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International Financing and International Financial Markets
FIU –
International Finance
Session 12
Use of International Financial Markets
Foreign cash flow movements of a typical MNC:
• Foreign trade. Exports generate foreign cash inflows, while imports require cash outflows.
• Direct foreign investment. Cash outflows to acquire foreign assets generate future inflows.
• Short-term investment or financing in foreign securities, usually in the Eurocurrency market.
• Longer-term financing in the Eurocredit, Eurobond, or international stock markets.
Implications for business
• Firms can borrow funds at a lower cost than they could domestically
• Minimum regulation in international capital markets helps lower the cost of capital, but also increases risk in both currencies and security
• International capital market provides opportunities for portfolio diversification and the lowering of systematic risk
Functions of a Generic Capital Market
• Brings together:– Those who want to invest:
• corporations, individuals, nonbank financial institutions.
– Those who want to borrow:• individuals, companies, governments.
• Market makers:– Commercial and investment banks that connect
investors with borrowers.
11-1
The Main Players in a Generic Capital Market
Investors: Companies Individuals Institutions
Market makers:“Intermediaries “ Commercial bankers Investment bankers
Borrowers: Individuals Companies Governments
11-2
Financial Intermediaries
• Middle people
• Being pushed out
• Disintermediation
• Who will preserve order if they are pushed out?
Attraction of the Global Capital Market?
• Increases the supply of funds available for borrowing.
• Borrower’s perspective– Lowers the cost of capital.
• Investor’s perspective– Provides a wider range of investment
opportunities
Financing Alternatives
• Internally generated cash - earnings
• Short and long term external funds:– Debt– Equity– Loans
• Traditional bank loans
• Private bonds from pension funds, insurance companies
What are the differences?
• Equity – stock – giving ownership to investors – giving up control?
• Debt – bonds – no ownership is relinquished
• Loans
Debt
The preferred method of financing….
• WHY?
BASIC FEATURES OF A BOND• Long-Term
• Fixed Income
• Interest Payments
• Principal, Par Value, Face Value ($1,000)
• Maturity– Short-Term (Money Market)– Intermediate (Notes)– Long-Term (Bonds)
Bond featuresCouponTerm to MaturityPrincipal (Par Value)Market Value (Price)Ownership
• Bearer Bonds• Registered Bonds
• Consider two bonds that are identical, except one is callable while the other is not. Which bond will sell at a higher price?
Straight Bond vs Callable Bond
Value ofstraight bond
25 50 75 100 125 150
25
50
75
100
bondValue of
Straight bond
Bond callableat 100
High-Yield Bonds
•Speculative Grade Bonds or Junk Bonds•Carry a Rating of BB (Ba) or Lower •Michael Milken - Firms Involved in Leveraged Buyouts• “Fallen Angels”
•Small Growth Firms
INTERPRETING BOND QUOTES
Corporate Bond Quotes
CurrentBonds Yield Volume Close Net Change
IBM 7 1/4 02 6.9 33 104 3/8 +3/8
Types of bonds
• Domestic Bonds –issued locally by a domestic borrower and denominated in the local currency.
• Foreign Bonds – issues by foreign borrower in the local currency and regulated by local regulators
• Yankee Bonds –Bonds issues by a non-US firm denominated in US $ and issued in the US.
• Samurai Bonds –Bonds issues in Japan by non-Japanese companies denominated in Yen
Eurobonds
• Bonds underwritten by a multi-national syndicate (group), placed mainly in countries other than the currency’s country.
• Not traded on a specific market.• Unregulated and untaxed! Because they are
untaxed, buyers will accept a lower rate of interest and issuers pay less to borrow. They are also in bearer from.
Euro vs Foreign Bonds(Billions of Dollars)
0 50 100 150 200
Euro
Foreign
11-17
Types of Foreign Bonds
• Fixed rate issues –• Floating rate issues- Coupon rate is tied to the
market interest rate – So still leaves some risk to the bondholders
• Equity related issues-
Advantages and Disadvantages of Debt
• Advantages– Tax deductibility of interest– Financial leverage can increase EPS– Ownership is not diluted
• Disadvantages– Increased financial risk– Indenture provisions restrict firm’s
flexibility
The International Bond Market• Bonds tend to be fixed rate.• Foreign bonds
– Sold outside the borrower’s country and in currency of country where issued.
• Eurobonds– underwritten by an international syndicate.– issued by large corporations, international institutions
and governments.– placed in country other than country of currency and
its residents.
