IBF Chapter-8 the-global-capital-market

1. INTERNATIONAL BUSINESS FINANCE
ACFN542-CREDIT HOURS:2
CHAPTER-EIGHT
THE GLOBAL CAPITAL MARKET
PROF. DR. ANBALAGAN CHINNIAH
PROFESSOR OF ACCOUNTING AND
FINANCE
COLLEGE OF BUSINESS AND ECONOMICS
SAMARA UNIVERSITY, AFAR STATE,
ETHIOPIA, EAST AFRICA
MAIL ID:DR.CHINLAKSHANBU@GMAIL.COM
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2. Functions of a Capital Market
 The capital market matches those who wish to
invest excess cash with those who wish to
borrow
 Intermediaries put the two parties together
(‘Market Makers’)
– Commercial Banks: pay depositors a rate of return
and make loans at a higher rate of return
– Investment Banks: broker a direct transaction
between an investor and borrower
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3. Advantage of a Global Capital Market
 For a borrower, it lowers the cost of capital
 See Figure 11.2 in the textbook; global capital market acts like a
supply shift in a supply/demand graph
 For an investor, it allows for international
portfolio diversification which theoretically
decreases the risk of a portfolio (more on this
later…)
 Overall, the global capital market achieves a
lower cost of capital which allows firms to take
on more long term projects because the hurdle
rate for the investment is lower (which leads to
more economic growth, etc.)
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4. Does the global capital market really achieve risk
reduction for investors?
 Research such as Solnik (1974) postulates that
global markets are weakly correlated
 According to portfolio theory, weak correlation
leads to diversification and less systematic risk
of the portfolio
 While during ‘normal’ times this may be true,
crisis are a different story!
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5. Weak correlation? Japan Market
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6. Weak Correlation? U.S. Market
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7. Weak Correlation? U.K. Market
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8. Strong Correlation!
 Benefit of a global market for investors may be
overstated because of a hidden risk - correlation risk
– Very difficult to hedge!
 Studies by Solnik and followers overlook the
endogenous relationship of the development of global
capital markets and correlation; the more investors shift
money abroad, the more correlated all markets become
 the LESS diversified a portfolio becomes
 Why? A crisis in one country leads investors to liquidate
holdings across portfolio to make up for shortfall 
cascading fall in global markets!
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9. Why do companies seek global equity?
 Improved liquidity
 Possible higher share price
 Increase the firm’s visibility with bankers,
suppliers, government, etc.
 “Acquisition currency”
 Compensate foreign management
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10. Eurocurrency Markets
 Eurocurrency – any currency banked outside of its
country of origin.
 Eurodollars – dollars banked outside of the U.S.
– Euroyen, europound, euro-euro
 1950 Eurocurrency Market is born as Eastern Europeans
were afraid to deposit $ in the U.S. fearing that they
would be seized to finance lost business from the
Communist takeover of Europe. Continued expansion by
OPEC nations during Oil spike in 1970’s.
– London was happy to take the money and paid higher interest
rates (see the next slide).
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11. Comparative Spreads Between Lending and Deposit
Rates in the Eurodollar Market
3.000 %
7.000 %
Domestic
Loan Rate
Domestic
Deposit Rate
Domestic Spread
of 4.000%
Eurodollar Loan Rate
Eurodollar Deposit Rate
Eurodollar Spread of 0.500%
Interest Rate
4.625 %
4.125 %
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12. Why doesn’t everyone bank in eurodollars?
 Eurocurrency market is not regulated; no FDIC
insurance in the case of U.S.
 In the case of a bank failure, depositors don’t have the
recourse that they do in domestic banking
 Therefore, the higher rate of interest paid on deposits is
simply a risk/reward calculation
 During September/October 2008, eurocurrency deposit
rates and lending rates (LIBOR, etc.) sky rocketed
because of this risk
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13. Global Bond Markets
 Foreign bonds are bonds issued in one country by a
foreign issuer.
– “Yankee Bonds” are bonds issued by a non-U.S. entity that are
traded in the U.S.
– “Samurai Bonds” are bonds traded in Japan issued by a non-
Japanese entity.
– “Bulldog bonds” are traded in the U.K. but issued by a non-U.K.
entity,
– “Rembrandt Bonds” are bonds traded in the Netherlands by a
non-Dutch entity,
– “Matador Bonds” are bonds traded in Spain issued by a non-
Spanish entity.
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14. Eurobonds
 Eurobonds have the following characteristics:
– Underwritten by an international syndicate
– Issued to investors in more than one country
– Generally, not issued in the country that issues the currency in
which they are denominated.
– Usually unregistered.
