International Financial Markets Final

INTERNATIONAL FINANCIAL MARKETS
A
PROJECT REPORT
On
SUBMITTED BY
RESHMA VISHNU MALI
ROLL NO 31
M.COM BANKING AND FINANCE
SEMESTER IV (2013201!"
UNDER THE GUIDANCE OF
P#$%. A&'( K)#n*'+)# .
SUBMITTED TO
S.K SOMAIYA DEGREE COLLEGE OF ARTS,
SCIENCE AND COMMERCE,
VIDHYAVIHAR (E", MUMBAI!000--
AFFILIATED TO UNIVERSITY OF MUMBAI
MCOM B & F SEM-IV Page 1
CERTIFICATE
This is to certify that (Reshma Mali) of M.Com Banking &Finance
Semester I (!"#$%#&) has s'ccessf'lly Com(lete) the (ro*ect on
(I+TER+ATI,+A- FI+A+CIA- MAR.ETS) g'i)ance of /rof. A*it
.arn)ikar.
Co'rse Co%or)inator /rinci(al
/ro*ect g'i)e0Internal E1aminer
E1ternal E1aminer
2EC-ARATI,+
I (Reshma Mali) a st')ent of M.com Banking & Finance Semester I
(!"#$%#&) here3y )eclare that I ha4e Com(lete) the (ro*ect on
(International Financial Markets).
The information s'3mitte) is tr'e an) original to the 3est of my
kno5le)ge.
Signat're
(Reshma Mali)
AC.+,6-E7EME+T
I 5o'l) sincerely like to gi4e my heartfelt ackno5le)gement an)
thanks to my (arents. Any amo'nt of thanks gi4en to them 5ill ne4er
3e s'fficient.
I 5o'l) sincerely like to thank o'r /rinci(al 2r.Sangeeta .ohli. I
5o'l) also like to thank my (ro*ect g'i)e for his 4al'a3le s'((ort
an) g'i)ance 5hene4er nee)e).
I also feel heartiest sense of o3ligation my li3rary staff mem3ers &
seniors 5ho hel(e) in collection of 2ata an) materials an) also in
this (rocessing as 5ell as in )rafting man'scri(t.
-ast8 3't not the least8 I 5o'l) like to thank my frien)s & colleag'es
for al5ays 3eing there.
(Reshma Mali)
I+TER+ATI,+A- FI+A+CIA- MAR.ETS
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In economics, a financial market is a mechanism that allows people to
buy and sell (trade) financial securities (such as stocks and bonds),
commodities (such as precious metals or agricultural goods), and other
fungible items of alue at low transaction costs and at prices that reflect
the efficient!market hypothesis"
#oth general markets (where many commodities are traded) and
speciali$ed markets (where only one commodity is traded) e%ist" &arkets
work by placing many interested buyers and sellers in one 'place', thus
making it easier for them to find each other" (n economy which relies
primarily on interactions between buyers and sellers to allocate resources
is known as a market economy in contrast either to a command economy
or to a non!market economy such as a gift economy"
MCOM B & F SEM-IV Page )
In finance 8 financial markets facilitateA
*he raising of capital (in the capital markets)
*he transfer of risk (in the deriaties markets)
*he transfer of li+uidity (in the money markets)
International trade (in the currency markets)
, and are used to match those who want capital to those who have it"
*ypically a borrower issues a receipt to the lender promising to pay back
the capital" *hese receipts are securities which may be freely bought or
sold" In return for lending money to the borrower, the lender will e%pect
some compensation in the form of interest or diidends"
In mathematical finance, the concept continuous!time #rownian motion
stochastic process is sometimes used as a model"
Definition
MCOM B & F SEM-IV Page -
In economics, typically, the term market means the aggregate of possible
buyers and sellers of a certain good or serice and the transactions
between them"
*he term 'market' is sometimes used for what are more strictly
exchanges, organi$ations that facilitate the trade in financial securities,
e"g", a stock e%change or commodity e%change" *his may be a physical
location (like the ./01) or an electronic system (like .(02(3)" &uch
trading of stocks takes place on an e%change4 still, corporate actions
(merger, spinoff) are outside an e%change, while any two companies or
people, for whateer reason, may agree to sell stock from the one to the
other without using an e%change"
*rading of currencies and bonds is largely on a bilateral basis, although
some bonds trade on a stock e%change, and people are building electronic
systems for these as well, similar to stock e%changes"
5inancial markets can be domestic or they can be international"
Types of financial markets
*he financial markets can be diided into different subtypes6
8apital markets which consist of6
o 0tock markets, which proide financing through the issuance
of shares or common stock, and enable the subse+uent
trading thereof"
o #ond markets, which proide financing through the issuance
of bonds, and enable the subse+uent trading thereof"
8ommodity markets, which facilitate the trading of commodities"
&oney markets, which proide short term debt financing and
inestment"
2eriaties markets, which proide instruments for the
management of financial risk"
5utures markets, which proide standardi$ed forward contracts for
trading products at some future date4 see also forward market"
Insurance markets, which facilitate the redistribution of arious
risks"
5oreign e%change markets, which facilitate the trading of foreign
e%change"
*he capital markets consist of primary markets and secondary markets"
.ewly formed (issued) securities are bought or sold in primary markets"
0econdary markets allow inestors to sell securities that they hold or buy
e%isting securities" *he transaction in primary market e%ist between
inestors and public while secondary market its
Raising the capital
*o understand financial markets, let us look at what they are used for, i"e"
what where firms make the capital to inest
:ithout financial markets, borrowers would hae difficulty finding
lenders themseles" Intermediaries such as banks help in this process"
#anks take deposits from those who hae money to sae" *hey can then
lend money from this pool of deposited money to those who seek to
borrow" #anks popularly lend money in the form of loans and mortgages"
&ore comple% transactions than a simple bank deposit re+uire markets
where lenders and their agents can meet borrowers and their agents, and
where e%isting borrowing or lending commitments can be sold on to other
parties" ( good e%ample of a financial market is a stock e%change" (
company can raise money by selling shares to inestors and its e%isting
shares can be bought or sold"
The follo5ing ta3le ill'strates 5here financial markets fit in the
relationshi( 3et5een len)ers an) 3orro5ersA
MCOM B & F SEM-IV Page 1;
Relationshi( 3et5een len)ers an) 3orro5ers
-en)ers
Financial
Interme)iaries
Financial
Markets
Borro5ers
Indiiduals
8ompanie
s
#anks
Insurance
8ompanies
<ension 5unds
&utual 5unds
Interbank
0tock
1%change
&oney
&arket
#ond &arket
5oreign
1%change
Indiiduals
8ompanies
8entral
=oernment
&unicipalities
<ublic
8orporations
-en)ers
:ho hae enough money to >end or to gie someone money from own
pocket at the condition of getting back the principal amount or with some
