Chapter 3
International Financial Markets Lecture Outline
Motives for Using International Financial Markets Motives for Investing in Foreign Markets
Motives for Providing Credit in Foreign Markets
Motives for Borrowing in Foreign Markets
Foreign Exchange Market
History of Foreign Exchange
Foreign Exchange Transactions
Exchange Quotations
Foreign
Interpreting
Currency Futures and Options Markets
International Money Market
Origins and Development
Standardizing Global Bank Regulations
International Credit Market
Syndicated Loans
International Bond Market
Eurobond Market
Development of Other Bond Markets
Comparing Interest Rates Among Currencies
International Stock Markets
Issuance of Foreign Stock in the U.S.
Issuance of Stock in Foreign Markets
Comparison of International Financial Markets
How Financial Markets Affect an MNC’s Value
Chapter Theme
This chapter identifies and discusses the various international financial markets used by MNCs.  These markets facilitate day-to-day operations of MNCs, including foreign exchange transactions, investing in foreign markets, and borrowing in foreign markets.
Topics to Stimulate Class Discussion
1. Why do international financial markets exist?
2. How do banks serve international financial markets?
3. Which international financial markets are most important to a firm that consistently needs
short-term funds?  What about a firm that needs long-term funds?
Critical debate
Should firms that go public engage in international offerings?
Proposition Yes. When a firm issues shares to the public for the first time in an initial public offering (IPO), it is naturally concerned about whether it can place all of its shares at a reasonable price. It will be able to issue its shares at a higher price by attracting more investors. It will increase its demand by spreading the shares across countries. The higher the price at which it can issue shares, the lower is its cost of using equity capital. It can also establish a global name by spreading shares across countries.
Opposing view No. If a firm spreads its shares across different countries at the time of the IPO, there will be less publicly traded shares in the home country. Thus, it will not have as much liquidity in the secondary market. Investors desire shares that they can easily sell in the secondary market, which means that they require that the shares have liquidity. To the extent that a firm reduces its liquidity in the home country by spreading its share across countries, it may not attract sufficient home demand for the shares. Thus, its efforts to create global name recognition may reduce its name recognition in th
e home country.
With whom do you agree?  State your reasons. Use InfoTrac or some other search engine to learn more about this issue. Which argument do you support? Offer your own opinion on this issue.
ANSWER: The key is that students recognize the tradeoff involved. A firm that engages in a relatively small IPO will have limited liquidity even when all of the stock is issued in the home country. Thus, it should not consider issuing stock internationally. However, firms with larger stock offerings may be in a position to issue a portion of their shares outside the home country. They should not spread the stocks across several countries, but perhaps should target one or two countries where they conduct substantial business. They want to ensure sufficient liquidity in each of the foreign countries where they sell shares.
Stock Markets are inefficient
Proposition
I cannot believe that if the value of the euro in terms of, say, the British pound increases three days in a row, on the fourth day there is still a 50:50 chance that it will go up or down in value. I think that most investors will see a trend and will buy, therefore the price is more
likely to go up. Also, if the forward market predicts a rise in value, on average, surely it is going to rise in value. In other words, currency prices are predictable. And finally, if it were so unpredictable and therefore unprofitable to the speculator, how is it that there is such a vast sum of money being traded every day for speculative purposes – there is no smoke without fire.
The simple answer is that if that is what you believe, buy currencies that have view
Opposing
increased three days in a row and on average you should make a profit, buy currencies where the forward market shows an increase in value. The fact is that there are a lot of investors with just your sort of views.  The market traders know all about such beliefs and will price the currency so that such easy profit (their loss) cannot be made. Look at past currency rates for yourself, check all fourth day changes after three days of rises, any difference is going to be not enough to cover transaction costs or trading expenses and the slight inaccuracy in your figures which are likely to be closing day mid point of the bid/ask spread. No, all currency movements are related to information and no-one knows if tomorrows news will be better or worse than expected.
With whom do you agree? Could there be undiscovered patterns? Could some movements not be rela
ted to information? Could some private news be leaking out?
ANSWER: Clearly there are no obvious patterns. Discussion on the impossibility of obvious patterns is worth emphasizing. However, does market inefficiency necessarily involve patterns, could market manipulation be occasional. There is worrying evidence from share price movements that there is unusual movement before announcements on many occasions, so the ideathat traders do not occasionally collude and move the price without supporting economic evidence is not an unreasonable view. Proof is however difficult as we have to separate anticipation from prior knowledge, the lucky speculator from the speculator who was in the know.
