INSTRUMENTS IN INTERNATIONAL FINACIAL MARKETS - INTERNATIONAL FINANCE

Notes 14 Pages

Bengaluru City University

Bachelor of Business Administration

Contributed by

Prajwal Hallale

INTERNATIONAL FINANCE
VI SEM BBA

SUSHMITHA V, ASST PROFESSOR, MES INSTITUTE OF MANAGEMENT
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INTERNATIONAL FINANCE
CHAPTER 3- INSTRUMENTS IN INTERNATIONAL FINACIAL
MARKETS

Meaning: An international financial market is one of the mechanisms of International
Financial Management. The global financial market is more beneficial to borrowers and
investors, Borrowers are benefitted as the funds are made available in surplus and at low cost. It
benefits the investors by providing wide range of investment opportunities and allowing the
investors to build portfolios of international investments that diversify their risks. It functions
through International Banks, Euro currency market, Eurobond market and Global equity markets.

Definition: According to Garbbe, International financial markets consist of international
markets for foreign exchange. Euro currencies and Euro bonds.
International finuncial markets have been categorized into five markets:
A Foreign exchange markets
B. International money market
C. International credit market
D. International bond market
E. International stock markets

A. Foreign Exchange Market: The foreign exchange market allows for the exchange
of one currency for another. Large commercial banks serve this market by holding
inventories of cach currency, so that they can accommodate requests by individuals or
MNCs.
History of Foreign Exchange: The system used for exchanging foreign currencies has
evolved from the gold standard, to an agreement on fixed exchange rates, to a floating
rate system.
Interbank market: If a bank begins to experience a shortage in 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.

B. International Money Market: In most countries, local corporations commonly
need to borrow short-term funds to support their operations. Country governments may
also need to borrow short-term funds to finance their budget deficits. Individuals or local
institutional investors in those countries provide funds through short-term deposits at
commercial banks. In addition, corporations and governments may issue short-term
securities that are purchased by local investors, Thus, a domestic money market in each
country serves to transfer short-term funds denominated in the local currency from local
surplus units (savers) to local deficit units (borrowers).
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Two other important components of the international money market are:
1.European money market
2.Asian money market
1. European money market: The origins of the European money market can be traced to
the Euro currency market that developed during the 1960s and 1970s. MNCS
expanded their operations during that period, international financial intermediation
cmerged to accommodate their needs.
2. Asian money market: Like the European money market, the Asian money market
originated as a market involving mostly dollar-denominated deposits. Hence, it was
originally known as the Asian dollar market. The market emerged to accommodate the
needs of businesses that were using the U.S. dollar (and some other foreign currencies) as
a medium of exchange for international trade.

C. International credit market: Multinational corporations and domestic firms sometimes
obtain medium-term funds through term loans from local financial institutlons or through
the issuance of notes (medium-term debt obligations) in their local markets. However,
MNCs also have access to medium-term funds through banks located in foreign markets.
Loans of one year or longer extended by banks to MNCS or government agencies in
Europe are commonly called Euro credits or Euro credit loans. These loans are provided
in the so called Euro credit market. The loans can be denominated in dollars or many
other countries and commonly have a maturity of 5 years. The loan rate floats in
accordance with the movement of some market interest rate. such as the London
Interbank Offer Rate (LIBOR), which is the rate commonly charged for loans between
banks.

D. International Bond Market: Although MNCs, like domestic firms, can obtain long-
term debt by issuing bonds in their local markets, MNCs can also access long-term funds
in foreign markets. MNCS may choose to issue bonds in the international bond markets
for three reasons.
• Issuers recognize that they may be able to attract a stronger demand by issuing their
bonds in a particular foreign country rather than in their home country. Some countries
have a limited investor base, so MNCs in those countries seek financing elsewhere.
• MNCs may prefer to finance a specific foreign project in a particular currency and
therefore may attempt to obtain funds where that currency is widely used.
• Financing in a foreign currency with a lower interest rate may enable an MNC to reduce
its cost of financing, although it may be exposed to exchange rate risk.

Euro bond market: Eurobonds are bonds that are sold in countries other than the country of
the currency denominating the bonds.The major types of international bond instruments and their
distinguishing characteristics are:
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a) Straight fixed-rate bond issue: It has a designated maturity date at which the principle of
the bond issue is promised to be repaid.
b) Floating -Rates Notes (FRNs): They are typically medium- term bonds with their coupon
payments indexed to some reference rate.
c) Convertible bond: This issue allows the investor to exchange the bond for a pre-
determined number of equity shares of the issuer.
d) Zero coupon bond: These bonds are sold at a discount from face value and do
not pay any coupon interest over their life. At maturity the investor receives
the full face value.
e) Dual-currency bond: It is a straight fixed-rate bond which is issued in one currency and
pays coupon interest in that sane currency. At maturity, the principle is repaid in a
second currency.
The difference between Foreign bonds and Euro bonds:
The two segments of the international bond market are: foreign bonds and Euro bonds,
A foreign bond issue is one offered by a foreign borrower to investors in a national
capital market and denominated in that nation's currency.
A Eurobond issue is one denominated in a particular currency, but sold to investors in
national capital markets other than the country which issues the denominating currency.