interest or charge, is the >ender"
In)i4i)'als & 2o'3les
&any indiiduals are not aware that they are lenders, but almost
eerybody does lend money in many ways" ( person lends money when
he or she6
puts money in a saings account at a bank4
contributes to a pension plan4
pays premiums to an insurance company4
inests in goernment bonds4 or
inests in company shares"
Com(anies
Companies tend to be borrowers of capital" :hen companies hae
surplus cash that is not needed for a short period of time, they may seek
to make money from their cash surplus by lending it ia short term
markets called money markets"
*here are a few companies that hae ery strong cash flows" *hese
companies tend to be lenders rather than borrowers" 0uch companies may
decide to return cash to lenders (e"g" ia a share buyback") (lternatiely,
they may seek to make more money on their cash by lending it (e"g"
inesting in bonds and stocks")
Borro5ers
Individuals borrow money ia bankers? loans for short term needs or
longer term mortgages to help finance a house purchase"
Companies borrow money to aid short term or long term cash flows"
*hey also borrow to fund modernisation or future business e%pansion"
Governments often find their spending re+uirements e%ceed their ta%
reenues" *o make up this difference, they need to borrow" =oernments
also borrow on behalf of nationalised industries, municipalities, local
authorities and other public sector bodies" In the @A, the total borrowing
re+uirement is often referred to as the <ublic sector net cash re+uirement
(<0.8B)"
=oernments borrow by issuing bonds" In the @A, the goernment also
borrows from indiiduals by offering bank accounts and <remium #onds"
=oernment debt seems to be permanent" Indeed the debt seemingly
e%pands rather than being paid off" Cne strategy used by goernments to
reduce the value of the debt is to influence inflation"
Municipalities and local authorities may borrow in their own name as
well as receiing funding from national goernments" In the @A, this
would coer an authority like Dampshire 8ounty 8ouncil"
Public Corporations typically include nationalised industries" *hese may
include the postal serices, railway companies and utility companies"
&any borrowers hae difficulty raising money locally" *hey need to
borrow internationally with the aid of 5oreign e%change markets"
#orrower?s haing same need can form them into a group of borrowers" It
can also take an organi$ational form" Eust like &utual 5und" *hey can
proide mortga$e on weight basis" *he main adantage is that it lowers
their cost of borrowings"
Derivative products
2uring the 197;s and 199;s, a maEor growth sector in financial markets is
the trade in so called )eri4ati4e (ro)'cts, or )eri4ati4es for short"
In the financial markets, stock prices, bond prices, currency rates, interest
rates and diidends go up and down, creating risk" 2eriatie products
are financial products which are used to control risk or parado%ically
exploit risk" It is also called financial economics"
2eriatie products or instruments help the issuers to gain an unusual
profit from issuing the instruments" 5or using the help of these products a
contract hae to be made" 2eriatie contracts are mainly 3 types6 1"
5uture 8ontracts 2" 5orward 8ontracts 3" Cption 8ontracts"
Currency markets
&ain article6 5oreign e%change market
0eemingly, the most obious buyers and sellers of currency are importers
and e%porters of goods" :hile this may hae been true in the distant past,
Fwhen?G
when international trade created the demand for currency markets,
importers and e%porters now represent only 1H32 of foreign e%change
dealing, according to the #ank for International 0ettlements"
F1G
*he picture of foreign currency transactions today shows6
#anksHInstitutions
0peculators
=oernment spending (for e%ample, military bases abroad)
ImportersH1%porters
*ourists
Analysis of financial markets
ee tatistical analysis of financial markets, statistical finance!!!
&uch effort has gone into the study of financial markets and how prices
ary with time" 8harles 2ow, one of the founders of 2ow Iones J
8ompany and *he :all 0treet Iournal, enunciated a set of ideas on the
subEect which are now called 2ow *heory" *his is the basis of the so!
called technical analysis method of attempting to predict future changes"
Cne of the tenets of 'technical analysis' is that market trends gie an
indication of the future, at least in the short term" *he claims of the
technical analysts are disputed by many academics, who claim that the
eidence points rather to the random walk hypothesis, which states that
the ne%t change is not correlated to the last change"
*he scale of changes in price oer some unit of time is called the
olatility" It was discoered by #enoKt &andelbrot that changes in prices
do not follow a =aussian distribution, but are rather modeled better by
>Ly stable distributions" *he scale of change, or olatility, depends on
the length of the time unit to a power a bit more than 1H2" >arge changes
up or down are more likely than what one would calculate using a
=aussian distribution with an estimated standard deiation"
( new area of concern is the proper analysis of international market
effects" (s connected as today?s global financial markets are, it is
important to reali$e that there are both benefits and conse+uences to a
global financial network" (s new opportunities appear due to integration,
so do the possibilities of contagion" *his presents uni+ue issues when
attempting to analy$e markets, as a problem can ripple through the entire
connected global network ery +uickly" 5or e%ample, a bank failure in
one country can spread +uickly to others, which makes proper analysis
more difficult"
Financial market slang
/oison (ill, when a company issues more shares to preent being
bought out by another company, thereby increasing the number of
outstanding shares to be bought by the hostile company making the
bid to establish maEority"
B'ant, a +uantitatie analyst with a <h2
Fcitation neededG
(and aboe)
leel of training in mathematics and statistical methods"
Rocket scientist, a financial consultant at the $enith of
mathematical and computer programming skill" *hey are able to
inent deriaties of high comple%ity and construct sophisticated
pricing models" *hey generally handle the most adanced
computing techni+ues adopted by the financial markets since the
early 197;s" *ypically, they are physicists and engineers by
training4 rocket scientists do not necessarily build rockets for a
liing"
6hite .night, a friendly party in a takeoer bid" @sed to describe
a party that buys the shares of one organi$ation to help preent
against a hostile takeoer of that organi$ation by another party"
2istinction 3et5een Cre)it an) Bon) Market

