International Capital Markets

Roll No. 37 30 28 43 5 4

Name Vikramaditya Murlidhran Kushal Mansukhani Suveer Malhora Sharan Sanil Antriksh Bajaj Dhruv Ajmera

Contents

1) What is International Capital Markets 2) FDI v/s FPI 3) Euro Currency Market 4) Euro Credit 5) LIBOR Market Model 6) Euro Bond 7) Short Term Debt Instruments 8) American deposit Receipt and Global Depository receipt 9) Bibliography

What are International Capital Markets?

International capital market is that financial market or world financial center where shares, bonds, debentures, currencies, hedge funds, mutual funds and other long term securities are purchased and sold. International capital markets are the groups of different country's capital markets. They associate with each other with Internet. They provide the place to international companies and investors to deal in shares and bonds of different countries. International capital markets were started with dealing of foreign exchange. After globalization of financial sector, companies have to take certificate for dealing in international market. Suppose, Indian companies wants to sell shares in France, for this, Indian company should take certificate named global depository receipt (GDR). International capital market's daily turnover has crossed $ 5 trillion. International capital market is very helpful for reducing the risk of small company because in international market, you can buy different countries companys shares, debentures and mutual funds. Different countries have different business environment, so if any country is facing loss and due to financial crisis, your investment in that country may suffer losses but you can fulfill this loss from other country's investment. So, overall risk will be reduced by this technique.

Illustration on Capital Markets

FDI v/s FPI

FDI is an acronym that stands for Foreign Direct Investment. It refers to the type of investment carried out at international level where an investor will acquire a stake in an enterprise in a foreign country with long term realization of goals in the enterprise. FPI stands for Foreign Portfolio Investment where an international investor acquires stakes in a foreign country in terms of stock, bonds and some other assets but with the investor having an inert role in the management of those financial holdings. FDI typically involves establishment of some physical entity such as a factory or an enterprise in a foreign country. It may involve a relationship created between a parent company in one country and an affiliate in another country which would together form a multinational company. All kinds of capital contributions are included while calculating FDI, for instance stock acquisitions, reinvestments of business profits by a parent company in its foreign subsidiary or just direct lending by a subsidiary company. It is not easy to withdraw from FDI so it is common to have members with a direct interest in the investment committing to managing the day to day affairs of their foreign interests or at least making major strategic decisions. FPI usually aims at short term benefits and typical target countries for this type of foreign investment, given its transient nature, are developing countries. It offers easier escape routes compared to FDI, where an investor can easily withdraw from a foreign portfolio either when targets have been realized or when theres an unexpected occurrence affecting the economic standing of that country which may adversely affect foreign investments.

Unlike FPI, FDI requires more investment specific capital and so its harder to adjust this type of investment in short term changing conditions whereas FPI can easily be adjusted as the business conditions fluctuate. Summary: 1. FDI tends to yield more returns on investment as a direct result of investors controlling position in the investment but with FPI, although theres a lot of flexibility to adjust to short term environmental changes, theres generally less returns realized, making this a favorite investment route for smaller firms looking for flexibility and lower investment specific costs other than bigger returns. 2. FDI and FPI investment calculations are determined by the amount of investments made in a single year, which is the flow, or as stock, which is the amount of investment massed in a year. It is therefore harder to make estimates for FPI portfolio flows especially if a FPI investment is made for one year or less as they contain various instruments, so a definite value is hard to estimate. 3. However on a whole, the difference between FDI and FPI may be hard to establish, especially if it is a relatively big foreign investor considering investing in stock options. The two models coincide in part with each other in this case and it may go down to choosing between flexibility and returns on investment.

