POLYTECHNIC UNIVERSITY OF THE PHILIPPINES

Chapter 8 : International Financial Markets

A Written Report Presented to the Faculty of the

Polytechnic University of the Philippines

Sta. Mesa, Manila

In Partial Fulfillment of the

Requirement for the Subject

Fundamentals of Financial Markets

ABEJUELA, Marlou H.

CRUZ, Andrea Rae O.

CUBIO, Genesis C.

Reporters

BSMA 2-8

September 2019

Luzviminda S. Payongayong

Adviser
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INTERNATIONAL FINANCIAL MARKETS

Every day, we find ourselves in constant contact with
internationally traded goods. This lead to less visible in
daily life is the international trade in financial assets,
but its dollar volume is much greater. International trade in
financial assets is easy and reliable, due to low transactions
costs in liquid markets – that is why, international financial
markets are characterized by high capital mobility.
Financial Capital was highly mobile in the 19th century.
Early 20th century brought two world wars and the Great
Depression. Many government implemented controls on
international capital flows – fragmented the international
financial markets and reduced capital mobility. Post-war
efforts to increase the stability and integration of markets
for goods and services – the creation of General Agreement on
Tariffs and Trade (GATT); the precursor to the World Trade
Organization (WTO). Low capital mobility is reflected in the
economic models of the 1950s and 1960s – conducting
international analyses under the assumption of capital
immobility.
Financial Innovations such as the Eurocurrency Markets;
undermined the effectiveness of capital controls.
Technological innovations; lowered the costs of international
transactions. These factors, combined with the
liberalizations of capital controls in the 1970s and 1980s,
led to the development of highly integrated world financial
markets, also known to be the “globalization” and now usually
adopt perfect capital mobility as a reasonable approximation
of conditions in the international financial markets.
International capital flows surged after the oil shock
of 1973 to 1974, which spurred financial intermediation on a
global scale. Surpluses in the oil-exporting countries and
corresponding deficits amoing oil importers led to a
recycling of “petrodollars” in the growing Euromarkets. Many
developing countries gained new access to international
capital markets, where they financed mounting external
imbalances. Most of this intermediation occurred in the form
of bank lending and large banks in the industrial countries
accepted huge exposures to developing country debt. Debt
crisis of the 1980s led to significant slowdown in capital
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flows to emerging markets in the 1990s. Private Capital
responded to the efforts of many Latin American countries to
liberize, privatize, open markets, and enhance macroeconomic
stability. Central and Eastern Europe began a transition
toward market economies and rapid growth in a group of
economies in East Asia had caught the attention of investors
worldwide.
Net flows have been large and growing, but gross cross-
border inflows and outflows have grown even faster. Another
thing, due to growth in international financial markets that
are available so that they can use those markets to facilitate
their international business transactions.
International Financial Market
The International Financial Market is the place where
financial wealth is traded between individuals and/or between
countries. It can be seen as a wide set of rules and
institutions where assets are traded between agents in
surplus and agents in deficit and where institutions lay down
the rules. It is a network of people, firms, financial
institutions, and governments borrowing and investing
internationally.
The financial market comprises the markets strictu sensu
(stock market, bond market, currency market, derivatives
market, commodity market and money market), the institutions
which work in them with different aims and functions (Central
Bank, Ministry of Economy and Finance, Monte Titoli, Borsa
Italiana and CONSOB), as well as direct/indirect policies
orientated to making the market the place (not necessarily a
physical place and not necessarily ruled but regulated) where
the exchange between surplus and deficit units is carried out
as efficiently as possible.
With regard to policies, consideration must be given to
those connected with monetary, fiscal and more structural
policies, as well as those directly connected with the
governance of the market itself.
Governance in the financial market can be defined as a
set of rules useful in interconnecting the agents who operate
within it and the institutions. These rules define the market.
Governance rules in a financial market can be defined at both
a microeconomic and macroeconomic level.
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Microeconomic rules deal not only with individuals
(single money savers, professional agents, and companies) but
also with the market itself and its microstructure.
Macroeconomic governance rules deal with the market as a
whole, but they are also strictly connected with policies
regulating the market.
* The international capital market affects money markets
in at least four ways:
1. It expands the money supply for borrowers by providing
access to international sources of capital.
2. It reduces the cost of money for borrowers by increasing
its supply and forcing down borrowing costs.
3. It reduces risk for lenders by expanding the set of
available lending opportunities.
4. And it allows investors to offset gains in some economies
with losses in others.
INTERNATIONAL FINANCIAL MARKET DRIVERS
Three main forces are expanding the international
capital market.
1. Information technology reduces the time and money needed
to communicate globally and allows for 24-hour electronic
trading.
2. Little regulation relative to other financial markets
increases competition, lowers transaction costs, and opens
up national financial markets.
3. And growth has resulted from securitization—the
repackaging of hard-to-trade financial assets into more
liquid, negotiable, and marketable securities.
INTERNATIONAL FINANCE VS. DOMESTIC FINANCE
International finance is different from domestic finance
in many aspects and first and the most significant of them is
foreign currency exposure. There are other aspects such as
the different political, cultural, legal, economical, and
taxation environment.
International financial management involves a lot of
currency derivatives whereas such derivatives are very less
used in domestic financial management.
The term ‘International Finance’ has not come from Mars.
It is similar to the domestic finance in many of the aspects.
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If we talk on a macro level, the most important difference
between international finance and domestic finance is of
foreign currency or to be more precise the exchange rates.
In domestic financial management, we aim at minimizing
the cost of capital while raising funds and try optimizing
the returns from investments to create wealth for
shareholders. We do not do any different in international
finance.
The most significant difference is of foreign currency
exposure. Currency exposure impacts almost all the areas of
an international business starting from your purchase from
suppliers, selling to customers, investing in plant and
machinery, fund raising etc. Wherever you need money,
currency exposure will come into play and as we know it well
that there is no business transaction without money.
Macro Business Environment
The other important aspect to look at is the legal and
tax front of a country. Tax impacts directly to your product
costs or net profits i.e. ‘the bottom line’ for which the
whole story is written. International finance manager will
look at the taxation structure to find out whether the
business which is feasible in his home country is workable in
the foreign country or not.
The Different Group of Stakeholders
It is not only the money which along matters, there are
other things which carry greater importance viz. the group of
suppliers, customers, lenders, shareholders etc. Why these
group of people matter? It is because they carry altogether
a different culture, a different set of values and most
importantly the language also may be different. When you are
dealing with those stakeholders, you have no clue about their
likes and dislikes. A business is driven by these stakeholders
and keeping them happy is all you need.
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Foreign Exchange Derivatives

