MODULE 5

INTERNATIONAL MONEY
&
CAPITAL MARKETS
LEARNING OBJECTIVES:

1. Discuss and illustrate the importance of the international

market and its effects.
2. Distinguish between the Money Market and Capital Market.
3. Illustrate and analyse the advantage and risks involved in
the international market.
I. THE INTERNATIONAL MONEY MARKET
Money Market

• A segment of the financial market in which financial instruments

with high liquidity and very short maturities are traded.

• Used by participants as a means for borrowing and lending in the

short term, from several days to just under a year.
 I. THE INTERNATIONAL MONEY MARKET

HISTORY AND WORLD EVENTS

• The International Monetary Market (IMM) was introduced in December 1971 and

formally implemented in May 1972,
• Its roots can be traced to the end of Bretton Woods through the 1971 Smithsonian
Agreement and Nixon's suspension of U.S. dollar's convertibility to gold.
• The IMM Exchange was formed as a separate division of the Chicago Mercantile
Exchange, and as of 2009, was the second largest futures exchange in the world. 

• The primary purpose of the IMM is to trade currency futures, a relatively new product
previously studied by academics as a way to open a freely traded exchange market
to facilitate trade among nations.
 I. THE INTERNATIONAL MONEY MARKET
The Three World Events that Resulted to Explosive Growth for the IMM in
1990s
 
1)  Basel lin July 1988
 
• Its primary objective was to establish minimum capital standards
designed to protect against credit risk.

• The 12 nation European Central Bank governors agreed to standardize

guidelines for banks. Bank capital had to be equal to 4% of assets.
 I. THE INTERNATIONAL MONEY MARKET
2) 1993 Single European Act
 
• This not only allowed capital to flow freely throughout national borders but also
allowed all banks to incorporate in any EU nation.

3) Basel II
 
• Its purpose was to improve on the rules as set forth in the Basel I by bringing risk-
based capital requirements more in line with underlying risks to which banks are
exposed.

• This is geared to control risk by preventing losses, the realization of which is still a
work in progress.
 II. BANK'S ROLE & ITS PURPOSE
BANK’S ROLE AND ITS PURPOSE

• A bank's role is to channel funds from depositors to borrowers.

• Depositors could be:

• Governments,
• Governmental Agencies and
• Multinational Corporations
 
II. BANK'S ROLE & ITS PURPOSE
• The role for banks in this new international arena exploded in order
to meet the demands of financing capital requirements, new loan
structures and new interest rate structures such as overnight
lending rates;

• Plus, a whole host of new trading instruments was introduced such

as money market swaps to lock in or reduce borrowing costs,
and swaps for arbitrage against futures or hedge risk. 
 III. THE INTERNATIONAL CAPITAL MARKET

A. Capital Market

• Markets for buying and selling equity and debt instruments.

• It channels savings and investment between suppliers of capital such

as retail investors and institutional investors, and users of
capital like businesses, government and individuals.

• Capital markets are vital to the functioning of an economy,

since capital is a critical component for generating economic output.
 III. THE INTERNATIONAL CAPITAL MARKET

• It includes primary markets, where new stock and bond issues are sold to

investors, and secondary markets, which trade existing securities. 

• Perhaps the most widely followed markets.

• Both the stock and bond markets are closely followed and their daily movements
are analyzed as proxies for the general economic condition of the world markets

• As a result, the institutions operating in capital markets - stock exchanges,

commercial banks and all types of corporations, including nonbank institutions
such as insurance companies and mortgage banks - are carefully scrutinized.
III. THE INTERNATIONAL CAPITAL MARKET

• The institutions operating in the capital markets access them to raise capital
for long-term purposes, such as

a. for a merger or acquisition,

b. to expand a line of business or enter into a new business,
c. or for other capital projects
 III. THE INTERNATIONAL CAPITAL MARKET

B. MONEY MARKET vs. CAPITAL MARKET

 
1.) SIMILARITIES
• Together the money and capital markets comprise a large portion of the
financial market

• Both are often used together to manage liquidity and risks for companies,
governments and individuals.

