International Business: The Challenges
of Globalization
Tenth Edition
Chapter 10
International Financial
Markets
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Learning Objectives
10.1 Describe the nature and main components of the
international capital market.
10.2 Outline the main functions and risks of the foreign
exchange market.
10.3 Explain the different types of currency exchange rates
and instruments.
10.4 Describe the foreign exchange market structure and
currency convertibility.
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Samsung’s Number Won
• Samsung Electronics
– 237 subsidiaries across
the world generate
annual revenue of 240
trillion won ($200 billion)
▪ Exposed to
transaction risk
– Periodically integrates
subsidiary earnings into
consolidated financial
statements
▪ Exposed to
translation risk
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The International Capital Market
Capital market
• System that allocates financial resources in the form of
debt and equity according to their most efficient uses
• Two primary means of obtaining external financing:
– Debt
▪ Bonds
– Equity
▪ Stock
– Dividends
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The International Capital Market: Benefits
International capital market
• Network of individuals, companies, financial institutions,
and governments that invest and borrow across national
boundaries
• Offers two key benefits:
– Expands opportunities for borrowers
– Reduces risk for lenders
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Photo and Discussion Question (1 of 4)
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The International Capital Market: Bonds (1 of 2)
International bond market
• Market consisting of all bonds sold by issuing companies,
governments, or other organizations outside their own
countries
• Issuing bonds is a popular way to obtain needed funding
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The International Capital Market: Bonds (2 of 2)
Types of international bonds:
• Eurobond
– Bond issued outside the country in whose currency it
is denominated
• Foreign bond
– Bond sold outside the borrower’s country and
denominated in the currency of the country in which it
is sold
• Low interest rates fuel growth in the bond market
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Culture Insights: Big Results from
Microfinance
Microfinance Defined: Microfinance provides small loans and
financial services to underbanked entrepreneurs, small
businesses, and families without access to traditional providers.
Overcoming Obstacles: Loans in developing countries can be
difficult to obtain and high interest rates may devour an
entrepreneur’s profits.
One for All, All for One: Peer pressure and support help
prevent defaults.
Friends and Family: A variation of microfinance is helping
minority entrepreneurs in developed nations.
Additional Options: Consider job training, savings accounts,
and basic health
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The International Capital Market: Equity (1 of 2)
International equity market
• Market consisting of all stocks bought and sold outside
the issuer’s home country
• The stock exchanges of Frankfurt, London, and New
York list the greatest number of companies from outside
their own borders.
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The International Capital Market: Equity (2 of 2)
• Factors in the growth of the international equity market:
– Privatization
▪ Telefonica del Peru
– Emerging markets
▪ International markets are a major source of funding
– Investment banks
▪ Bring together borrowers and investors
– Electronic trading
▪ Match buyers and sellers in nanoseconds
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Photo and Discussion Question (2 of 4)
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The International Capital Market:
Eurocurrency (1 of 2)
Eurocurrency market
• Market consisting of all the world’s currencies that are banked
outside their countries of origin (referred to as Eurocurrency)
– Eurodollars
– Europounds
– Euroyen
• Sources
– Governments
– Commercial banks
– International companies
– Wealthy individuals
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The International Capital Market:
Eurocurrency (2 of 2)
• The main appeal of the Eurocurrency market is a
complete absence of regulation
– Lowers the cost of banking but increases potential
risk
Interbank interest rates
• Interest rates that the world’s largest banks charge one
another for loans
– London Interbank Offer Rate (LIBOR)
– London Interbank Bid Rate (LIBID)
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The Foreign Exchange Market (1 of 2)
Foreign exchange market
• Market in which currencies are bought and sold and their
prices are determined
Exchange rate
• Rate at which one currency is exchanged for another
• Currency transactions are conducted through a process of bid
and ask quotes
– The bid quote is the price at which the bank will buy
– The ask quote is the price at which the bank will sell
– The bid-ask spread is the difference between the two
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The Foreign Exchange Market (2 of 2)
• An exchange rate quote in the foreign exchange market states the
amount of a currency that is required to buy one unit of another
currency
– The exchange rate between the Japanese yen and the US dollar
is stated as ¥110/$
▪ We read this as “110 yen to the dollar,” or “110 yen are
needed to buy one dollar.”
