Global Capital Market Notes

Global Capital Market Overview

Learning Objectives

  • Benefits of Global Capital Market: Understand the advantages gained by tapping into global capital.
  • Growth of Global Capital Market: Identify factors contributing to rapid expansion.
  • Risks Associated: Discuss potential dangers of capital market globalization.
  • Comparison of Markets: Differentiate benefits and risks of Eurocurrency, global bond, and equity markets.
  • Foreign Exchange Risks: Analyze how these affect capital costs.

Benefits of the Global Capital Market

Functions of a Generic Capital Market
  • Market Makers: Financial service firms that connect investors and borrowers.
    • Commercial Banks: Indirectly connect borrowers with investors.
    • Investment Banks: Directly connect borrowers with investors.
Types of Capital Market Loans
  • Equity Loans: Sold via shares to investors participating in corporate growth.
  • Debt Loans: Fixed repayments irrespective of profit margins; critical for financial planning and stability.
Attractions of Global Capital Market
  • Lower Cost of Capital:
    • Domestic markets tend to have a higher cost of capital compared to global markets.
    • Cost of capital is the price of borrowing.
Investor's Perspective: Portfolio Diversification
  • Wider Opportunities: Expands investment options globally to reduce overall risk.
  • Systematic Risk: Relates to market-wide factors affecting portfolio values.
    • Lower correlation between stock market movements across different countries enhances diversification.
    • However, higher global economic integration has increased correlations as well.
    • Volatile exchange rates can negate diversification benefits.
Growth Factors in the Global Capital Market
Information Technology
  • Advanced technology enables instant communication and 24-hour trading.
  • Captures and processes vast data for quick decision-making.
Deregulation
  • Increased acceptance of free market ideology led to reduced capital controls.
  • Post-2008 financial crisis raised questions on the extent of deregulation needed.

Risks of the Global Capital Market

  • Speculative Capital Flows: Nations may become vulnerable to volatile short-term capital, potentially destabilizing economies.
  • Information Asymmetry: Lack of reliable data on foreign investments leads to rapid, uninformed capital movement.
  • Accounting Standards: Diverse national accounting practices complicate comparisons of investment quality.

The Eurocurrency Market

Characteristics
  • Definition: Eurocurrencies, primarily Eurodollars, are created outside the U.S. and serve as a cost-effective resource for international companies.
  • Regulatory Appeal: Lacks government oversight, allowing banks to offer competitive interest rates.
Drawbacks
  • Regulatory Safety: Without regulation, banks face higher risks of failure. Borrowers may experience foreign exchange risk due to currency fluctuations.

The Global Bond Market

Importance
  • Bonds serve a crucial financing function; fixed-rate bonds provide predictable cash flows.
  • Categories include foreign bonds (outside the borrower's country) and Eurobonds (offered by multinationals, etc.).
Advantages of Eurobond Market
  • Minimal regulatory interference and favorable tax conditions encourage capital flow.

The Global Equity Market

Historical Separation
  • Previously, national markets faced significant barriers restricting capital movement and investment opportunities.
  • Now, increased internationalization allows cross-border equity investments.
Effects of International Equity Investment
  1. Growing international corporate ownership.
  2. Firms from one nation are increasingly listing stocks in other countries.

Foreign Exchange Risk and Cost of Capital

  • The floating exchange rate regime adds complexity, with adverse currency movements increasing borrowing costs.
  • Unpredictable exchange rate fluctuations can heighten borrowing risk.

Managerial Implications

  • The global capital market offers reduced borrowing costs compared to domestic only.
  • Lack of regulation presents risk management challenges while allowing for diversified investments that mitigate some risks.