• Both markets provide a necessary business function such as maintaining

adequate levels of funding.
2.) DIFFERENCES

MONEY MARKET  CAPITAL MARKET

1.) Used for short-term basis usually for assets up to 1.) Used for long-tern assets which are any
one year asset with maturity greater than one year
2.) Money market securities consist of the following: 
2.) Capital markets include the  following:
a. negotiable certificates of deposit
• stocks (equity market) and
(CDs),
• bonds (debt market)

b. bankers acceptances,
c. U.S. Treasury bills,
d. commercial paper,
e. municipal notes,
f. federal funds and
g. repurchase agreements (repos).
 MONEY MARKET  CAPITAL MARKET
3.) The institutions operating are: 3.) The institutions operating are:
• Central Banks • Stock Exchanges
• Commercial Banks • Commercial Banks
• Acceptance Houses, etc. • All types of corporations including

4.) Short term debt is issued for the non-bank institutions such as
purpose of covering operating • Insurance Companies
expenses or working capital for a 4.) Buyers of securities in the capital
company or government and not for market tend to use funds that are
capital improvements or large scale targeted for long-term investment.
projects.
 MONEY MARKET CAPITAL MARKET

5.) Considered low risks; Typically 5.) Offer higher-risk investments;

seen as a safe place to put money Risky markets and are not usually
due the highly liquid nature of the used to invest short-term funds
securities and short maturities

6.) Investors use money markets to 6.) Investors access this to save for
invest funds in a safe retirement or education (as long as
manner (Liquidity is often the main investors have long time horizons,
purpose for accessing money which usually means are young and
markets) risk takers)
IV. INTERNATIONAL CREDIT MARKETS
INTERNATIONAL CREDIT MARKETS
 
• The broad market for companies looking to raise funds through debt
issuance.

• It encompasses both investment-grade bonds and junk bonds, as well as

short-term commercial paper.

• The market for debt offerings as seen by investors of bonds, notes and
securitized obligations such as mortgage pool and Collateralized Debt
Obligations (CDOs).
IV. INTERNATIONAL CREDIT MARKETS
• CDOs - A structured financial product that pools together cash
flow-generating assets and repackages this asset pool into discrete
tranches that can be sold to investors.

• A collateralized debt obligation (CDO) is so-called because the

pooled assets – such as mortgages, bonds and loans – are
essentially debt obligations that serve as collateral for the CDO.
IV. INTERNATIONAL CREDIT MARKETS
Three Major Types of International Credit Markets:

1. Euro Credits
2. Eurobond
3. Foreign Bond Markets
 IV. INTERNATIONAL CREDIT MARKETS
1.) Euro Credits

• A loan whose denominated currency is not the lending bank's national currency.
• Euro credit helps the flow of capital between countries and the financing of investments at home
and abroad.
• These trades add liquidity to both currencies as the U.S. bank accounts for the incoming payments
from the loans in U.S. dollar terms, and are often large and function in a long-term basis
• A market for floating-rate bank loans whose rates are tied to LIBOR (London Interbank Offer Rate).
• LIBOR is an interest rate offered by the largest and strongest banks on large deposits.
On September 17, 2009, the 3-month LIBOR rate was 65%.
• Tend to be issued for a fixed term with no early repayment.
• The oldest example of Euro Credit is the Eurodollar deposit, which is a U.S. dollar deposited in a
bank outside the United Sates.
• Today, euro credits exist for most major trading currencies. A similar credit in Asia is called Asian
dollar which is a U.S dollar deposited in banks based in Asian countries.
IV. INTERNATIONAL CREDIT MARKETS
2.) Eurobond

• International bond written by an international bank and sold to investors in

countries other than the one in whose currency the bond is denominated.
• True international debt instruments and are usually issued in bearer form,
which means that the owner’s identity is not registered and thus is not
known.
• To receive interest payments, the owner must clip a coupon and present it
for payment at one of the designated payor banks.
• Can be issued with either fixed-coupon rate or floating-rate coupon
depending on the preferences of the issuer.
IV. INTERNATIONAL CREDIT MARKETS
3.) Foreign Bond Markets

• Issued in the country in whose currency the bond is denominated, and

they are unwritten by investment banks in that country. However, the
borrower is head-quartered in a different country.

• Examples:
• Yankee Bonds - foreign bonds issued in the U.S.
• Bulldogs - foreign bonds issued in London.
• Samurai Bonds - foreign bonds issued in Japan.
 V. INTERNATIONAL STOCK MARKETS
INTERNATIONAL STOCK MARKETS

• The term for the overall market in which shares are issued and traded on exchange
s or in over-the counter  
• Also known as the equity market
• It is one of the most vital areas of a market economy because it provides companies
with access to capital and allows investors town companies and participates in
economic growth.
• The stock market is made up of the primary and secondary  
• The primary market is where new issues (IPOs) first are offered, with
any subsequent trading going on in the secondary 
 
 VI. AMERICAN DEPOSITARY RECEIPT (ADR)

AMERICAN DEPOSITARY RECEIPT (ADR)

• A certified negotiable instrument issued by an American bank suggesting the number of shares of a
foreign company that can be traded in U.S. financial markets.