E. International Stock Markets: MNCs and domestic firms commonly obtain long-term
funding by issuing stock locally. Yet, MNCs can also attract funds from foreign investors
by issuing stock in international markets. The stock offering may be more easily digested
when it is issued in several markets. In addition, the issuance of stock in a foreign country
can enhance the firm's image and name recognition there.

Nature and funetions of international financial market:
Nature:
• International financial markets undertake intermediation by transferring purchasing
power from lenders and investors to parties who desire to acquire assets that they expect
to yield future benefits.
• International financial transactions involve exchange of assets between residents of
different financial centers across national boundaries.
• International financial centers are reservoirs of savings and transfer them to their most
efficient use irrespective of where the savings are generated.

Functions: There are three important functions of financial markets:
• The interactions of buyers and sellers in the markets determine the prices of the assets
traded which is called the price discovery process.
• The financial markets ensure liquidity by providing a mechanism for an investor to sell a
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financial asset.
• The financial markets reduce the cost of transactions and information.
Benefits of International Financial Markets:
• International financial markets and the transactions there in has enabled and helped the
expansion of international trade based on comparative absolute advantage causing
welfare benefits in terms of higher income among participant nations.
• The grow th of international financial markets has facilitated cross-country financial flows
which contribute to be more efficient allocation of resources.

Classification of International Financial Markets:
International financial markets may be divided into money market and capital markets:
Money markets: This deals with assets created or traded with relatively short maturity.
say less than a year.
Capital markets: This deals with instruments whose maturity excecds one year or which
lack definite maturity. They are in the course of rapid evolution. Capital flows which
were formerly directed towards banks and controlled by Governments are now held by
individuals, institution or private mutual funds and can circulate freely and
instantaneously to projects which will yield the maximum profit. Electronic computerized
data transınission now gives them an unprecedented mobility on all the financial markets
on the planet. Moreover, the volume of such flows has grown tripling or increasing
tenfold in the past few years mainly as a result of the success of mutual funds, whose
assets often exceed those of many Governments.
Current Situation:
• Today, the main problem that the Goverments are facing is how to attract new investment
with a view to creating jobs and promoting sustained economic growth.
• Governments compete for capital.
• To this end, nations vie with each other through variations in their interest rates or their
rates of exchange and through the competitiveness of their markets.
• The world has become capitalist and the ever-increasing financial movements can reward
savings and productivity and thus strengthen a country's economy.
Demand for capital:
• During the 1900s, over 50 developing countries have created capital markets.
• During this period, 3 billion people have freed themselves from Marxist or government
controlled economies.
• These countries need capital to get their new market economies to take off.
• In Asia and Latin America, economies are in a state of full expansion; they must establish
infrastructures and find capital to sustain their economic growth.
• In the face of this increased demand for capital, the competition has become increasingly
fierce
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• China and India have appealed to the capital markets in order to avoid a recession. In
South Africa, reforms became essential when the international embargo on capital, led to
the country's paralysis.
• All these countries are feverishly engaged in establishing a complete capital market
infrastructure.
Supply of capital:
• Private capital is offered on the world investnent market for the purchase of bonds and
shares in companies and is outside government control.
• The capital comes mainly from mutual funds, pension funds or insurance funds and,
thanks to a worldwide network of computerized communication; it circulates freely in
search of the maximum profit.
• The assets of institutional investors amount to approximately$8,000 billion in the United
States and $6.000 billion in Europe.
• At present, these funds have invested less than 1 percent in the emerging markets.
• All projections indicate that investment in these markets will increase to 5 to 10 percent
of the total assets in the next 10years.
• These investors are now convinced that the emerging markets offer higher returns than
those of the industrialized countries and that the risk can be controlled by a policy of
diversification.
• There is therefore a unique opportunity during which countries seeking capital will have
access to the resources of the industrialized countries.

