MODULE 8.

INTERNATIONAL FINANCIAL MARKET AND INNOVATIONS

OBJECTIVES
After successful completion of this module, you should be able to:
Describe the different factors that affect the strategies in doing international financial
market
Describe the roles of international agencies that may affect the financial market
Identify the risk that may affect the financial market strategies

COURSE MATERIALS
Nature of International Financial Markets
(source: efinancemanagement.com)
International financial markets consist of mainly international banking services and
international money market. The banking services include the services such as trade financing,
foreign exchange, foreign investment, hedging instruments such as forwards and options, etc. All
these banking services are provided by international banks. International money market includes
the Eurocurrency markets, Euro credits, Euro notes, Euro commercial Paper etc.

International financial markets, as we saw, can broadly be classified into international

banking and international money market. International markets are accessed by multinational
corporations more than anybody else. Traders or businesses having import and export transaction
also have frequent access to these markets.

Motives for Using International Financial Market

Motives for Investing in Foreign Market
Economic conditions - investors may expect in a particular foreign country to achieve

favorable for good investments.

Exchange rate expectations - some investors purchase financial securities denominated

International diversification
s economy, cross-border differences in economic conditions can allow
for risk-reduction benefits.

Motives for Providing Credit in Foreign Markets

High foreign interest rates foreign creditors may attempt to capitalize on higher rates
when some countries experienced a shortage of loanable funds resulting to high interest
rates, thereby providing capital to overseas markets.
Exchange rate expectation creditors may consider supplying capital to countries
whose currencies are expected to appreciate against their own currencies.
International diversification creditors can benefit from international diversification
which may reduce the profitability of simultaneous bankruptcy across borrowers.

Motives in Borrowing in Foreign Markets

Low interest rates countries with large supply of available funds compared to the
demand of funds will result to low interest rates. Borrowers will take advantage of these
low interest rates by borrowing funds from these countries.

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 Exchange rate expectations this involves exchange rate risk in terms of a foreign
subsidiary remittance to its parent company in another country. The lower the exchange
rate, the higher the remittance will be.

Foreign Exchange Transactions

Spot Market this is the most common type of foreign exchange transaction for
immediate exchange at the so-called spot rate.
Forward transactions
A forward contract specifies the amount of a particular currency that will be purchased
or sold by an MNC (Multinational Company) at a specified future point in time and at

payments that the expect to make or receive in a foreign currency.

Currency futures and options
Currency futures contract specifies a standard volume of a particular currency to be
exchanged on a specific settlement date.

Currency options contracts, there are two classifications:

o Currency call option provides the tight to buy a specific currency at a specific
price (called the strike price or exercise price) within a specific period of time.
o Currency put option provides the right to sell a specific currency at a specific
price within a specific period of time, which is used to hedge future receivables.
Eurocurrency Market
The eurocurrency market is the money market for currency outside of the country
where it is legal tender. The eurocurrency market is utilized by banks, multinational
corporations, mutual funds, and hedge funds. They wish to circumvent regulatory
requirements, tax laws, and interest rate caps often present in domestic banking,
particularly in the United States.

The term eurocurrency is a generalization of Eurodollar and should not be

confused with the EU currency, the euro. The eurocurrency market functions in many
financial centers around the world, not just Europe.
Asian Dollar Market- this is a market located in East Asia used for loans or bank deposits
that are denominated in US dollars. Banks in Asia sometimes offer dollar market services
as well.
Eurocredit Market comprises banks that accept deposits and provide loans in large
denominations and in a variety of currencies. The banks that constitute this market are the
same banks that constitute the Eurocurrency market; the difference is that Euro credit
loans are longer-term than so-called Eurocurrency loans.
Eurobond Market is a market based in Europe, comprising a web of international banks
and money brokers, which is engaged in the borrowing and lending of FOREIGN
CURRENCIES such as US dollars outside their countries of origin, as a means of financing
trade and investment transactions.
International Stock Market refers to all the international markets that negotiate stocks
from their domestic companies. Most countries have their own stock exchange. The
indexes track the fluctuations in the value of stocks of one market.

Foreign Direct Investments (FDI)

This is an investment made by a firm or individual in one country into business interests
located in another country. FDI takes place when an investor establishes foreign business

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operations or acquires foreign business assets, including establishing ownership or controlling
interest in a foreign company.

Types of Foreign Investments

- Horizontal direct investment which refers to the investor establishing the same type
of business operation in a foreign country as it operates in its home country.

