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Chapter # 12
The Global Capital
Market
Presented by
Prof. Dr. Zafar U. Ahmed

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 Benefits of the Global Capital Market 1

The Functions of a Generic Capital Market

Market makers are the financial service companies that
connect investors and borrowers, either directly or indirectly.
• Commercial banks perform an indirect connection function.
• Investment banks perform a direct connection function.

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 Figure 12.1 The Main Players in the Generic Capital
Market

Access the text alternative for slide images.

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 Benefits of the Global Capital Market 2

The Functions of a Generic Capital Market continued

Capital market loans:
• Equity loans – made when a corporation sells stock to
investors.
• Debt loans – requires corporations to repay a
predetermined portion of the loan amount at regular
intervals regardless of how much profit it is making.

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 Benefits of the Global Capital Market 3

Attractions of the Global Capital Market

The Borrower’s Perspective: Lower Cost of Capital.
• Domestic capital market – higher cost of capital.
• Global capital market – lower cost of capital.
• Cost of capital refers to the price of borrowing money.

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 Benefits of the Global Capital Market 4

Attractions of the Global Capital Market continued

The Investor’s Perspective: Portfolio Diversification.
• Wider range of investment opportunities.
• Investors can diversify their portfolios internationally,
reducing risk.
• Systematic risk—movement in a stock’s portfolio’s value that
are attributable to macroeconomic forces affecting all firms in
an economy.

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 Benefits of the Global Capital Market 5

Attractions of the Global Capital Market continued

The Investor’s Perspective: Portfolio Diversification continued
• Relatively low correlation between movement of stock
markets in different countries.
• Growing perception that integration of global economy and
emergence of global capital market has increased
correlation between different stock markets.
• Risk-reducing effects of international portfolio
diversification would be greater except for the volatile
exchange rates associated with the floating exchange rate
regime.

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 Benefits of the Global Capital Market 6

Growth of the Global Capital Market

Information Technology.
• Advances have created instantaneous communication.
• Allows market makers to absorb and process large
volumes of information from around the world.
• 24-hour a day trading.
• “Shocks” spread quickly.

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 Benefits of the Global Capital Market 7

Growth of the Global Capital Market continued

Deregulation:
• Response to development of Euro currency market.
• Increasing acceptance of the free market ideology.
• Many countries started to dismantle capital controls in the
1970s.
• Financial crisis of 2008 - 2009 caused experts to question if
deregulation had gone too far.
• Need for new regulations to govern sectors of financial
services industry, including hedge funds.

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 Benefits of the Global Capital Market 8

Global Capital Market Risks

Individual nations may be more vulnerable to speculative
capital flows.
• Could destabilize national economies.

Economist Martin Feldstein:

• “Hot money” refers to short-term capital.
• “Patient money” supports long-term cross-border capital
flows.
• Investors need better information about foreign assets to
make the global capital market work more efficiently.

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 Benefits of the Global Capital Market 9

Global Capital Market Risks continued

Lack of information about the quality of foreign investments
may encourage speculative flows.
• Causes investors to react to dramatic events in foreign
nations and move their money too quickly.
• Different accounting methods make it difficult to compare.

In the 2000s, there has been rapid movement toward

harmonization of different national accounting standards.

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 The Eurocurrency Market 1

Eurocurrency
• Eurodollars account for two-thirds of all Eurocurrencies.
• Can be created anywhere in the world.
• Important and relatively low-cost source of funds for
international businesses.

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 The Eurocurrency Market 2

Genesis and Growth of the Market

Eastern European holders of dollars were afraid to deposit
their money in the U.S.
• Many deposited these dollar holdings in London.
British government prohibited British banks from lending
British pounds to finance non-British trade in 1957.
U.S. government enacted regulations that discouraged U.S.
banks from lending to non-U.S. residents in 1960s.
• Oil price increases engineered by OPEC created huge
amounts of dollars that were deposited in banks in London.

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 The Eurocurrency Market 3

Attractions of the Eurocurrency Market

Lack of government regulation.
• Allows banks to offer higher interest rates on Eurocurrency
deposits than on deposits made in the home currency, and
charge borrowers a lower interest rate.
• Banks have more freedom in their dealings in foreign
currency.
• Companies receive a higher interest rate on deposits and
pay less for loans.

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 The Eurocurrency Market 4

Drawbacks of the Eurocurrency Market

• In a regulated system, the chance of bank failure is lower.
• Borrowing funds internationally can expose a company to
foreign exchange risk.

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 The Global Bond Market 1

Bonds are an important means of financing.

Most common is fixed-rate bond – receives a fixed set of
cash payoffs.
International bonds:
• Foreign bonds are sold outside the borrower’s country and
are denominated in the currency of country where they are
issued.
• Eurobonds are routinely issued by multinational
corporations, large domestic corporations, sovereign
governments, and international institutions.

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 The Global Bond Market 2

Attractions of the Eurobond Market

An absence of regulatory interference.
• Fall outside of the regulatory domain of any single nation.
Less stringent disclosure requirements than in most domestic
bond markets.
A favorable tax status.
• U.S. laws revised in 1984 to exempt any withholding tax for
holders of bonds issued by U.S. corporations.
• Caused other governments to liberalize their tax laws to
avoid outflows of capital.

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 The Global Equity Market 1

National equity markets historically separated by regulatory

barriers.
• Difficult to take capital out of a country and invest it
elsewhere.
• Corporations frequently lacked the ability to list their shares
on stock markets outside their home nations.
• Difficult to attract equity capital from foreign investors.

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 The Global Equity Market 2

Consequences of international equity investment:

1. Internationalization of corporate ownership.
2. Companies historically rooted in one nation are listing
stock in equity markets of other nations.

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 Foreign Exchange Risk and the Cost of
Capital
Floating exchange rate regime complicates foreign exchange
risk.
• Adverse movements in foreign exchange rates can
substantially increase the cost of foreign currency loans.
• Unpredictable movements in exchange rates can inject risk
into foreign currency borrowing.

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 360° View: Focus on Managerial
Implications
Growth of the Global Capital Market
• Created opportunities for international businesses that
wish to borrow and/or invest money.
• Firms can often borrow funds at a lower cost than is
possible in a purely domestic capital market.
• The global market lacks government regulation.
• Foreign exchange risk is greater.
• Firms, institutions, and individuals can diversify their
investments to limit risk.

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 Thank You
Question and Answer

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