Eurocurrency Market
• Consists of banks, called “Eurobanks” that accept deposits and make loans in foreign currencies.
• Eurocurrency is a dollar or other freely convertible currency deposited in a bank outside its country of origin.
Eurocurrency
• It’s not the Euro!• It is any currency banked outside its country
of origin. • 1950s. Eastern Europeans afraid US would
seize deposits to reimburse claims for business losses as a result of Communist takeover of Eastern Europe.
The Eurocurrency Market• Characterized by a lack of regulation compared
to domestic financial markets.
• This means that you don’t have to pay for the cost of regulation.
• Hence, cheap (or cheaper) money.
• Downside:– Banks could be more likely to fail (not probable)– Because you are getting foreign money, you have
currency exchange risks.
Eurocurrency Market
• U.S. dollar deposits placed in banks in Europe and other continents are called Eurodollars and are not subject to U.S. regulations.
• In the 1960s and 70s, the Eurodollar market, or what is now called the Eurocurrency market, grew to accommodate increasing international business.
• The market is made up of several large banks called Eurobanks that accept deposits and provide loans in various currencies.
$$
Eurocurrency Market
• U.S. dollar deposits placed in banks in Europe and other continents are called Eurodollars and are not subject to U.S. regulations.
• In the 1960s and 70s, the Eurodollar market, or what is now called the Eurocurrency market, grew to accommodate increasing international business.
• The market is made up of several large banks called Eurobanks that accept deposits and provide loans in various currencies.
$$
• Although the market focuses on large-volume transactions, at times no single bank is willing to lend the needed amount. A syndicate of Eurobanks may then be composed.
• Two regulatory events allow for a more competitive global playing field:– The Single European Act opens up the European banking
industry and calls for similar regulations.– The Basel Accord includes standardized guidelines on the
classification of capital.
Eurocurrency Market $$
Securitization
• Popular because of deregulation
• Banks must make their offering more attractive
• The matching of borrowers and lenders• The process of aggregating similar
instruments, such as loans or mortgages, into a negotiable security – like GNMA and FNMA.
Benefits of globalization to obtaining capital
• Freer markets
• More information
Exchange RateRisk of Foreign Bonds
• Some foreign currencies exhibit more risk than others.
• The exchange rate risk from financing with bonds in foreign currencies can be hedged with1 offsetting cash inflows in that currency,2 forward contracts, or3 currency swaps.
• Bonds sold outside the country whose currency they are denominated in.
• Eurobonds are underwritten by a multi-national syndicate of investment banks and simultaneously placed in many countries. They are usually issued in bearer form.
• Bonds have become popular in the last 20 years as Swaps have become more popular
Eurobond Market BONDSBONDS
• Eurobonds increased rapidly in volume when in 1984, the withholding tax was abolished in the U.S. and corporations were allowed to issue bonds directly to non-U.S. investors.
• Interest rates for each currency and credit conditions change constantly, causing the market’s popularity to vary among currencies.
• In recent years, governments and corporations from emerging markets have frequently utilized the Eurobond market.
Eurobond Market BONDSBONDS
• Interest rate swaps can be used to hedge interest rate risk. They enable a firm to exchange fixed rate payments for variable rate payments, or vice versa.
• Financial intermediaries are usually involved in swap agreements. They match up participants and also assume the default risk involved for a fee.
Using Swapsto Hedge Financing Costs
International Stock Markets• MNCs can obtain funds by issuing stock in international
markets, in addition to the local market.
• By having access to various markets, the stocks may be more easily digested, the image of the MNC may be enhanced, and the shareholder base may be diversified.
• The proportion of individual versus institutional ownership of shares varies across stock markets. The regulations are different too.
• The locations of the MNC’s operations may affect the decision about where to place stock, in view of the cash flows needed to cover dividend payments in the future.
• Stock issued in the U.S. by non-U.S. firms or governments are called Yankee stock offerings.
• Non-U.S. firms can also issue American depository receipts (ADRs), which are certificates representing bundles of stock. The use of ADRs circumvents some disclosure requirements.
International Stock Markets
Trading in Non-US Stocks
0
100
200
300
400
500
NASDAQ NYSE
1994199519961997
US Billions
11- 20
Global Equity Markets
• Where investors can buy/sell stocks.
• Made up of many stock exchanges around the world.
Who Uses These Markets?
• Investors seeking to diversify their portfolios.
• Companies seeking to– issue stock in the country– use stock and options as a form of employee incentives– satisfy local ownership requirements– create funding for future acquisitions– increase the visibility of the company.
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