EURO Currency Market

A Eurocurrency Market is a money market that provides banking services to a variety of customers by using foreign currencies located outside of the domestic marketplace. The concept does not have anything to do with the European Union or the banks associated with the member countries, although the origins of the concept are heavily derived from the region. Instead, the Eurocurrency Market represents any deposit of foreign currencies into a domestic bank. For example, if Japanese yen is deposited into a bank in the United States, it is considered to be operating under the auspices of the Eurocurrency Market. The Eurocurrency Market has its roots in the World War II era. While the war was going on, political challenges caused by the takeover of the continent by the Axis Powers meant that there was a limited marketplace for trading in foreign currency. With no friendly government operations within the European marketplace, the traditional economies of the nations were displaced, along with the currencies. To combat this, especially due to the fact that many American companies were tied to the well-being of business behind enemy lines, banks across the world began to deposit large sums of foreign currency, creating a new money market. One of the factors that make the Eurocurrency Market unique compared to many other money market accounts is the fact that it is largely unregulated by government entities. Since the banks deal with a variety of currencies issued by foreign entities, it is difficult for domestic governments to intervene, particularly in the United States. However, with the establishment of the flexible exchange rate system in 1973, the Federal Reserve System was given powers to stabilize lending currencies in the event of a crisis situation. But one problem that arises is that these crises are not defined by the regulations, meaning that intervention must be established based on each case and the Federal Reserve must work directly with central banks around the world to resolve the matter.

This adds to the volatility of the Eurocurrency Market. Despite its name, the Eurocurrency Market is primarily influenced by the value of the American dollar. Nearly two-thirds of all assets around the globe are represented by U.S. currency. The challenge with foreign banks revolves around the fact that regulations enforced by the Federal Reserve are really only enforceable within the U.S. The taxation level and exchange rate of the American dollar varies depending on the nation. For example, an American dollar in Vietnam is worth more than it is in Canada, further influencing the market.

EURO Credit
The term "Eurocredit" refers to loans in a currency that is not the lending bank's national currency. Eurocredit loans are large and long-term, and usually only large corporations and government agencies request them. Banks that extend these loans usually also participate in the Eurocurrency Market, where they hold deposits in currencies other than the local currency. The prefix "euro-" is often used in finance to refer to funds in a foreign currency and has nothing to do with Euro currency or European countries. A bank extends a Eurocredit loan when the loan is not in the bank's national currency and the loan is extended in a country other than the one in whose currency the loan is denominated. For example, an American bank provides a loan denominated in Japanese yen or Russian rubles for an American company. Eurocredit loans increase the flow of capital between various countries and help companies and governments finance their investments. Banks set the interest rates on these loans based on the prevailing London Interbank Offered Rate (LIBOR), with the rates usually being reset every six months depending on changes in LIBOR. These loans are usually large loans with a fixed term and no provision for early repayment. The loan size is usually large, so banks sometimes form a syndicate to provide a Eurocredit loan that spreads the risk between syndicate banks and limits the risk exposure any one bank faces in case the borrower fails to repay the loan. For example, a company from Germany borrows $200 million US Dollars (USD) through a syndicated Eurocredit facility for five years at an interest rate of 200 basis points (2 percent) over LIBOR. The interest rate floats and is reset every six months according to the prevailing LIBOR. LIBOR turns out to be at 5 percent for the first six months of the loan and 4 percent for the second six months. In this case, the loan rate becomes 7 percent for the first six months of the loan and 6 percent for the second six months. The company has to pay $7 million USD in interest six months after taking out the loan and $6 million USD in interest one year

after taking out the loan. If the company fails to make its payments, the whole syndicate absorbs the impact so each lending institution only has to bear a portion of the loss. Eurocredit facilities also often charge an upfront fee for the loan, usually a percentage of the loan. For example, the German company might have to pay 2 percent at the beginning of the loan to cover administrative and operative costs. It would have to pay $4 million USD and would effectively receive only $196 million when taking out the loan.

LIBOR MARKET MODEL

The LIBOR market model is a model of the interest rate market. It predicts the behavior of interest rates based on certain assumptions of which factors influence their movement. The model is often used for its method of pricing financial derivatives, most notably interest rate swaps, and determining a hedging strategy for investors who hold them. The exact origin of the model is unknown, but it was probably in use for several years before its formal publication in an economic paper. It was published in three papers in 1997: one by Alan Brace, Dariusz Gatarek and Marek Musiela; one by Farshid Jamshidian; and one by Kristian Miltersen, Klaus Sandmann and Dieter Sondermann. These authors names inspired alternative names for the model. It is sometimes known as the BGM model or the BGM/J model. The most common name for the model, however, is the LIBOR market model, or the LMM. The LIBOR in LIBOR market model is a commonly used abbreviation for the London Interbank Offered Rate. LIBOR is the interest rate that banks offer each other for overnight loans that demand no collateral from the borrowing bank. This interest rate is a widely accepted benchmark rate that serves as a basis for many of the interest rate swaps sold on the market. The LIBOR market model uses stochastic processes to predict the movement of LIBOR rates. Other models predict short-term interest rates, but the LIBOR market model gives a set of forward rates. These rates are all predictions of future LIBORs, so the accuracy of the model may be tested by comparing its predictions with observed LIBORs in the market.

