Global Capital Market

Learning Objectives

• Benefits of global capital market
• Rapid growth of global capital market
• Risks of globalization in capital markets
• Comparison of Eurocurrency, global bond, and global equity markets
• Impact of foreign exchange risks on cost of capital

Benefits of the Global Capital Market

• Functions of a Capital Market:

  • Market makers connect investors and borrowers. (Commercial banks: indirect, Investment banks: direct)

• Attractions for Borrowers:

  • Lower Cost of Capital:
  • Domestic markets: higher costs
  • Global markets: lower costs
  • Cost of capital: price of borrowing money

• Attractions for Investors:

  • Portfolio Diversification:
  • International opportunities reduce risk.
  • Low correlation between different countries' stock markets.
  • Higher international integration increases market correlation.
  • Volatile exchange rates can lessen diversification benefits.

• Growth Factors:

  • Information Technology:
  • Instant communication, 24/7 trading, rapid information processing.
  • Deregulation:
  • Market liberalization since the 1970s, but the 2008 crisis raised regulation concerns.

Global Capital Market Risks

• Vulnerability to speculative capital flows:

  • “Hot money”: short-term, volatile investments.
  • “Patient money”: long-term, stable investments.

• Information Gaps:

  • Lack of quality information can lead to quick, dramatic investment changes.
  • Challenges in comparing foreign investments due to differing accounting standards.

The Eurocurrency Market

• Definition:

  • Eurocurrencies (e.g., Eurodollars) are low-cost sources for international funding.

• Attractions:

  • Less regulation allows for higher interest on deposits and lower borrowing costs.

• Drawbacks:

  • Higher exposure to foreign exchange risk due to fewer regulations.

The Global Bond Market

• Importance:

  • Bonds are a common source of financing (fixed-rate most common).
  • Types: Foreign bonds and Eurobonds.

• Attractions:

  • Lower regulatory constraints and favorable tax treatment.

The Global Equity Market

• Evolution:
  • Internationalization allows corporates to list stocks abroad and attract foreign investments.

Foreign Exchange Risk

• Floating Rate Issues:
  • Unpredictable exchange movements increase foreign borrowing costs.

Managerial Implications

• Opportunities: Firms can borrow at lower costs internationally.
• Risks: Increased foreign exchange risks and reduced regulatory oversight.