- Conglomerate or vertical direct investment is a type of foreign direct investment

where a company or individual makes a foreign investment in a business that is
unrelated to its existing business in its home country.

Country Risk Premium (CRP) is the additional return or premium demanded by investors to
compensate them for the higher risk associated with investing in a foreign country, compared to
investing in the domestic market. Oversees investment opportunities are accompanied by higher
risk because of the plethora of geopolitical and macroeconomic risk factors that need to be
considered. Country risk encompasses numerous factors, including:
a. Political instability
b. Economic risks such as recessionary conditions, higher inflation, etc.
c. Sovereign debt burden and default probability
d. Currency fluctuations
e. Adverse government regulations

In determining the CRP. Two common approaches were observed, as follows:

Sovereign Debt Method CRP for a particular country can be estimated by comparing the
spread n sovereign debt yields between the country and a mature market like the U.S.
Equity Risk Method CRP is measured on the basis of the relative volatility of equity
market returns between a specific country and a developed nation.

Cryptocurrency
. A cryptocurrency is a digital or virtual currency that uses cryptography for security. The
first blockchain-based cryptocurrency was Bitcoin, which still remains the most popular and most
valuable. This cryptocurrency that captured the public imagination was launched in 2009 by an
individual or group known under the pseudonym, Satoshi Nakamoto.

Cryptocurrencies are systems that allow for the secure payments of online transactions

such as elliptical curve encryption, public-private key pairs, and hashing functions, are employed.

Cryptocurrencies hold the promise of making it easier to transfer funds directly between
two parties in a transaction without the need for a trusted third party such as a bank or credit card
company; these transfers are facilitated through the use of public keys and private keys for
security purposes.

Offshore Banking Units (OBU)

This is a bank shell branch, located in another international financial center. Offshore
banking units make loans in the Eurocurrency market, when they accept deposits from foreign

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restrictions.

The World Bank

The World Bank Group (WBG) was established in 1944 to rebuild post-World War II
Europe under the international Bank for Reconstruction and Development (IBRD). It is one of a
variety of organizations seeking to shape the world economy.

The World Bank functions as an international organization that fights poverty by offering
developmental assistance to middle-income and low-income countries, by giving loans and
offering advice and training in both the private and public sectors.

Sectors of the World Bank Group

The International Bank and Construction and Development (IBRD) aids middle
income and poor, but creditworthy countries.
The International Development Association
countries. These loan
offer a 10-year grace period and hold a maturity of 35 years to 40 years.
The Multilateral Investment Guarantee Agency (MIGA) supports direct foreign
investment into a country by offering security against the investment in the event of political
turmoil, comes in political risk insurance guarantee.
The International Centre for Settlement of Investment Disputes facilitates and works
towards a settlement in the event of a dispute between a foreign investor and a local
country.
The International Finance Corporation (IFC) works to promote private sector
investments by both foreign and local investors. It provides investment and asset
management services to encourage the development of private enterprise in nations that
might be lacking the necessary infrastructure or liquidity for businesses to secure
financing. The IFC was established in 1956 as a sector of the World Bank Group, focused
on alleviating poverty and creating jobs through the development of private enterprise.

ACTIVITIES/ASSESSMENTS
Answer the following exercises:
Exercise Mod 8-1 (True or False)
1). When international trade in financial assets is easy and reliable, due to low transactions costs
in liquid markets, we say international financial markets are characterized by high capital mobility.

2). The existence of perfect markets has precipitated the internationalization of financial markets.

3). Motives for Investing in Foreign Market: Economic conditions. Investors may expect firms in a
particular foreign country to achieve more favorable performance th
home country.

4). Motives for Investing in Foreign Market: Exchange rate expectations. Some investors
purchase financial securities denominated in a currency that is expected to appreciate against
their own.

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5). Motives for Investing in Foreign Market: International diversification. Investors may achieve
benefits from internationally diversifying their asset portfolio.

6). Motives for Providing Credit in foreign markets: Low foreign interest rates. Some countries
experience a shortage of loanable funds, which can cause market interest rates to be relatively
high, even after considering default risk. Foreign creditors may attempt to capitalize on the higher
rates, thereby providing capital to overseas markets.

7). Motives for Providing Credit in foreign markets: Exchange rate expectations. Creditors may
consider supplying capital to countries whose currencies are expected to appreciate against their
own.