Having a set of forward interest rates enables investors to perform various calculations to determine pricing and investment strategies. They can use the forward rates to discount the expected cash flows from derivatives so they can more accurately decide what to pay for them in the present. Expectations of interest rates also help them to determine how to construct their portfolios to guard against risk using a combination of derivatives.

The LIBOR is the basis for a variety of derivatives, which means the LIBOR market model can be used to price complicated derivatives that include interest rate swaps in their structures. Its uses include calculating the prices of Bermudan swaptions, an option to enter into an interest rate swap that is complicated by its limitations on the dates on which the options may be exercised. The LIBOR market model is also instrumental in determining prices for a range of other derivatives.

Euro Bond
A Eurobond is a contract for debt that records the obligations of a borrower to pay the principal amount due plus a given interest rate on a specific set of dates. It is underwritten by international investment firms and banks from several countries in Europe and is issued in a currency other than that of the country where it is issued. It is an instrument of trade that is intended to be purchased and sold through public offering on the stock exchange during the period leading up to maturity. The bonds are popular because they are tax free and virtually free of regulation by any government.

The Eurobond originated in 1963 with the Italian Autostrade network. Eurobonds are traded in several stock exchanges. London and Luxembourg trade in these bonds the most frequently. Tokyo, Singapore, the United States and many other nations trade Eurobonds by issuing them in the denomination of their currency. Eurodollars, for example, would denote Eurobonds based on the U.S. Dollar, and Euro Yen would denote bonds issued to be paid in Japanese currency. This fluidity and flexibility offers an attractive financing tool by giving issuers choice of where to offer the bonds. Issuers can take into consideration the regulations and restraints on trade instruments of each country before making a choice. Investors are attracted to this market for the high liquidity and low par value. These features have helped the Eurobond market grow immensely. The Eurobond market is larger than the U.S. bond market. Detractors of the Eurobond market point out risk factors inherent to the instrument. Purchasing Eurobonds is risky because of investors' lack of familiarity with conditions in foreign countries. Currency exchange is often a very volatile situation. Drastic price changes and higher sensitivity to the political climate of the world makes the Eurobond less attractive to many. Currency exchange rates can dip to the point that investors lose money with Eurobonds and other foreign bond markets. There are relatively few records kept on Eurobonds issued and fewer regulations.

Most Eurobonds are purchased in electronic form as opposed to paper tickets with detachable coupons. One of a select few companies acting as a clearing system for the bonds can hold and trade them within the system. Upon maturity, funds are paid electronically via this clearing system to the owner of the Eurobond. Although this does help ensure better record keeping, there is not central regulation of the Eurobond market.

Short term Debt Instruments

1) Bankers Acceptance 2) Euro Commercial Paper 3) Euro Certificate Of Deposit

Bankers Acceptance A short-term debt instrument issued by a firm that is guaranteed by a commercial bank. Banker's acceptances are issued by firms as part of a commercial transaction. These instruments are similar to T-Bills and are frequently used in money market funds. Banker's acceptances are traded at a discount from face value on the secondary market, which can be an advantage because the banker's acceptance does not need to be held until maturity. Banker's acceptances are regularly used financial instruments in international trade.

Euro Commercial Paper An unsecured, short-term loan issued by a bank or corporation in the international money market, denominated in a currency that differs from the corporation's domestic currency. For example, if a U.S. corporation issues a short-term bond denominated in Canadian dollars to finance its inventory through the international money market, it has issued euro-commercial paper.

Euro Certificate Of Deposit An interest bearing, time-obligated debt instrument issued by a non-U.S. bank. To compensate for their lower liquidity and increase their attractiveness to investors, Euro CDs typically earn a higher yield than CDs issued by U.S. banks.

