International Financial Management

Abridged 10th Edition

by Jeff Madura

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 3
International Financial Markets

Chapter Objectives
This chapter will describe the:

A. Foreign exchange market

B. International money market

C. International credit market

D. International bond market

E. International stock markets

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 Foreign Exchange Market

1. Allows for the exchange of one currency for another.

2. Exchange rate specifies the rate at which one currency
can be exchanged for another.

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 History of Foreign Exchange

1. Gold Standard (1876 – 1913)

2. Agreements on Fixed Exchange Rates
a. Bretton Woods Agreement 1944
b. Smithsonian Agreement 1971
3. Floating Exchange Rate System

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 Foreign Exchange Transactions

1. Over the counter market

2. Foreign exchange dealers serve as intermediaries
3. Spot Market: transaction for immediate exchange at
the spot rate.

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 Spot Market

1. Spot market structure: electronic

2. Use of the Dollar in the spot market: commonly
accepted medium of exchange
3. Spot market time zones
4. Spot market liquidity: more buyers and sellers means
more liquidity

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 Attributes of Banks That Provide Foreign
Exchange
1. Competitiveness of quote
2. Special relationship with the bank
3. Speed of execution
4. Advice about current market conditions
5. Forecasting advice

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 Foreign Exchange Quotations

Ask rate  Bid rate

Bid / ask spread 
Ask rate

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 Factors That Affect the Spread

1. Order costs
2. Inventory costs
3. Competition
4. Volume
5. Currency risk

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 Interpreting Foreign Exchange Quotations

1. Direct Quotation represents the value of a foreign

currency in dollars (number of dollars per currency)
Example: $1.40 per Euro

2. Indirect quotation represents the number of units of a

foreign currency per dollar
Example: €0.7143 per Dollar

3. Cross Exchange Rates: exchange rate between two

nondollar currencies.
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 Forward, Futures, and Option Markets

1. Forward Contracts: agreements between a foreign

exchange dealer and an MNC that specifies the
currencies to be exchanged, the exchange rate, and the
date at which the transaction will occur.
2. Futures Contracts: similar to forward contracts but
sold on an exchange
3. Option Contracts
a. Currency Call Option: provides the right to buy currency at a
specified strike price within a specified period of time.
b. Currency Put Option: provides the right to sell currency at
specified strike price within a specified period of time.

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 International Money Market

1. Corporations or governments in a particular country

need for short-term funds denominated in a currency
different from their home currency.
2. Reasons for international money market:
a. Need to borrow funds to pay for imports denominated in a
foreign currency.
b. Borrowing in a currency in which the interest rate is lower.

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 Origins and Development

1. European Money Market: Dollar deposits in banks in

Europe and other continents are called Eurodollars or
Eurocurrency.
2. Asian Money Market: centered in Hong Kong and
Singapore

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 Standardized Global Bank Regulations

1. Single European Act

2. Basel Accord
3. Basel II Accord

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 International Credit Market

1. Eurocredit Market: loans denominated in dollars or

other currencies often maturities of 5 years.
2. London Interbank Offer Rate (LIBOR): rate charged
for loans between banks
3. Syndicated Loans

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 International Bond Market

1. Foreign bonds: issued by borrower foreign to the

country where the bond is placed.
2. Eurobonds: bonds sold in countries other than the
country of the currency denominating the bond

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 Eurobonds

1. Features:
a. Bearer bonds
b. Annual coupon payments
c. Convertible or callable
2. Denominations
3. Underwriting Process
a. multinational syndicate
4. Secondary Market

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 International Stock Markets

1. Issuance of Stock in Foreign Markets

2. Issuance of Foreign Stock in the U.S.
a. Yankee stock offerings
b. American Depository Receipts (ADR)

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 Exhibit 3.5 Comparison of Stock Exchanges (as of 2008)

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 Exhibit 3.6 Impact of Governance on Stock Market
Participation and Trading Activity

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 Exhibit 3.7 Foreign Cash Flow Chart of an MNC

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