MCOM B & F SEM-IV Page 1)
#oth bonds and credit (currency) financing hae their adantages and
disadantages" 5or a gien company, under specific circumstances, one
method of financing may be preferred to the other" *he maEor differences
are6

1. Cost of 3orro5ing
#onds are issued in both fi%ed rate and floating rate forms" 5i%ed rate
bonds are an attractie e%posure management tool since the known long!
term currency inflows can be offset by the known long!term outflows in
the same currency" In contrast, currency loans carry ariable
rates"
2" Mat'rity
#onds hae longer maturities while the period of borrowing in the
currency market has tended to lengthen oer time"

3" Si>e of the iss'e
1arlier, the funds aailable for lending at any time hae been much more
in the inter!bank market than in the bond market" #ut of late, this
situation does not hold true" &oreoer, although in the past the flotation
costs of a 1uro currency loan hae been much lower than a 1uro bond
(about ;"5 M of the total loan amount ersus about 2"25 M of the face
MCOM B & F SEM-IV Page 1-
alue of a 1uro bond issue), compensation has worked to lower 1uro
bond flotation costs"

4. Fle1i3ility
In a 1uro bond issue, the funds must be drawn in one sum on a fi%ed date
and repaid according to a fi%ed schedule, unless the borrower pays a
substantial prepayment penalty" #y contrast, the drawdown in a floating
rate loan can be staggered to suit the borrowerNs needs and can be repaid
in whole or in part at any time, often without penalty" &oreoer, a 1uro
currency loan with a multi!currency clause enables the borrower to switch
currencies on any roll!oer date, whereas switching the denomination of a
1uro bond from currency ( to currency # would re+uire a costly,
combined, refunding and reissuing operation"

9. S(ee)
5unds can be raised by a known borrower ery +uickly in the 1uro
currency market" Cften, a period of two to three weeks should suffice" (
1uro bond financing generally takes more time, though the difference is
becoming less significant"

!. Cre)it Market

8redit or >oans are the loans e%tended for one year or longer" *he market
that deals in such loans is called 8redit &arket"

*he common maturity for credit loans is 5 years" 0ince banks accept
short!term deposits and proide long!term loans, it is likely that asset
liability mismatch may arise" *o aoid this banks often e%tend floating
rate credit loans fi%ed to some market interest rate" *he >ondon Inter
#ank Cffer Bate (>I#CB) is the most commonly used interest rate" It is
the rate charged for loans between #anks"