American deposit Receipt and Global Depository receipt

Indians are known world over for their regular savings habit. We have imbibed this very healthy habit from our forefathers who practiced it in their own way throughout their life, and lived a safe and satisfactory retired life due to this habit. In this generation too the same habit is widely prevalent. We invest in traditional savings like Bank Deposits, Mutual Funds, and many such avenues. The latest being, investments in stocks and shares. In the last two decades people investing and trading in stocks and shares of various companies that are listed in most of our stock exchanges that are spread across India, has become a regular means of earning extra income, or a means of creating savings in the near future. What if the companies whose shares are publicly traded in stock exchanges wishes to expand its fund raising capacities to opportunities to raise funds from people from other countries. This is where ADR and GDR come into picture. What is ADR? ADR is the full form of American Depository Receipts. This is the recent method adopted by many large and well respected companies from India to raise funds from American Markets. How ADR Operates? Indian companies have direct access to raise funds from Indian public by way of issuing Shares, Debentures etc. However Indian companies cannot do so, in such a direct manner, when it comes to raising funds from American people. That would entail the Indian companies to adopt US Accounting Norms which is also called as GAAP, maintain accounting practices as per American Financial Year (Which starts in January and ends in December of any particular year), as also follow variety of stringent standards as per American norms.

Effectively, it would mean that the Indian company would have to follow two different set of rules simultaneously, one to comply with the laws of Indian Companies Act, and the other to comply with the American Laws.

The method to circumvent the American norms, but still raise funds from American people is available by way of ADR or American Depository Receipts. In this system, the Indian company deposits certain amount of its Indian shares with designated American Banks. The banks, in turn, issues receipts that are equivalent in values (And also based on the intrinsic value the Indian Companys shares would fetch in the American market) to the Indian Company. These receipts essentially would be in number of receipts. Then these Indian Companies can trade these ADRs or American Depository Receipts with the American public. These ADRs can be purchased and traded freely without any encumbrances in the American Stocks and Shares Market. This way the Indian company is able to enter into the American Stocks and Shares market, and raise funds from the American public. The role of the American bank which has issued these receipts is very crucial, since it is they who stand guarantee to the issued receipts. Hence they do exhaustive study of the Indian company from all perspectives, and only then issue the ADR to the Indian company.

What is GDR and how it operates? The full form of GDR is Global Depository Receipt. It is not a different financial instrument, as it may sound, from that of ADR. In fact if the Indian Company which has issued GDRs in the American market wishes to further extend it to other developed and advanced countries such as Europe, then they can sell these ADRs to the public of Europe and the same would be named as GDR. Indian Companies with ADR & GDR?

There are quite a lot of successful Indian companies that have now issued ADRs and GDRs. Some such companies are given underneath.

Dr. Reddys HDFC Bank ICICI Bank Infosys Technologies MTNL VSNL WIPRO

Benefits of ADR and GDR

For the Company

A company may opt to issue a GDR to obtain greater exposure and raise capital in the world market. Issuing GDRs has the added benefit of increasing the shares liquidity while boosting the companys prestige on its local market (the company is traded internationally). Global Depositary receipts encourage an international shareholder base, and provides expatriates living abroad with an easier opportunity to invest in their home countries. Moreover, in many countries, especially those with emerging markets, obstacles often prevent foreign investors from entering the local market. By issuing a GDR, a company can still encourage investment from abroad without having to worry about barriers to entry that a foreign investor might face.

For the Investor

Buying into a GDR immediately turns an investors portfolio into a global one. Investors gain the benefits of diversification, while trading in their own market under familiar settlement and clearance conditions. More importantly, GDR investors will be able to reap the benefits of these usually higher-risk, higher-return equities, without having to endure the added risks of going directly into foreign markets, which may pose lack of transparency or instability resulting from changing regulatory procedures. It is important to remember that an investor will still bear some foreign-exchange risk, stemming from uncertainties in emerging economies and societies. On the other hand, the investor can also benefit from competitive rates the U.S. dollar and euro have to most foreign currencies.

Conclusion Giving you the opportunity to add the benefits of foreign investment while bypassing the unnecessary risks of investing outside your own borders, you may want to consider adding these securities to your portfolio. As with any security, however, investing in GDRs requires an understanding of why they are used, and how they are issued and traded.