• American Depository Receipts provide US investors with an opportunity to trade in shares of a foreign
company.

• ADR shares float on supply and demand, just like a regular stock.

• ADRs are denominated in U.S. dollars, with the underlying security held by a U.S. financial institution
overseas.

• ADRs help to reduce administration and duty costs that would otherwise be levied on each
transaction.
 VI. AMERICAN DEPOSITARY RECEIPT (ADR)

• This is an excellent way to buy shares in a foreign company while realizing any dividends and
capital gains in U.S. dollars.

• One of the most convenient and popular ways for investors to buy stocks of companies based
outside the US.

PURPOSE: It exists because many foreign companies do not want to bother with the expense and
hassle of directly listing their shares on US stock exchange.

EXAMPLE: Volkswagen, a German company trades on New York Stock Exchange. The investor in
America can easily invest into the German company, through the stock exchange. Volkswagen is
listed on the American stock exchange after complying the required laws.

NOTE: If, on other hand if the shares of Volkswagen are listed in stock markets of countries
other than US then it is termed as GDR (Global Depository Receipt).
VI. AMERICAN DEPOSITARY RECEIPT (ADR)

Several Types of ADRs:

 
1) Unsponsored ADRs
2) Level 1 ADRs
3) Level 2
4) Level 3
VI. AMERICAN DEPOSITARY RECEIPT (ADR)

1.) Unsponsored ADRs

• No involvement or support from the foreign company itself because

the company is not supporting this issue.

• It may not release English versions or financial information or news

releases

• They are often not liquid

 VI. AMERICAN DEPOSITARY RECEIPT (ADR)

2.) Level 1 ADRs

• This is the most basic type of ADR where foreign companies either do not qualify or do not wish to have
their ADR listed on an exchange.

• Being traded over the counter.

• They are found on the over-the-counter market and are an easy and inexpensive way to gauge interest
for its securities in North America.

• Does not require full SEC registration

• Level 1 ADRs also have the loosest requirements from the Securities and Exchange Commission (SEC). 

• Does not require the company to report results according to US Accounting guidelines
VI. AMERICAN DEPOSITARY RECEIPT (ADR)

3.) Level 2

• This type of ADR is listed on an exchange or quoted on Nasdaq.

• Level 2 ADRs have slightly more requirements from the SEC, but
they also get higher visibility trading volume.
VI. AMERICAN DEPOSITARY RECEIPT (ADR)

4.) Level 3

• The most prestigious of the three, this is when an issuer floats a

public offering of ADRs on a U.S. exchange.

• Level 3 ADRs are able to raise capital and gain substantial visibility
in the U.S. financial markets.
VI. AMERICAN DEPOSITARY RECEIPT (ADR)

Both Levels 2 & 3 ADRs

• They can not be listed on US Exchanges

• The companies must register with the SEC

• Companies are also required to report results in compliance with the US

Accounting laws and offer regular reports

• All of these makes it easier for Americans to invest in foreign companies

VI. AMERICAN DEPOSITARY RECEIPT (ADR)

Risks Associated with Buying ADRs:

• Inflationary Risk
• Political Risk
• Exchange Rate Risk
VI. AMERICAN DEPOSITARY RECEIPT (ADR)

1.) Inflationary Risk

• Inflationary risk is the risk that inflation will undermine an

investment's returns through a decline in purchasing power.

• Several financial instruments exist to counteract inflationary risks.

VI. AMERICAN DEPOSITARY RECEIPT (ADR)

2.) Political Risk

• Political risk is the risk an investment's returns could suffer as a result of political
changes or instability in a country.

• Instability affecting investment returns could stem from a change in government,

legislative bodies, other foreign policymakers or military control.

• Political risk is also known as "geopolitical risk," and becomes more of a factor
as the time horizon of investment gets longer.

• They are considered a type of jurisdiction risk.

VI. AMERICAN DEPOSITARY RECEIPT (ADR)

3.) Exchange Rate Risk

• Currency risk, commonly referred to as exchange-rate risk, arises

from the change in price of one currency in relation to another.

• Investors or companies that have assets or business operations

across national borders are exposed to currency risk that may
create unpredictable profits and losses.