/artici(ants in cre)it Market
*he maEor lending banks in the credit market are banks, (merican,
Iapanese, #ritish, 0wiss, 5rench, =erman and (sian (specially that of
0ingapore) banks, 8hemical #ank, I< &organ, 8iticorp, #ankers *rust,
8hase &anhattan #ank, 5irst .ational #ank of 8hicago, #arclay?s #ank,
.ational :estminster, #.<, etc" (mong the borrowers, there are banks,
multinational groups, public utilities, goernment agencies, local
authorities, etc"

2ealing 5ith cre)its
:hen a borrower approaches a bank for credit, a formal document is
prepared on behalf of potential borrowers" *his document contains the
principal terms and conditions of loan, obEecties of loan and details of
the borrower"

#efore launching syndication, the approached bank decides primarily, in
consultation with the borrower, on a strategy to be adopted, i"e" whether
to approach a large market or a restricted number of banks to form the
syndicate" 1ach of the banks in syndicate lends a part of the loan" *he
duration of this operation is normally about ) to 7 weeks"

0eeral clauses may be introduced in the contract of debt6
O Pari!passu clause that preents the borrower from contracting new
debts that subordinate the interest of lenders4
O "xchange option clause that allows the withdrawal of a part or totality
of loan in another currency4
O #egative guarantee clause that commits the borrower not to contract
other debts that subordinate the interest of lenders"

Characteristics of cre)it
( maEor part (more than 7; M) of the debts is made in @0 dollars" *he
second (but far behind) is <ound 0terling followed by 2eutsch mark,
Iapanese yen, 0wiss franc and others"

&ost of the syndicated debts are of the order of P5; million" (s far as the
upper limits are concerned, amounts inoled are of as high magnitude as
P5 billion and more" In 199;, 1uro tunnel borrowed P)"7 billion"

Cn an aerage, maturity periods are of about fie years (in some cases it
is about 2; years)" *he reimbursement of the loan may take place in one
go (bullet) or in seeral installments"

*he interest rate on 1uro debt is calculated with respect to a rate of
reference, increased by a margin (or spread)" *he rates are aailable and
generally renewable (roll oer credit) eery si% months, fi%ed with
reference to >I#CB" *he >I#CB is the rate of money market applicable
to short!term credits among the banks of >ondon" *he reference rate can
e+ually be <I#CB at <aris and 5I#CB at 5rankfurt, etc" It is reised
regularly"

*he margin depends on the supply and demand of the capital as also on
the degree of the risk of these credits and the rating of borrowers"
5inancial institutions are in igorous competition" *here is an actie
secondary market of 1uro debts" .umerous techni+ues allow banks to sell
their titles in this market"

$. Bon) Market
1uro #ond issue is one denominated in a particular currency but sold to
inestors in national capital markets other than the country that issued the
denominating currency" (n e%ample is a 2utch borrower issuing 2&!
denominated bonds to inestors in the @A, 0wit$erland and the
.etherlands"

*he 1urobond market is the largest international bond market, which is
said to hae originated in 19)3 with an issue of 1urodollar bonds by
(utos trade, an Italian borrower" *he market has since grown enormously
in si$e and was worth about P 427 billion in 1994"

bond markets in all currencies e%cept the Iapanese /en are +uite free
from any regulation by the respectie goernments" 0traight bonds are
priced with reference to a benchmark, typically treasury issues" *hus a
dollar bond will be priced to a yield a /*& (/ield!to!&aturity)
somewhat aboe the @0 treasury bonds of similar maturity, the spread
depending upon the borrowers ratings and market conditions"
5loatation costs of the bond are comparatiely higher than costs indicated
with syndicated credits"
&. Commercial (a(er(C/s)
8ommercial paper is a corporate short!term, unsecured promissory
note issued on a discount to yield basis" 8ommercial paper maturities
generally do not e%ceed 2-; days" 8ommercial paper represents a cheap
and fle%ible source of funds :hile 8<s are negotiable, secondary markets
tend to be not ery actie since most inestors hold the paper to maturity"
*he emergence of the 1uro 8ommercial <aper (18<) is much more
recent" It eoled as a natural culmination of the .ote Issuance 5acility
and deeloped rapidly in an enironment of securitisation and
disintermediation of traditional banking" 8< has also deeloped in the
domestic segments of some 1uropean countries offering attractie
funding opportunities to resident entities"

9. Certificate of 2e(osit (C2s)
( 8ertificate of 2eposit (82) is a negotiable instrument eidencing a
deposit with a bank" ( 82 is a marketable instrument so that the inestor
can dispose it off in the secondary market wheneer cash is needed" *he
final holder is paid the face alue on maturity along with the interest" It is
used by the commercial banks as short! term funding instruments"
1uro 82s are mainly issued in >ondon by banks" Interest on 82s with
maturity more than a year is paid annually than semi!annually"

