‘studying the chapter, you should be able to ... ~ Know the importance of global financial markets 2. Familiarize yourself of the largest financial markets in the world . Explain briefly the value of cross-border financing _ Understand the factors affecting the long-run trends ‘of increased financial market activity . Distinguish between individual and institutional investors Explain the types of institutional investors Know the major types of international credit markets: Id not be markets, governments wou! le vs would not have access to the capital they need to buy and sell foreign ct nancial markets has become an im ‘h larger than e growing internationalization of fi trend. Before the 1980s, U.S. financial markets were muc! r 2 markets outside the United States, but in recent years the dominance of markets has been disappearing. The extraordinary growth of foreign fina narkets has been the result of both large increases in the pool of savit foreign countries such as Japan and the deregulation of foreign financial which has enabled them to expand their activities. American corporations banks are now more likely to tap international capital markets to raise nee funds, and American investors often seek investment opportunities abro Similarly, foreign corporations and banks raise funds from Americans, af foreigners are becoming important investors in the United States. A look! international bond markets and world stock markets will give us a picture of he this globalization of financial markets is taking place. 4 FINANCIAL MARKETS AROUND THE WORLD New York, USmes $ a aS stock exchanges: the cl ; jen Stock Exchange (SZSE) ($2.36 trillion) ge of Hong Kong (SEHK) ($3.32 trillion). "The London Stock Exchange (LSE) is Europe’s largest ($2.68 trillion). European Union Euronext has headquarters in Amsterdam. Brussels, Lisbon, London, and Paris ($2.56 trillion). ” Frankfurt, Germany Deutsche Borse is based in Frankfurt (FWB) ($1.24 trillion). WORLD STOCK MARKETS financial markets grew rapidly during the 1990s. At the start of the decade, active trading in financial instruments was confined to a small. umber of countries, and involved mainly the same types of securities, bonds and equities that had dominated trading for two countries. By the first years of the 21" century, financial markets were thriving in dozens of countries, and instruments accounted for a large proportion of market dealings. Be Intil recently, the U.S. stock market was by far the largest in th gn stock markets have been growing in importance, Now the | ways number one: In the 1990s, the value of stocks tr jnited By all these measures, d the value of bast; 5 urkets fell markedly at the turn the world were ee in ae Hd) y as financial crisis led to the failures of several maj “and a dramatic reduction in lending. Although credit markets “in 2009, their expansion was subdued because of the prolonged “financial crisis affecting the euro zone, recession or sluggish growth in a numbe of major economies, and new regulatory requirements that constrained bank ing and discouraged use of certain financing methods, notably securitization _ 2017, the US Federal Reserve Board and the European Central Bank Pe ‘announced that they would gradually end their bond-purchase programmes. This likely to occur over a number of years, gradually making it more costly for irms and governments to issue bonds and possibly dampening total issuance. SIZE OF THE MARKETS Estimating the overall size of the financial markets is difficult. It is hard in the first place to decide exactly what transactions should be included under the rubri¢ financial markets", and there is no way to compile complete data on éach of the millions of sales and purchases occurring each year. ‘ “ Itis different to estimate the overall size of the financial life a markets. In the first place it is hard to decide exactly what transaction should be included under the expression “financial markets”, and there is no practical way to compile complete ta on each of the millions of sales and purchases occurring each year.. [Fall these other financial aétivities were to be included, the markets would be much larger. ible 11-1: The world’s financial markets end, $trn | 2015 2016 2017 [Intemational bank Toans 136 2.6 204 Intemational debt securities 11.5 18.9 21.9 ‘Domestic debt securities 44.4 59.8 62.5 ti 37.2 32.6 54.6 5.2 8.0 84 Total value outstanding _ 111.6 141.9 167.8 Sources: Bank for International Settlements; World Federation of Exchanges CROSS-BORDER MEASURE Another way of measuring the growth of finance is to examine the value of cross- border financing. Cross-border finance is by no means new, and at various times in the past (in the late 19th century, for example) it has been quite large relative tothe size of the world economy. The period since 1990 has been marked by a ge increave in the amount of international financing broken by financial er and Russia in 1998, the recession in the United States in 2001, and the 41 meltdowns of 2008-09 in the United States and 2008-13 ii Euroy Df border finance in 2016, including internati than $46 trill inhich firms and governments raise funds in internatic d substantially. In 1993, bonds accounted for 59% of ing. By 1997, before financial crises in Asia and Russia shook the 1 only 47% of the funds raised on international markets were obtained. ‘bond issues. Equities became an important source of cross-border 2000, when share prices were high, but bonds and loans regained importan the low-interest-rate environment of 2007-2010. In 2018, syndicated lending off as lack of capital forced banks to restrain their lending activities. Issuance of international bonds was relatively flat in the years following 2018, as financial companies increased their bond issuance even while banks reduced theit outstanding bond indebtedness. In more recent years, international bank lend has fallen off, but extremely low interest rates in the United States, Japan, Britain, and the EU have encouraged greater use of long-term bond financing. FACTORS AFFECTING THE LONG-RUN TRENDS OF INCREASED — FINANCIAL MARKET ACTIVITY A. Lower inflation Inflation rates around the have fallen markedly since the 1990s. Inflation erodes the value of financial assets and increases the value of physical assets, such as houses and machines, which will cost far more to repl than they are worth today. When inflation is high, as was the case in tl Unites States, Canada and much of Europe during the 1970s throughout Latin America in the 1980s, firms avoid raising long: pital because investors require a high return on i knoMany countries’ stock and bond markets performed well during the 1990s and in the period before 2008, with the global bond-marke boom continuing until interest rates began to rise in 2013. Stock markets, after several difficult years, rose steeply in many countries in 2012 and 2013 and again in 2016 and 2017. A rapid increase in financial wealth feeds on itself: investors whose portfolios have appreciated are willing to reinvest some of their profits in the financial markets. And the appreciation in the value of their financial assets gives investors’ the collateral to borrow additional money, which can then be invested. Risk management Innovation has generated many new financial pyoduets, such as derivatives and asset-backed securities, whose basic purpose is to redistribute risk. This led to enormous growth in the use of financial markets for risk-management purposes. To an extent previously unimaginable, firms and investors could choose which risks they wished to bear and use financial instruments to shed the risks they did not want, or, alternatively, to take on additional risks in the expectation of earning higher returns. The risk-managet ti sulted Fein expansion of financial-market activity. The credit crisis began in 2007, however, revealed that the pricing of many oh management products did not properly reflect the risks i I result, these products have become more costly, and are aringly, than in earlier years. 