8). Motives for Providing Credit in foreign markets: International diversification. Debtors can
benefit from international diversification, which may reduce the probability of simultaneous
bankruptcy across borrowers.

9). Motives in Borrowing in Foreign Markets: Low interest rates. Some countries have a large
supply of funds available compared to the demand for funds, which can cause relatively low
interest rates.

10). Motives in Borrowing in Foreign Markets: Exchange rate expectations. When a foreign
subsidiary of a U.S.-based MNC remits funds to its U.S. parent, the funds must be converted to
dollars and are subject to exchange rate risk.

11). The foreign exchange market allows currencies to be exchanged in order to facilitate
international trade or financial transactions.

12). Companies normally exchange one currency for another through a commercial bank over a
telecommunications network.

13). The most common type of foreign exchange transaction is for immediate exchange at the so-
called forward rate. The market where these transactions occur is known as the spot market.

14). A currency futures contract specifies the amount of a particular currency that will be
purchased or sold by the MNC at a specified future point in time and at a specified exchange rate.

15). MNCs commonly use the forward market to hedge future payments that they expect to make
or receive in a foreign currency. In this way, they do not have to worry about fluctuations in the
spot rate until the time of their future payments.

16). A currency futures contract specifies nonstandard volume of a particular currency to be

exchanged on a specific settlement date. Some MNCs involved in international trade use the
currency futures markets to hedge their positions.

17). Futures contracts are somewhat similar to forward contracts except that they are sold on an
exchange whereas forward contracts are offered by commercial banks.

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180. Currency options contracts can be classified as calls or puts. A currency call option provides
the right to buy a specific currency at a specific price (called the strike price or exercise price)
within a specific period of time. It is used to hedge future receivables.

19). A currency put option provides the right to sell a specific currency at a specific price within a
specific period of time. It is used to hedge future payables.

20). U.S.-dollar deposits in banks located in Europe and on other continents as well became
known as Eurodollars.

21). The Eurocurrency market is composed of several large banks (referred to as Eurobanks) that
accept deposits and provide loans in various currencies.

22). The syndicate of banks is usually formed in about six weeks, or less if the borrower is well
known because the credit evaluation can then be conducted more quickly.

23). Although the Eurocurrency market can be broadly defined to include banks in Asia that accept
deposits and make loans in foreign currencies (mostly dollars), this market is sometimes referred
to separately as the Asian dollar market.

24). The only significant difference between the Asian market and the Eurocurrency market is the
purpose and set up.

25. Loans of one year or longer extended by Eurobanks to MNCs or government agencies are
commonly called Eurocredits or Eurocredit loans.

26). MNCs can access long-term funds in foreign markets by issuing bonds in the international
bond markets. International bonds are typically classified as either foreign bonds or Eurobonds.

27). The adoption of the euro by many European countries has encouraged MNCs based in
Europe to issue stock. Investors throughout Europe are more willing to invest in stocks when they
do not have to worry about exchange rate effects.

28). Some foreign stock markets are much smaller than the U.S. markets because their firms
have relied more on equity financing than debt financing in the past.

29). The spot market, forward market, currency futures market, and currency options market are
all classified as foreign stock markets.

30)
foreign customers of the MNC. Changes in foreign interest rates can affect economic growth,
which in turn affects the demand for products sold by foreign subsidiaries of the MNC.

Exercise Mod 8-2 (Multiple Choice)

1). Which of the following is not a motive for Investing in the Foreign Market?
a. Economic Conditions
b. Exchange rate expectations

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 c. International Diversification
d. High foreign interest rates (Motive in providing credit in the foreign market)

2). Which of the following is not a motive for providing Credit in Foreign Market?
a. Low foreign interest rate (Motive in borrowing in the foreign market)
b. Exchange rate expectations
c. International Diversification
d. High foreign interest rates

3). Which of the following is a motive for Borrowing in Foreign Markets?

a. Economic Conditions b. Exchange rate expectations
c. International Diversification d. High foreign interest rates

4). MNCs rely on the ____________________________ to exchange their home currency for a
foreign currency that they need to purchase imports or use for direct foreign investment.
a. Foreign Currency Market b. Financial Exchange Market
c. Foreign Exchange Market d. Financial Currency Market

5). ____________ is the most common type of foreign exchange transaction.

a. Spot Market b. Forward Market c. Futures Market d. Option Market

6). A ______________ specifies the amount of a particular currency that will be purchased or
sold by the MNC at a specified future point in time and at a specified exchange rate.
a. Spot Contract b. Forward Contract c. Futures Contract d. Option Contract

