IBT Chapter 12 Reviewer
can move in different ways.
Capital Market- bring together those who want
to invest money and those who want to borrow
money
Main Players in Capital Market
1. Investors
2. Market Makers- financial service
companies that connect investors and
borrowers, either directly or indirectly
3. Borrowers
Interest rate spread- is what the company
charges on a loan compared to its cost of money
Capital market loans to corporations are:
1. Equity loan- made when corporation sells
stock to investors
2. Debt loan- requires the corporation to
repay a predetermined portion of loan
amount at regular intervals
*A global capital market benefits both
borrowers and investors.
Attractions of Global Capital Market
 For borrower: lower cost of capital
 For investor: portfolio diversification
Cost of Capital- price of borrowing money, which
is the rate of return that borrowers must pay
investors
Systematic Risk- movements in a stock
portfolio’s value that are attributable to
macroeconomic forces affecting all firms in an
economy
*By diversifying a portfolio internationally, an
investor can reduce the level of risk even further
because the movements of stock market prices
across countries are not perfectly correlated.
The relatively low correlation between the
movement of stock markets in different
countries reflect two basic factors:
 Countries pursue different
macroeconomic policies and face different
economic conditions, so their stock
markets respond to different forces and
 Different stock markets are still
somewhat segmented from each other by
capital controls—that is by restrictions on
cross-border capital flows.
Factors affecting growth of the global capital
market
1. Information technology
Financial services- information-intensive
industry; has been revolutionized more than any
other industry
*Most market participants would argue that the
benefits of an integrated global market capital
far outweigh any potential costs.
2. Deregulation
Big Bang of October 1986- removed barriers that
had existed between banks and stockbrokers and
allowed foreign financial service companies to
enter the British stock market
Little Bang of 1987- opened the French stock
market to outsiders and to foreign and domestic
banks
*World Trade Organization brokered a deal
that removed many of the restrictions on cross-
border trade in financial services.
Hedge funds- private investment funds that
position themselves to make “long bets” on
assets that they think will increase in value and
“short bets” on assets that they think will decline
in value
*Some believe the globalization of capital holds
inherent serious risks such as having a
destabilizing effect on national economies.
*Most of the capital that moves internationally is
pursuing temporary gains, and it shifts in and out
of countries as quickly as conditions change.
Hot Money- flow of funds from one country to
another in order to earn a short-term profit on
interest rate differences and/or anticipated
exchange rate shifts
Patient Money- money left for investment
purposes, after making full allowance for
housing costs and living and emergency financial
requirements
Important Segments of Global Capital Market
1. The Eurocurrency Market
Eurocurrency- currency banked outside of its
country of origin
Eurodollars- 2/3 of all Eurocurrencies; are
dollars banked outside of United States
Eurocurrency market- born in the mid-1950s
when Eastern holders of dollars were afraid to
deposit their holdings of dollars in the United
States lest they be seized by the US government
*London became the leading center of
Eurocurrency trading.
Attractions of Eurocurrency Market
• The main factor that makes the
Eurocurrency market attractive to both
depositors and borrowers is its lack of
government regulation, allowing banks to
charge borrowers a lower interest rate
than for borrowings in the home
currency.
• The Eurobank has no reserve
requirements regarding dollar deposits.
Drawbacks of Eurocurrency Market
• The probability of a bank failure that
would cause depositors to lose their
money is greater.
• Borrowing funds internationally can
expose a company to foreign exchange
risk.
2. The International Bond Market
Fixed-rate bond- most common kind of bond
where investor receives a fixed set of cash
payoffs
Types of International Bonds
 Foreign Bonds- sold outside of the
borrower’s country and are denominated
in the currency of the country in which
they are issued
 Eurobonds- normally underwritten by an
international syndicate of banks and
placed in countries other than the one in
whose currency the bond is denominated
Attractions of Eurobond Market
 An absence of regulatory interference
 Less stringent disclosure requirements
than in most domestic bond markets
 A favorable tax status
3. The International Equity Market- it
enables firms to attract capital from
international investors, to list their stock
on multiple exchanges, and to raise funds
by issuing equity or debt around the
world.
*An interesting consequence of the trend toward
international equity investment is the
internationalization of corporate ownership.
*Companies with historic roots in one nation are
broadening their stock ownership by listing their
stock in the equity markets of other nations.
*While a firm can borrow funds at a lower cost in
the global capital market than in the domestic
capital market, foreign exchange risk
complicates this picture under a floating
exchange rate regime.
*Unpredictable movements in exchange rates
can inject risk into foreign currency borrowing,
making something that initially seems less
expensive ultimately much more expensive.
*A borrower must weigh the benefits of a lower
interest rate against the risks of an increase in
the real cost of capital due to adverse exchange
rate movements.
*The forward exchange market does not
provide adequate coverage for long-term
borrowings.