Meaning of Globalization: The process by which business develop international influence
by moving beyond domestic and national markets to other markets around the globe is called
globalization. Globalization implies the opening of local and nationalistic perspectives to a
border outlook of an interconnected and interdependent world with free transfer of capital,
goods, and services across national boundaries.
Stages of Globalization:
Stage l: The purpose of this stage is the physical movement of goods and services from the
country of its origin. It includes physically export and establishes one strong contact
oversens. As a result one market is established. Trial and errors are overcome, confidence is built
Stage2: The purpose of this stage is to study the whole nation and explore the avenues for
production. It includes finding out a right partner. Jointly promote the products and establish
brand in one market. As a result awareness is created in one territory. The demand level is
known for the production
Stage3: The purpose of this stage is to set up production facility with a local or alone. It
includes identifying location or develops a complete network. Reduce the cost and services
the market. As a result become close to the'customer at a reduced cost and part of the local.
Stage4: The purpose of this stage is to expanding to neighboring areas through production. It
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includes Take the products from the unit and spread in nearby countries and build brand
name. As a'result the whole region is aware. Loyalty is built. The network members become
patrons.
Stage5: The purpose of this stage is to review all the pitfalls and gear up to other regions. It
includes analyzing the potential in various regions. Evaluate the partners, investment climate and
Socio-Cultural background. As a result comparing and selection of right locations,right partners
and right markets.
Stage6: The purpose of this stage is to emerge as global enterprise. It includes production,
distribution, investing, build corporate image and face competition. As a result global
production, global investments, global brand name and status of global company are
achieved.
Implications of Globalization on Business:
Expanded Markets
Cheaper Resources
International Development
Competition
Exchange of Technology
Knowledge or Information transfer
Culture
More efficient markets
Transportation

Advantages of Globalization:
Proper use of resources
Multiple choices
Foreign Exchange
Creates Employment
Government incentives
Technology
Spreading of Risk of loss

Benefits to the consumcrs
Free trade
Free movement of Lalior
Increased Economies of Scale
Greater competition
Increased investment

Financial Globalization: The term financial globalization refers to the process by which
financial markets of various countries of the globe are integrated as one. Financial
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globalization may also be defined as a free movement of finance across national boundaries
without facing any restrictions.
The essential attributes for capital market stability, efficiency and growth are:
• Investor needs for information are well defined and met.
• The roles of the various stakeholders in these markets preparers, regulators, investors
standards setters and auditors are aligned and supported by effective forums for
• The auditing profession is vibrant, sustainable and providing sufficient choice fon ell
stakeholders in these markets.
• A new business reporting model is developed to deliver relevant and reliable
in a timely way.
• Large, collusive frauds are more and more rare.
• Information is reported and audited pursuant to globally consistent standards.

Globalization of Financial Markets: Over recent decndes, there has been a
increase in cross-border financial flows around the world. It includes:
• Various financial institutions including banks and institutional investors have expanded
their activities geographically. In this process, they acted as an intermediary to ohamel
funds from lenders to borrowers across natignal borders.
• The more mature securities markets have gained a clear cross-border orientntion In many
instances, newly issued securities are designed and offered to the public in such a way as
to maximize their appeal to international investors.

Meaning of Global markets: Global markets are markets in which the law of one price
applies, in the sense that it would be possible to buy or sell products for the same price
irrespective of geographical location and local circumstances. When products are purchased
and sold outside national boundaries, price dilferentials may remain as long as there are costs
specifically associated with cross-border exchange as opposed to exchange within national
boundaries. Hence, the process of internationalization of financial markets is only a step towards
global financial markets.
Benefits and risks associated with the Globalization of Financial Markets:
I. Economic Benefits of Globalization: Globally integrated financial markets provic
more flexible ways of both financing current account deficits and recycling current
account surpluses. Moreover, the free play of market mechanisms should tend to ensure
that both borrowers and lenders do not knowingly take excessive risks.
The economic benefits of globalization are:
➢ In order to attract the capital necessary for their development, national economies must
become, or remain, open to foreign investment and must adopt responsible fiscal and
monetary policies.
➢ A fully developed financial market also makes it possible to steer investments towards
the most useful projects, and thus to acquire the indicators essential to a market economy.
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This development will be achieved more rapidly if foreign investors have access to the
domestic market. Since Brazil opened the BOVESPA stock exchange to foreign investors, the
volume of transactions has increased tenfold.
➢ World capital also permits the transfer of essential technology which makes it possible
develop financial market architecture.
➢ The majority of Governments have made economic stability one of their highest
priorities. Thus, the lowering of customs barriers has introduced competition into
previously protected markets.
➢ The play of market forces may, however, also have adverse consequences. The decision
makers and controllers of capital, indeed, turn away from States which are experiencing
serious budget deficits or whose budgets are burdened by considerable social
expenditure.
➢ Lastly, it is believed that, if Governments reduce taxes on capital movements, create off-
shore markets and establish a stable and convertible currency, private capital will flow in.

II. More rapid spreading of technological advances: In a global financial market,
technological advances in payment, settlement and trading systems as well as in financial
information systems can be made available to all market participants instantaneously.