2 ment revolution thus resulted in anpreferences, turn, wil IV -financial-market products are deliberately designed to offer gains and no yield, or vice versa, to satisfy these preferences. CATEGORIES OF INVESTORS “households in the wealthier countries own some financial assets, often in the form of retirement savings or of shares in the employer of a household member. Most such holdings, however, are quite small, and their composition varies greatly from one country to another. Institutional Investors Insurance companies and other institutional investors (see below), including high-frequency traders, are responsible for most of the trading in financial markets. The assets of institutional investors based in the 34 member countries of the OECD totalled approximately $120 trillion in 2018. The size of institutional investors varies greatly from country to country, depending on the development 9f collective investment vehicles. Investment practices vary considerably as Well._ from time to time. Investors wishit must buy or sell the trust’s share from stockbrokers. Hedge funds Another type of investment company, @ hedge fund, can accept investments from only a small number of wealthy individuals or big institutions. In return it is freed from most types of regulation meant to protect consumers. Hedge funds are able to employ aggressive investment strategies, such as using borrowed money to increase the amount invested and focusing investment on one or another type of asset rather than diversifying. If successful, such strategies can lead to very large returns; if unsuccessful; they can result in sizeable losses and the closure of the fund. ‘5 All investment companies earn a profit by charging investors a fee for their services. Some, notably hedge funds, may also take a portion of any gain in the value of the fund. Hedge funds have come under particular criticism because their fee structures may give managers an undesirable incentive to take large risks with investors’ money, as fund managers may share in their fund's gains but not its. losses. .Pension funds aggregate the retirement savings of a large workers. Typically, pension funds are sponsored by an emp! group of employers or a labour union. In the Philippines, the $S and GSIS represent the largest investors of pension fund. Uni individual pension accounts, pension funds do not give individuals control over how their savings are invested, but they do typica offer a guaranteed benefit once the individual reaches retirement age. Pension-fund assets in the OECD countries exceeded $25 ion at the end of 2016. Algorithmic traders Algorithmic trading, also known as high-frequency trading, has expanded dramatically in recent years as a result of increased computing power and the availability of low-cost, high-speed — communications. Investors specializing in this type of trading program computers to enter buy and sell orders automatically int an effort to exploit tiny price differences in securities and currency markets. They typically have no interest in fundamental factors, such as a company's prospects or a country's economic outlook, and own the-asset for only a brief period before reselling it. Algorithmic trading firms control only a tiny proportion of the world's financial ae but they account for a large proportion of the trading in some markets.,Currently, Eurocredit exist for most major trading example of a Eurocredit is a Eurodollar deposit, which is a U.S “deposited in a bank outside the United States. ie ,_ Eurobond Market A Eurobond is an intemational bond underwritten by an international syndicate of banks and sold to investors in countries other than the one in whose money unit the bond is denominated. . - For example, a U.S. dollar-denominated Eurobonds are not sold in the United States nor Yen Eurobonds are not sold in Japan. These bonds are usually issued in bearer form which means that the investor's identity is not registered and thus is not known. Interest is claimed through a coupon which is presented for payment at one of the designated payor banks, Most Eurobonds are not rated by the rating agencies such as Moody's or Standards & Poor's, Eurobonds can be issued with either a. floating-coupon rate depending on the preferences of the issuer and they: have medium or long-term maturities. . Foreign Bond Market Foreign bonds are international bonds issued in the country in whose is denominated, and they are underwritten by investment bank in that country. The borrower may be located in a ‘ferent country. Foreign bonds issued in the USA are sometimes called "Yankee bonds" while "Samurai bonds" are foreign bonds issued 1 ‘okyo. They can have ‘a floating-rate coupon or @ fixed-rate ¢ have the same maturities as the purely d bonds ¥y must compete for funds. currency the bondtrac 's among its members, money and securities change day after the transaction. Over the years, however, many of the distinctive features of the inte market have been eroded. As national governments have liberalized their rules for issuing and trading securities and eased restrictions on cross-border capital flows the advantages of international issues have ceased to loom large. Global bond issues and the creation of cross-border issues within the EU have blurred the distinction between Eurobonds and other international bond issues. Some securities traditionally considered to be domestic, ; These changes have blurred the difference between Eurobonds and foreign “bonds. The term international bonds is now applied to both, and the Euromarkets label has fallen out of use. But although the Euromarkets may have faded into history, the intemational bond markets are flourishing and are likely to grow rapidly.4, What is, ‘meant by Cross-Border financing? . Explain the development of financial instruments in the it _ markets. . Explain briefly how the following factors influenced the long-run trends of increased financial market activity i, Lower inflation ii, Pensions iii, Stock and bond market performance iv. Risk management v. Investors |. Give the explain briefly the types of institutional investors. . Distinguish between the major types of international credit markets © Burocredits 5 Eurobond market © Foreign bond market