7). _______________ are somewhat similar to forward contracts except that they are sold on an
exchange whereas forward contracts are offered by commercial banks.
a. Spot Contract b. Forward Contract c. Futures Contract d. Option Contract

8). A currency call option provides the right to buy a specific currency at a specific price (called
the strike price or exercise price) within a specific period of time. It is used to hedge
_____________.
a. future payables b. future receivables c. contingent payable d. contingent receivables

9). A currency put option provides the right to sell a specific currency at a specific price within a
specific period of time. It is used to hedge _______________.
a. future payables b. future receivables c. contingent payable d. contingent receivables

10). Which of the following statements is incorrect related to Eurocurrency market?

a. The Eurodollar market was created as corporations in the United States deposited U.S.
dollars in European banks.
b. The growth of the Eurodollar market was stimulated by U.S. regulations in 1968, which
limited foreign lending by U.S. banks.
c. Eurodollar deposits were not subject to reserve requirements.

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 d. The Eurocurrency market is composed of several large banks (referred to as Eurobanks)

and provides loans in various currencies)

10). Although the Eurocurrency market concentrates on large-volume transactions, at times no

single Eurobank may be willing to provide the amount needed by a particular corporation or
government agency. In this case, a _______________ of Eurobanks may be organized.
a. group b. joint venture c. corporation d. syndicate

11). Loans of one year or longer extended by Eurobanks to MNCs or government agencies are
commonly called ______________ loans. These loans are provided in the so-called
_________________ market.
a. Foreign credit b. Eurocredit c. Eurobonds d. Eurocurrency

12). Which of the following statement is not correct?

a. Loans of one year or longer extended by Eurobanks to MNCs or government agencies are
commonly called Eurocredits or Eurocredit loans.
b. Because Eurobanks accept short-term deposits and sometimes provide longer term loans,

c. To avoid this risk, Eurobanks now commonly use floating rate Eurocredit loans. The loan
rate floats in accordance with the movement of some market interest rate, such as the London
Interbank Offer Rate (LIBOR), which is the rate commonly charged for loans between Eurobanks.
d. The premium paid above LIBOR will depend on the credit risk of the borrower.

13). MNCs can access long-term funds in foreign markets by issuing bonds in the international
bond markets. International bonds are typically classified as either foreign bonds or
_____________.
a. Foreign credit b. Eurocredit c. Eurobonds d. Eurocurrency

14). Which of the following is not correct about International Stock Market?
a. MNCs and domestic firms commonly obtain long-term funding by issuing stock locally. Yet,
MNCs can also attract funds from foreign investors by issuing stock in international markets.

recognition there.
c. The recent conversion of many European countries to a single currency (the euro) has
resulted in few stock offerings in Europe by U.S.- and European-

d. The stock offering may be more easily digested when it is issued in several markets.

15). In recent years, ECNs have been created to match orders between buyers and sellers. ECNs
do not have a visible trading floor, as the trades are executed by a computer network. ECN stands
for _______________________.
a. Electric Communications Network b. Extended Communications Network
c. Electronic Communications Network d. Expanded Communications Network

16). International Financial Markets involve cashflows that can be classified into four corporate
functions. Which of the following is not?

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 a. Foreign Trade with Business Clients b. Direct Foreign Investment
c. Short Term Investment d. long term Investment (long term financing)

17). Which of the following is not within the function of long-term financing?
a. Eurobond b. Eurocredit
c. International Stock Market d. Commercial Paper (usually short term)

18). Which of the following is not correct?

a. The use of international financial markets can affect the value of an MNC
b. To the extent that issuing stock in a foreign market creates more name recognition in a
foreign country, an MNC may be able to increase its presence in that country, which can lead to
higher cash flows generated from that country and a lower valuation.

foreign customers of the MNC. Changes in foreign interest rates can affect economic growth,
which in turn affects the demand for products sold by foreign subsidiaries of the MNC.

issuing equity in some foreign markets rather than issuing equity in its local market. If the MNC
achieves a lower cost of capital, it can achieve a lower required rate of return and a higher
valuation.

19). MNC stands for?

a. Multinational Companies b. Multicurrency Companies
c. Multiportfolio Companies d. Multilocation Companies

20). Country risk encompasses numerous factors except:

a. Economic risks such as recessionary conditions, higher inflation, etc
b. Sovereign debt burden and default probability
c. Currency fluctuations
d. none of the above

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