are normally designated in the local currency. (b)Foreign Bonds The foreign bond market is that in which bonds are brought out by foreign borrowers. The foreign bonds are normally designated in the local currency. The local market authorities look after the issuing and selling of foreign bonds. Foreign Bond Markets The foreign bonds are traded in the foreign bond markets which constituted a significant portion of the international bond market until a few decades ago.
Some defining characteristics of the foreign bond markets are: * Issuers are normally governments and private sector utilities such as the railway companies * It was standard practice to underwrite as well as organize underwriting risk * Issues were pledged by the retail investors and the institutional investors * The structure of a foreign bond at that time is similar to the present day foreign bonds * Continental private banks and old merchant houses in London connected the investors and the issuers (c)Eurobonds
Eurobonds differ from the others in that they are not sold in any particular national bond market. Eurobonds are issued by a group of multinational banks. If a Eurobond is designated in any currency, it would be sold outside the country which uses that currency. For example if a Eurobond is denominated in the United States dollar, it would not be sold in the United States. (04)Derivatives market The derivatives market is the financial market for derivatives, financial instruments like futures contracts or options, which are derived from other forms of assets.
It is a contract between a buyer and a seller entered into today regarding a transaction to be fulfilled at a future point in time, for example, the transfer of a certain amount of US dollars at a specified USD-EUR exchange rate at a future date. Over the life of the contract, the value of the derivative fluctuate with the price of the so-called “underlying” of the contract – in our example, the USD-EUR exchange rate.
The life of a derivative contract, that is, the time between entering into the contract and the ultimate fulfillment or termination of the contract, can be very long – in some cases more than ten years. Given the possible price fluctuation of the underlying and thus of the derivative contract itself, risk management is of particular importance. The market can be divided into two, that for exchange-traded derivatives and that for over-the-counter derivatives. The legal nature of these products is very different as well as the way they are traded, though many market participants are active in both.