:. International Ca(ital Markets

International 8apital &arkets hae come into e%istence to cater to the
need of international financing by economies in the form of short,
medium or long!term securities or credits" *hese markets also called
markets, are the markets on which currencies, bonds, shares and bills are
tradedHe%changed" Cer the years, there has been a phenomenal growth
both in olume and types of financial instruments transacted in these
markets" currency deposits are the deposits made in a bank, situated
outside the territory of the origin of currency" 5or e%ample, dollar is a
deposit made in @0 dollars in a bank located outside the @0(4 banks are
the banks in which currencies are deposited" *hey hae term deposits in
currencies and offer credits in a currency other than that of the country in
which they are located"

( distinctie feature of the financial strategy of multinational companies
is the wide range of e%ternal serices of funds that they use on an ongoing
basis" #ritish *elecommunication offers stock in >ondon, .ew /ork and
*okyo, while 0wiss #ank 8orporation!, aided by Italian, #elgian,
8anadian and =erman banks! helps corporations sell 0wiss franc bonds in
1urope and then swap the proceeds back into @0 dollars"

5irms hae three general sources of funds aailable6 (i) internally
generated cash, (ii) short!term e%ternal funds, and (iii) long!term e%ternal
funds" 1%ternal inestment comes in the form of debt or e+uity, which are
generally negotiable (tradable) instruments" *he pattern of financing
aries from country to country" 8ompanies in the @A get an aerage of
);!-;M of their funds from internal sources" =erman companies get
about 4;!5;M of their funds from e%ternal suppliers" In 19-5, Iapanese
companies got more than -;M of their money from outside sources, but
this pattern has since reersed4 maEor chunks of finances come from
internal sources"

(nother significant aspect of financing behaiour is that debt accounts for
the oerwhelming share of e%ternal finance" Industry sources of e%ternal
finance also differ widely from country to country" =erman and Iapanese
companies hae relied heaily on bank borrowing, while the @0 and
#ritish industry raised much more money directly from financial markets
by the sale of securities" Doweer, in all countries, bank borrowing is on
a decline" *here is a growing tendency for corporate borrowing to take
the form of negotiable securities issued in the public capital markets
rather than in the form of commercial bank loans" *his process known as
securitisation is most pronounced among the Iapanese companies"

;. /etro 2ollar
2uring the oil crises of 19-3, the 8apital markets hae played a ery
important role" *hey accepted the dollar deposits from oil e%porters and
channeled the funds to the borrowers in other countries" *his is called
Qrecycling the petrodollarsN"


<. C'nk Bon)s
( Eunk bond is issued by a corporation or municipality with a bad credit
rating" In e%change for the risk of lending money to a bond issuer
with bad credit, the issuer pays the inestor a higher interest rate"
'Digh!yield bond' is a nicer name for Eunk bond *he credit rating
of a high yield bond is considered 'speculatie' grade or below
'inestment grade'" *his means that the chance of default with
high yield bonds is higher than for other bonds" *heir higher credit
risk means that 'Eunk' bond yields are higher than bonds of better
credit +uality" 0tudies hae demonstrated that portfolios of high
yield bonds hae higher returns than other bond portfolios,
suggesting that the higher yields more than compensate for their
additional default risk"

Iunk bonds became a common means for raising business capital in the
197;s, when they were used to help finance the purchase of companies,
especially by leeraged buyouts, the sale of Eunk bonds continued to be
used in the 199;s to generate capital

=. Sam'rai Bon)s
*hey are publicly issued yen denominated bonds" *hey are issued by non!
Iapanese entities"
*he Iapanese &inistry of 5inance lays down the eligibility guidelines for
potential foreign borrowers" *hese specify the minimum rating, si$e of
issue, maturity and so forth" 5loatation costs tend to be high" <ricing is
done with respect to >ong!term <rime Bate"

Shi3osai Bon)s
*hey are priate placement bonds with distribution limited to banks and
institutions" *he eligibility criteria are less stringent but the &C5 still
maintains control"

0hogun H =eisha #onds
*hey are publicly floated bonds in a foreign currency while =eisha are
their priate counterparts"

#". Dankee Bon)s
*hese are dollar denominated bonds issued by foreign borrowers" It is the
largest and most actie market in the world but potential borrowers must
meet ery stringent disclosure, dual rating and other listing re+uirements,
options like call and put can be incorporated and there are no restrictions
on si$e of the issue, maturity and so forth"

/ankee bonds can be offered under rule 144a of 0ec" *hese issues are
e%empt from elaborate registration and disclosure re+uirements but
rating, while not mandatory is helpful" 5inally low rated or unrated
borrowers can make priate placements" Digher yields hae to be offered
and the secondary market is ery limited"

$. 6hat are the )ifferent international financial marketsE

*he international financial markets consist of the credit market, money
market, bond market and e+uity market"

*he international credit market, also called 1uro credit market, is the
market that deals in medium term 1uro credit or 1uro loans"

International banks and their clients comprise the 1urocurrency market
and form the core of the international money market" *here are seeral
other money market instruments such as the 1uro 8ommercial <aper
(18<) and the 1uro 8ertificate of 2eposit (182)"