III. Financial innovation: Another source of benefit from the globalization of financial
markets is the spreading of financial innovation. Irrespective of their location of residence.
financial market participants may, provided they can demonstrate sufficient creditworthiness.
make use of new financial products as soon as these instruments start being marketed in the
global financial market place.

IV. Financial performance: More importantly, in open financial markets the entry of
foreign financial institutions into domestic financial markets can bring sizeable benefits, as
increased competition can help to enhance efficiency in the financial sector.

The risks associated with the globalization of financial markets are:

➢ Economic policy makers together with market participants have devoted considerable
attention to the issue of how best to avoid financial crises. In particular, in April 1999, a
grouping called the Financial Stability Forum (FSF) was created with the otjective of
promoting international financial stability through information exchange and
international co-operation in financial supervision and surveillance.
➢ In economic terms, the risks to financial stability may be seen as mainly arising from
market inefficiencies. In border terms, these inefficiencies can manifest themselves in
various ways, including externality and co-ordination problems.

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Meaning of Foreign Security: Foreign security means any security denominated or
expressed in forèign curreney. Usually this takes the form of shares, stocks, bonds.
debentures or any other Instrument It includes securities expressed in foreign currency, but
where redemption or any form of return such as interest or dividends is payable in [domestic
currency]
Innovations in Foreign Securities:
1 Cross-Listing of Shares: It refers to a lirm having its equity shares listed on one or more
foreign exchanges. The number of firms doing this has exploded in recent years.
Financial gains: Cross-listing is a principle source of corporate financing, and one of the
main reasons for a company to cross-list its shares on a foreign stock exchange raise
capital funds at a lower cost compared to debt financing.
Increased Liquidity: Cross-listing enables companies to trade their shares in numerous
time zones and multiple currencies.
Shares marketability: Cross-listing assists companies to expand their shareholders base
as it brings foreign securities closer to potential investors."
Marketing and Growth Motivations: Cross-listing in a foreign country will assist the
issuing company in its marketing and cross border expansion plan, as the company's
brand and its products will be identifiable to investors and consumers of the foreign
countries, creating new distributing channels and export opportunities.
2. Yankee Stock Offerings: The direct sale of new equity capital to U.S. public investors
by foreign firms Privatization in South America and Eastern Europe. Equity sales by
Mexican firms try ing to "cash in" following implementations of North American Free
Trade Agreements (NAFTA).
4.American Depository Receipts: Foreign stocks often trade on U.S. exchanges as ADRS.
It is a reccipt that represents the number of foreign shares that are deposited at a U.S.
bank. The bank serves as a transfer agent for the ADRS. ADRS are denominated in U.S.
dollars, trade on U.S. exchanges and can be bought through any broker.
5. Volvo ADR: Volvo trades in the U.S. on the NASDAQ under the ticker VOLVY. The
depository instltution is JP Morgan ADR Group. The custodian is a Swedislh firm. SE
Banken Custody.
6. Global Registered share: A share issued and registered in multiple marketş around the
world. Global registered shares represent the same class of shares. Also knows as "global
share."

Debt instruments:
The debt instruments are:
Commercial paper
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Convertible bonds
Carrot and stick bonds
Convertible bonds with a premium put
Debt wih ejuity warrants
Dual-currercy bonds
COPS (covered option securities)
ECU (European Currency Unit Bonds)
ICONS (Indexed Currency Option Notes)
PERLS (Principle Exchange-Rate-Linked Securities)
Flip-flop notes
FRNs (Floating Rate Notes)
Capped floater
Convertible FRNs
Drop-lock FRNs
Minimax FRNs
Indexed debt instruments
Bull and Bear bonds
Put bonds
Stripped government securities
CATS: Certificates Accrual on Treasury Certificates.
COUGRS: Certificates of Government Receipts.
STAGS Sterling Transferrable Accruing Government Securities
STRIPS: Separate Trading of Registered Interest and Principal of Securities
TIGRs: Treasury investment growth certificates
ZEBRAS: Zero Coupon Euro Sterling Bearer or Registered Accruing Certificates
Zero-coupon bonds
LYONS: Liquid yield option notes

Assets-Backed Securities:
CMOS (Collaterized mortgage obligations)
Mortgage backed Securities
Securitized receivables
CARDS (Certificate of Amortizing Revolving Debts)
CARS (Certificate of Automobile Receivables )
CLEOS (Collateralized Lease Equipment Obligations)
FRENDS (Floating Rate Enhanced Debt Securities)

Equity Instruments:
MMP: Money Market Preferred Stock or Dutch auction Preferred stock
CMPS: Capital Market Preferred Stock.
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INSTRUMENTS IN INTERNATIONAL FINACIAL MARKETS - INTERNATIONAL FINANCE

INSTRUMENTS IN INTERNATIONAL FINACIAL MARKETS - INTERNATIONAL FINANCE

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