Answers to End of Chapter Questions
1. Motives for Investing in Foreign Money Markets. Explain why an MNC may invest funds
in a financial market outside its own country.
ANSWER: The MNC may be able to earn a higher interest rate on funds invested in a financial market outside of its own country. In addition, the exchange rate of the currency involved may be expected to appreciate.
2.  Motives for Providing Credit in Foreign Markets. Explain why some financial institutions
prefer to provide credit in financial markets outside their own country.
ANSWER: Financial institutions may believe that they can earn a higher return by providing credit in foreign financial markets if interest rate levels are higher and if the economic conditions are strong so that the risk of default on credit provided is low. The institutions may also want to diversity their credit so that they are not too exposed to the economic conditions in any single country.
3.  Exchange Rate Effects on Investing. Explain how the appreciation of the Australian dollar
against the euro would affect the return to a French firm that invested in an Australian money market security.
ANSWER: If the Australian dollar appreciates over the investment period, this implies that the French firm purchased the Australian dollars to make its investment at a lower exchange rate than the rate at which it will convert A$ to euros when the investment period is over.
Thus, it benefits from the appreciation. Its return will be higher as a result of this appreciation.
4.  Exchange Rate Effects on Borrowing.  Explain how the appreciation of the Japanese yen
against the UK pound would affect the return to a UK firm that borrowed Japanese yen and used the proceeds for a UK project.
ANSWER: If the Japanese yen appreciates over the borrowing period, this implies that the UK firm converted yen to pounds at a lower exchange rate than the rate at which it paid for yen at the time it would repay the loan. Thus, it is adversely affected by the appreciation. Its cost of borrowing will be higher as a result of this appreciation.
5.  Bank Services. List some of the important characteristics of bank foreign exchange services
that MNCs should consider.
ANSWER:  The important characteristics are (1) competitiveness of the quote, (2) the firm’s relationship with the bank, (3) speed of execution, (4) advice about current market conditions, and (5) forecasting advice.
6. Bid/ask Spread. Delay Bank’s bid price for US dollars is £0.53 and its ask price is £0.55.
appreciatesWhat is the bid/ask percentage spread?
ANSWER:  (£0.55– £0.53)/£0.55 = .036 or 3.6%
7. Bid/ask Spread. Compute the bid/ask percentage spread for Mexican peso in which the ask
rate is 20.6 New peso to the dollar and the bid rate is 21.5 New peso to the dollar.
ANSWER:  direct rates are 1/20.6 = $0.485:1 peso as the ask rate and 1/21.5 = $0.465:1 peso as the bid rate so the spread is
[($0.485 – $0.465)/$0.485]  = .041, or 4.1%. Note that the spread is fro the Mexiccan peso not the dollar.
8.  Forward Contract. The Wolfpack ltd is a UK exporter that invoices its exports to the United
States in dollars. If it expects that the dollar will appreciate against the pound in the future, should it hedge its exports with a forward contract? Explain.
.
ANSWER:  The forward contract can hedge future receivables or payables in foreign currencies to insulate the firm against exchange rate risk. Yet, in this case, the Wolfpack Corporation should not hedge because it would benefit from appreciation of the dollar when it converts the dollars to pounds.
9. Euro. Explain the foreign exchange situation for countries that use the euro when they
engage in international trade among themselves.
ANSWER:  There is no foreign exchange. Euros are used as the medium of exchange.
10. Indirect Exchange Rate. If the direct exchange rate of the euro is worth £0.685, what is the
indirect rate of the euro? That is, what is the value of a pound in euros?
ANSWER:  1/0.685 = 1.46 euros.
11. Cross Exchange Rate. Assume Poland’s currency (the zloty) is worth £0.17 and the
Japanese yen is worth £0.005.  What is the cross (implied) rate of the zloty with respect to yen?
ANSWER:  £0.17/£0.005 = 34 zloty:1 yen
12. Syndicated Loans. Explain how syndicated loans are used in international markets.
ANSWER: A large MNC may want to obtain a large loan that no single bank wants to accommodate by itself. Thus, a bank may create a syndicate whereby several other banks also participate in the loan.
13. Loan Rates. Explain the process used by banks in the Eurocredit market to determine the rate
to charge on loans.
ANSWER: Banks set the loan rate based on the prevailing LIBOR, and allow the loan rate to float (change every 6 months) in accordance with changes in LIBOR.
14. International Markets. What is the function of the international money market? Briefly
describe the reasons for the development and growth of the European money market. Explain how the international money, credit, and bond markets differ from one another.