5oreign bonds and 1urobonds comprise the international bond market"
*here are seeral types of bonds such as floating rate bonds, $ero coupon
bonds, deep discount bonds, etc"

*he international e+uity market tells us how ownership in publicly owned
corporations is traded throughout the world" *his comprises both, the
primary sale of new common stock by corporations to initial inestors
and how preiously issued common stock is traded between inestors in
the secondary markets"

International Financial Market% (general% can 3e 'se) in any)

*he last two decades hae witnessed the emergence of a ast financial
market across national boundaries enabling massie cross!border capital
flows from those who hae surplus funds and a search of high returns to
those seeking low!cost funding" *he degree of mobility of capital, the
global dispersal of the finance industry and the enormous diersity of
markets and instruments, which a firm seeking funds can tap, is
something new"

&aEor C182 (Crgani$ation for 1conomic 8o!operation and
2eelopment) countries had began deregulating and liberali$ing their
financial markets towards the end of seenties" :hile the process was far
from smooth, the oerall trend was in the direction of relaxation of
controls, which till then had compartmentali$ed the global financial
markets" 1%change and capital controls were gradually remoed, non!
residents were allowed freer access to national capital markets and
foreign banks and financial institutions were permitted to establish their
presence in the arious national markets"

:hile opening up of the domestic markets began only around the end of
seenties, a truly international financial market had already been born in
the mid!fifties and gradually grown in si$e and scope during si%ties and
seenties" *his refers to the 1uro currencies &arket where borrower
(inestor) from country ( could raise (place) funds from (with) financial
institutions located in country #, denominated in the currency of country
8" 2uring the eighties and nineties, this market grew further in si$e,
geographical scope and diersity of funding instruments" It is no more a
'euro' market but a part of the general category called Roffshore
marketsS"

(longside liberali$ation, other +ualitatie changes hae been taking place
in the global financial markets" Bemoal of restrictions has resulted into
geographical integration of the maEor financial markets in the C182
countries" =radually this trend is spreading to deeloping countries many
of which hae opened up their markets!at least partially!to non!resident
inestors, borrowers and financial institutions"

(nother noticeable trend is functional integration" *he traditional
distinctions between different financial institutions!commercial banks,
inestment banks, finance companies, etc"! are giing way to diersified
entities that offer the full range of financial serices" *he early part of
eighties saw the process of disintermediation get underway" Dighly rated
issuers began approaching inestors directly rather than going through the
bank loan route"

Cn the other side, debt crisis in the deeloping countries, adoption of
capital ade+uacy norms and intense competition, forced commercial
banks to reali$e that their traditional business of accepting deposits and
making loans was not enough to guarantee their long!term surial and
growth" *hey began looking for new products and markets" 8oncurrently,
the international financial enironment was becoming more olatile!
there were fluctuations in interest and e%change rates" *hese forces gae
rise to innovative forms of funding instruments and tremendous adances
in risk management" *he decade saw increasing actiity in and
sophistication of the deriatiesN market, which had begun emerging in
the seenties"

*aken together, these deelopments hae gien rise to a globally
integrated financial marketplace in which entities in need of short! or
long!term funding hae a much wider choice than before in terms of
market segment, maturity, currency of denomination, interest rate basis,
incorporating special features and so forth" *he same fle%ibility is
aailable to inestors to structure their portfolios in line with their risk!
return tradeoffs and e%pectations regarding interest rates, e%change rates,
stock markets and commodity prices"

&. -ist o't the gro5th an) f'nctions of c'rrency markets

seenties" *his refers to the well!known Q1urocurrencies &arketN" It is the
largest offshore market"

<rior to 197;, 1urocurrencies market was the only truly international
financial market of any significance" It is mainly an inter!bank market
trading in time deposits and arious debt instruments" :hat matters is the
location of the bank neither the ownership of the bank nor ownership of
the deposit" *he prefi% %"uro% is now outdated since such deposits and
loans are regularly traded outside 1urope"

Cer the years, these markets hae eoled a ariety of instruments other
than time deposits and short!term loans, e"g" certificates of deposit (82s),
euro commercial paper (18<), medium! to long! term floating rate loans,
eurobonds, floating rate notes and euro medium!term notes (1&*.s)"

*he difference between markets and their domestic counterparts is one of
regulation" 1urobonds are free from rating and a disclosure re+uirement
applicable to many domestic issues as well as registration with securities
e%change authorities"

1mergence of 1uro markets6
1" 2uring the 195;s, the erstwhile @00B was earning dollars from the
sale of gold and other commodities and wanted to use them to buy
grain and other products from the :est, mainly from the @0"
Doweer, they did not want to keep these dollars on deposit with
banks in .ew /ork, as they were apprehensie that the @0
goernment might free$e the deposits if the cold war intensified" *hey
approached banks in #ritain and 5rance who accepted these dollar
deposits and inested them partly in @0"
2" 2omestic banks in @0 (as in many other countries) were subEected
to resere re+uirements, which meant that a part of their deposits were
locked up in relatiely low yielding assets"
3" *he importance of the dollar as a ehicle currency in international
trade and finance increased, so many 1uropean corporations had cash
flows in dollars and hence temporary dollar surpluses" 2ue to distance
and time $one problems as well as their greater familiarity with
1uropean banks, these companies preferred to keep their surplus
dollars in 1uropean banks, a choice made more attractie by the
higher rates offered by 1uro banks"