– An exchange rate of €0.84/$ tells us that €0.84 are needed to
buy one US dollar
– To learn how many US dollars are needed to buy one euro, we
divide 0.84 into 1 (1 = 0.84 1.19 )
▪ This tells us that $1.19 is needed to buy one euro
– We write this exchange rate as $1.19/€
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The Foreign Exchange Market: Functions
Currency conversion
• To facilitate transactions, invest directly abroad, or repatriate profits
Currency hedging
• Practice of insuring against potential losses that result from adverse
changes in exchange rates
Currency arbitrage
• Instantaneous purchase and sale of a currency in different markets
for profit
– Interest arbitrage
Currency speculation
• Purchase or sale of a currency with the expectation that its value will
change and generate a profit
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Figure 10.1: World’s Most Traded
Currencies
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Photo and Discussion Question (3 of 4)
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The Foreign Exchange Market: Exchange
Rate Risk - Exposure
Exchange-rate risk
• Potential for adverse changes in exchange rates that could harm a
business
Transaction exposure
– Risk that an exchange rate change will affect the value of a
business transaction
Translation exposure
– Risk that an exchange rate change will affect a company’s
financial statements
Economic exposure
– Risk that an exchange rate change will affect a company’s
longer-term earnings potential from international operations
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The Foreign Exchange Market: Exchange
Rate Risk - Implications
• Scenario: Japanese supplier – Dutch buyer
– Euro drops relative to the yen
– Dutch buyer could increase its prices but risks a drop
in sales
– Dutch buyer could maintain prices but reduce profit
margin
– Japanese supplier could reduce price to maintain
relationship with buyer
– If euro declines too much, buyer will be forced to find
a new supplier in country with a more favorable
exchange rate or that uses the euro
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Currency Rates and Instruments: Spot
Rates
Spot rate
• Exchange rate requiring delivery of the traded currency within
two business days
Spot market
• Market for currency transactions at spot rates
– Convert income generated from sales abroad into the
home currency
– Convert funds into the currency of an international supplier
– Convert funds into the currency of a country in which the
company wishes to invest
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Currency Rates and Instruments:
Forward Rates
Forward rate
• Exchange rate at which two parties agree to exchange
currencies on a specified future date
Forward market
• Market for currency transactions at forward rates
– Used for all types of transactions that require future
payment in other currencies
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Currency Rates and Instruments: Swaps,
Options, and Futures
Currency futures contract
• Contract that requires the exchange of an agreed-on
amount of currency on an agreed-on date at a specified
exchange rate
Currency swap
• Simultaneous purchase and sale of foreign exchange for
two different dates
Currency option
• Right, or option, to exchange a specified amount of a
currency on a specified date at a specified rate
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Photo and Discussion Question (4 of 4)
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Market Structure and Convertibility:
Financial Centers
Vehicle currency
• Currency used as an intermediary to convert funds between two
other currencies
– European Union euro, Japanese yen, US dollar
• Currency trading centers
– London, New York City, Singapore, Hong Kong
▪ London accounts for 43% of global foreign exchange trading
Offshore financial center
• Country or territory whose financial sector features very few
regulations and few, if any, taxes
– Booking center
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Figure 10.2 Financial Trading Centers by
Time Zone
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Market Structure and Convertibility:
Interbank Market
Interbank market
• Market in which the world’s largest banks exchange
currencies at spot and forward rates
Clearing
• Process of aggregating the currencies that one bank
owes another and then carrying out the transaction
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Global Managers: Managing Foreign
Exchange
Match Needs to Providers: Find a provider that offers
transactions you perform and in the currencies you need.
Work with the Majors: Large money-center banks in financial
centers that work directly in foreign exchange can have cost and
service advantages over local banks.
Consolidate to Save: Time your international payments to
consolidate multiple transfers into a large transaction.
Get the Best Deals: If your foreign exchange activity is
substantial, develop relationships with two or more money center
banks to get the best rates.
Embrace Technology: Every time a transaction is phoned or
emailed in, human error could delay getting funds where and
when you need them.
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Market Structure and Convertibility:
Currency Convertibility (1 of 2)
Convertible currency
• Currency that trades freely in the foreign exchange
market, with its price determined by the forces of supply
and demand
• Goals of currency restrictions
– Repay debts owed to other nations
– Pay for imports and finance trade deficits
– Protect a currency from speculators
– Keep resident individuals and businesses from
investing in other nations
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Market Structure and Convertibility:
Currency Convertibility (2 of 2)
• Instruments for restricting convertibility
– Import deposit requirements
– Quantity restrictions
– Multiple exchange rate systems
Countertrade
• Practice of selling goods or services that are paid for, in
whole or in part, with other goods or services
– Barter
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