 Note: Eurobonds are named in accordance with the
currency in which they are denominated, not according
to where they are issued.
– Eurodollar bonds are denominated in U.S. dollars but not issued
in the U.S., Euroyen bonds are denominated in yen, but not
issued in Japan.
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15. Global Equity Markets
Source: www.world-exchanges.org
Market Capitalization May 2009 (USD Billions)
Americas 15, 257
Asia Pacific 11, 602
Europe, Middle East, Africa 10, 515
TOTAL 37, 374
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16. China’s Equity Markets
 Shanghai Stock
Exchange (SHSE)
 Shenzhen Stock
Exchange (SZSE)
Exchange Shanghai SE Shenzhen SE Hong Kong NYSE
End 1990 299 1,774
End 1991 357 1,989
End 1992 413 1,750
End 1993 477 1,945
End 1994 529 2,128
End 1995 542 2,242
End 1996 583 2,476
End 1997 658 2,626
End 1998 680 2,670
End 1999 708 3,025
End 2000 790 2,468
End 2001 646 508 867 2,400
End 2002 715 508 978 2,366
End 2003 780 505 1,037 2,308
End 2004 837 536 1,096 2,293
End 2005 833 544 1,135 2,270
Number of Listed Companies
Source: world-exchanges.org
Exchange Shanghai SE Shenzhen SE Hong Kong NYSE
End 1990 NA NA 83,385.9 2,692,123.0
End 1991 NA NA 121,880.9 3,484,340.3
End 1992 NA NA 171,983.5 3,798,238.1
End 1993 NA NA 385,042.7 4,212,956.0
End 1994 NA NA 269,507.8 4,147,936.7
End 1995 NA NA 303,705.3 5,654,815.4
End 1996 NA NA 449,218.8 6,841,987.6
End 1997 NA NA 413,322.6 8,879,630.6
End 1998 NA NA 343,566.5 10,277,899.8
End 1999 NA NA 609,090.4 11,437,597.3
End 2000 NA NA 623,397.7 11,534,612.9
End 2001 NA NA 506,072.9 11,026,586.5
End 2002 306,443.6 156,647.6 463,054.9 9,015,270.5
End 2003 360,106.3 152,872.4 714,597.4 11,328,953.1
End 2004 314,315.7 133,404.6 861,462.9 12,707,578.3
End 2005 286,190.3 115,661.9 1,054,999.3 13,310,591.6
Market Capitalization (in US millions)
Source: world-exchanges.org
HK less than 1/3 the size of NYSE NYSE had 18x the Market Cap
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17. Sourcing Equity Globally
 Designing a Strategy to Source Equity Globally
 American Depository Receipts (ADRs) are certificates
traded in the United States and denominated in US
dollars.
– ADRs are sold, registered, and transferred in the US in the same
manner as any share of stock with each ADR representing some
multiple of the underlying foreign share (allowing for ADR pricing
to resemble conventional US share pricing between $20 and $50
per share).
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18. ADRs Levels
 Level I
– OTC only
 Level II
– Listed on a U.S. stock exchange.
 New York Stock Exchange (NYSE), NASDAQ, and the
American Stock Exchange (AMEX).
 Level III
– Firm can also raise money
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19. Popular ADRs
Bank of New York: www.adrbny.com
JP Morgan: www.adr.com
Novartis – Biotech Sweden
HSBC – Banking UK
Nestle – Switzerland
Lan.com – Airline Chile
Ericsson – Telecom Switzerland
Vodafone – Telecom UK
Wipro – IT India
Nokia – Telecom Finland
Elan – Biotech Ireland
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20. Islamic Finance
 Muslims represent 1/4th of the world’s population.
 Under Islam, the following beliefs affect business and
finance:
– Making money from money is not permissible
– Earning interest is prohibited
– Profit and loss should be shared
– Speculation is prohibited
– Investments should only support activities that are legal under
Islamic law
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21. Islamic Finance
 An Islamic bank cannot pay interest to depositors who
are Muslim.
– So depositors are considered shareholders and the returns they
receive are a function of the bank’s investments.
– Returns are not guaranteed, because profit and loss must be
shared.
 To buy a home under Islamic law:
– The buyer selects a property which is purchased by the bank.
– The bank then resells the property to the buyer at a higher price
and the buyer is allowed to pay off the bank over a period of
time.
– One problem: in the U.S. and the U.K. the difference is not a tax
deductible expense for the homeowner.
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22. Implications for Managers
 Global Market Opportunities
 Currency Management
– Forecasting & Hedging Activities
– Strategic Flexibility
 Dispersed Production
 Outsourcing
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