*he main factors behind the emergence and strong growth of the
1urodollar markets were the regulations on borrowers and lenders
imposed by the @0 authorities which motiated both banks and
borrowers to eole 1urodollar deposits and loans" (dded to this are the
considerations mentioned aboe, i$" the ability of 1uro banks to offer
better rates both to the depositors and the borrowers and conenience of
dealing with a bank that is closer to home, who is familiar with business
culture and practices in 1urope"

0DCB* .C*10

#. /artici(ants in International /ro*ect Financing F a) S(onsors 3)
-en)ers

0ponsors
*hese are partners in the proEect who bring in the e+uity capital or risk
capital" #eing so, they are keenly interested in the successful completion
of the proEect and shoulder maEor responsibilities as regards its e%ecution"
*he fact that they bring in the e+uity capital is an indication of their
interest" (lso the amount of e+uity that they bring has a marked bearing
on the e%tent of debt that can be raised for the proEect"

0ometimes people who bring in the e+uity capital are Eust the initiators of
the proEect" Included in this category are multinational firms, future
buyers of products or serices of the proEect, the public or priate
inestors, international organisations, deelopment banks etc"

>enders
*hey bring in the debt capital" 5inancing of a big proEect necessitates
interention of a banking pool consortium composed of banks, national or
international financial institutions, e%port financing institutions etc"

=uarantors
=uarantees maybe proided by banks, public financing organisations,
international financial institutions, priate insurance companies etc"

<roEect Cperators
(n operating company interenes in the erection of the proEect" It brings
its organisational know!how to manage the proEect"

!. Risks associate) 5ith international (ro*ects% financial8 (olitical8
others

1" 5inancial risk
In general, international proEects are prone to greater financial risk as a
bulk of finance is in the form of debt" *he maEor factors affecting
financial risk are degree of indebtedness, the terms and conditions of
repayment of debt and currency used"

0ome proEects will hae e%penses and reenues that inole seeral
currencies" (s a result the e%change rate risk is ery high"

<roEects maybe financed with floating rates" In iew of the olatility
obsered on the rates like >I#CB, the interest rate risk is also
significant" *herefore it is necessary to plan the coerage of all these
risks"

2" 5oreign 1%change Bisk
(s corporations e%pand their international actiities, they begin to ac+uire
foreign assets and foreign liabilities" (s e%change rates change, the alues
of these foreign assets and liabilities change accordingly" 5or a
corporation, e%change rate risk is the sensitiity of the alue of the
corporation when the e%change rates change" Cbiously, the change in the
corporation alue is related to the net change in the alues of the foreign
assets and foreign liabilities" (1"g" foreign direct inestment, foreign
e%change loss, sales and income from foreign sources")

3" 1conomic Bisk
1conomic risk is risk created by changes in the economy" *ypically, it is
related to technological changes, the actions of competitors, shifts in
consumer preferences, etc" Ideally, a pure domestic firm is affected only
by domestic economic conditions ! the domestic economic risk" Doweer,
in today?s integrated world economy, the concept of a pure domestic firm
has less practical releance" &any firms that appear strictly pure domestic
confront foreign economic risk indirectly" (1"g"6 local restaurantHdept
store, real estate agent)

4" <olitical Bisk
<olitical risk is risk created by political changes or instability in a
country" *hese factors include, but are not limited to, nationali$ation,
confiscation, price controls, foreign e%change and capital controls,
administratie hurdles, uncertain property rights, discriminatie or
arbitrary regulations on business practices (hiring, contract negotiation),
ciil wars, riots, terrorism, etc" 1ach country in the world presents a
different political profile and represents a uni+ue source of political risk
that firms must assess and manage when they make foreign inestments"

In order to minimi$e this risk, local inestors or the local goernment
may be associated with the proEect" Insurance against political risk is
another useful techni+ue recommended for the purpose"

&hat constitutes political risk and how to measure it?
*he political risk management typically inoles6
! Identifying political risk and its likely conse+uences
! 2eeloping policies in adance to cope with the possibility of political
risk
! 0trengthening a firm?s bargaining position
! 2eising measures to ma%imi$e compensation in the eent of
e%propriation

8ountry Bisk6 It refers to elements of risk inherent in doing business in
the economic, social, and political enironment of another country"

5" 8ounter party Bisk ! *he risk that a counter party will default on a
financial obligation"

)" >i+uidity Bisk !*he risk that a financial position cannot be sold
+uickly at preailing prices"

-" 2eliery Bisk ! *he risk that a buyer will not delier payment of
funds after a seller has deliered securities or foreign e%change that
were purchased"

