This section begins the study of the international financial system by exploring the structure of the international financial markets. The two interrelated systems that comprise the international financial markets are the international capital market and the foreign exchange market.
2.INTERNATIONAL CAPITAL MARKET
A capital market is a system that allocates financial resources in the form of debt and equity according to their most efficient uses. Its main purpose is to provide a mechanism to borrow or invest money efficiently.
A. Purposes of National Capital Markets
National capital markets help individuals and institutions borrow the money from lenders; intermediaries exist to facilitate financial exchanges. Commercial banks lend their investors’ deposits at a specific rate of interest and provide loans and finance import/export activities. Investment banks act as agents, introducing clients to organizations that provide investment or borrowing opportunities.
1.Role of Debt
a.Debt consists of loans in which the borrower promises to repay the borrowed amount (the principal) plus a predetermined rate of interest. Company debt normally takes the form of bonds—debt instruments specifying the timing of principal and interest payments.
b.The holder of a bond (the lender) can force the borrower into bankruptcy if payment is not made on a timely basis. Bonds to fund investments are issued by private-sector companies and by municipal, regional, and national governments.
2.Role of Equity
a.Equity is part ownership of a company in which the equity holder participates with other part owners in the company’s financial gains and losses. Equity normally takes the form of stock—shares of ownership in a company’s assets that give shareholders a claim on the company’s future cash flows.
b.Shareholders may be rewarded with dividends—payments made out of surplus funds—or by increases in the value of their shares. They may also suffer losses due to poor company performance—and thus decreases in the value of their shares. Dividend payments are not guaranteed, but decided by the company’s board of directors and based on financial performance. c.Shareholders can sell one stock and buy another or liquidate exchange stock for cash. Liquidity refers to the ease with which bondholders and shareholders convert investments into cash.
B. Purposes of the International Capital Market
The international capital market is a network of individuals, companies, financial institutions, and governments that invest and borrow across national boundaries. Large international banks gather excess cash of investors and savers around the world and then channel it to global borrowers.
1. Expanding the Money Supply for Borrowers
a. Companies unable to obtain funds from investors in the domestic market seek financing in the international capital market.
b. Essential for firms in countries with small or developing capital markets or emerging stock markets.
c. An expanded supply of money benefits small companies that might not get financing under intense competition for capital.
2. Reducing the Cost of Money for Borrowers
a. An expanded money supply reduces the cost of borrowing. The “price” reflects supply and demand. Excess funds create a buyer’s market, forcing interest rates lower.
b. Projects regarded as infeasible because of low expected returns might be viable at a lower financing cost.
3. Reducing Risk for Lenders
a.The international capital market expands the available set of lending opportunities....