7" Bolloer Bisk ! *he risk of being closed out from a financial market
and unable to renew (or roll oer) a short!term contract"

=. Cther risks ! Cther risks relate to the risk of cost oerruns and bad
management"

$. Financing of M+Cs in local or international market

<roEect financing may be defined as financing of an economic unit,
legally independent, created with a iew to setting up of a big proEect,
which is commercially profitable and financially iable"
<roEect is considered as a distinct legal entity and is financed, to a marked
e%tent, by debt ()5 to -5 percent)" *herefore the risk to be borne is
substantial"

*here are two maEor methods of financing international proEects6

1" 5inancing with total risk borne by lenders where only the future
cashflows ensure the reimbursement of the loan" *his method of
financing was used in petroleum and gas industry in the @0( and
8anada" 2ue to increased leel of risks, this method of proEect
financing is generally not preferred"

2" In another type of financing, both the lender and the promoter share
the risk" *he problem sometimes encountered in this method is to
decide the proportion in which the risk is to be shared between two
parties"

2omestic 40s offshore markets
5inancial assets and liabilities denominated in a particular currency ! say
the 0wiss 5ranc ! are traded are primarily in the national financial
markets of that country" *hese financial markets are known as Q2omestic
&arketsN"

In case of many conertible currencies they are traded in the financial
markets outside the country of that currency" *hese financial markets are
known as QCffshore &arketsN"

:hile it is true that neither both markets will offer both the financing
options nor any entity can access all segments of a particular market, it is
true generally that a gien entity has an access to both the segments of the
markets for placing as well as raising funds"

*here are theories by e%perts that suggest that there are no two types of
financial markets (vi$' 2omestic and offshore markets) but eerything is a
part of single Q=lobal 5inancial &arketN"

0imilarity
1%perts suggest that QarbitrageN will ensure that both these markets will be
closely linked together in terms of costs of funding and returns on assets'

2ifferences
#oth of these markets significantly differ on the QBegulatory dimensionN"
&aEor segments of the domestic markets are subEect to strict superision
by the releant authorities such as 018 in @0, &inistry of 5inance in
Iapan and the 0wiss .ational #ank in 0wit$erland" *hese authorities
regulate foreign (non!resident) entitiesN access to the public capital
markets in their countries by laying down eligibility criteria, disclosure J
accounting norms and registration J rating re+uirements (similarly for
domestic banks, resere re+uirements and deposit insurance)"

*he offshore markets on the other hand hae minimal regulation and
often no registration"
5inally it must be noted that though the nature of regulation continues to
distinguish 2omestic from the offshore markets, there are segments like
<riate <lacements, @nlisted #onds, #ank loans etc" in domestic markets
where regulation tends to be the least"

&. c'rrency Markets

seenties" *his refers to the well!known Q1urocurrencies &arketN" It is the
largest offshore market"

<rior to 197;, 1urocurrencies market was the only truly international
financial market of any significance" It is mainly an inter!bank market
trading in time deposits and arious debt instruments" :hat matters is the
location of the bank neither the ownership of the bank nor ownership of
the deposit" *he prefi% %"uro% is now outdated since such deposits and
loans are regularly traded outside 1urope"

Cer the years, these markets hae eoled a ariety of instruments other
than time deposits and short!term loans, e"g" certificates of deposit (82s),
euro commercial paper (18<), medium! to long! term floating rate loans,
eurobonds, floating rate notes and euro medium!term notes (1&*.s)"

*he main factors behind the emergence and strong growth of the
1urodollar markets were the regulations on borrowers and lenders
imposed by the @0 authorities which motiated both banks and
borrowers to eole 1urodollar deposits and loans" (dded to this are the
considerations mentioned aboe, i$" the ability of euro banks to offer
better rates both to the depositors and the borrowers and conenience of
dealing with a bank that is closer to home, who is familiar with business
culture and practices in 1urope"

9. E1ternal Bon) Market

*he e%ternal bond market refers to bond trading actiity wherein the
bonds are underwritten by an international syndicate, are offered in
seeral countries simultaneously, are issued outside any country?s
Eurisdiction, and are not registered" *he 1urobond market is a maEor
e%ternal bond market" *he e%ternal bond market combined with the
internal bond market comprises the global bond market" 1%amples of an
e%ternal bond are the 'global bond,' issued by the :orld #ank, and
1urodollar bonds"
*he 1%ternal #ond &arket comprises of the 6
5oreign #ond &arket and
#ond &arket
5oreign #ond6 issue is one offered by a foreign borrower to the inestors
in a national capital market and denominated in that nations currency" (n
e%ample is =erman &.8 issuing dollar denominated bonds to the @"0"
inestors"

#ond6 issue is one denominated in a particular currency but sold to
inestors in national capital markets other than the country that issued the
denominating currency" (n e%ample is a 2utch borrower issuing 2&!
denominated bonds to inestors in the @A, 0wit$erland and the
.etherlands"

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INTERNATIONAL FINANCIAL MARKETS

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