Since, it is inevitable to expose to the risk of foreign
exchange in a multinational business. Knowledge of forwards,
futures, options and swaps is invariably required. A
financial manager has to be strong enough to calculate the
cost impact of hedging the risk with the help of different
derivative instruments while taking any financial decisions.
Different Standards of Reporting
If the business has a presence in say US and India, the
books of accounts need to be maintained in US GAAP and IGAAP.
It is not surprising to know that the booking of assets has
a different treatment in one country compared to other.
Managing the reporting task is another big difference. The
financial manager or his team needs to be familiar with
accounting standards of different countries.
MOTIVES FOR USING INTERNATIONAL FINANCIAL MARKET
Several barriers prevent the markets for real or
financial assets from becoming completely integrated; these
barriers include tax differentials, tariffs, quotas, labor
immobility, cultural differences, financial reporting
differences, and insignificant costs of communicating
information across countries. But these barriers can also
create unique opportunities for specific geographic markets
that will attract foreign creditors and investors. The
existence of imperfect markets has precipitated the
internationalization of financial markets.
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Motives for Investing Foreign Market
Investors invest in foreign markets for one or more of the
following motives:

 Economic Conditions
- Investors may expect firms in a particular foreign
country to achieve more favorable performance than those
in the investor’s home country.
 Exchange Rate Expectations
- Some investors purchase financial securities denominated
in a currency that is expected to appreciate against
their own, which is highly dependent on the currency
movement over the investment horizon.
 International Diversification
- Investors may achieve benefits from internationally
diversifying their asset portfolio, which allows for
RISK- REDUCTION benefits. Access to foreign market
allows investors to spread their funds across a more
diverse group of industries than may available
domestically. This is especially true for investors
residing in countries where firms are concentrated in a
relatively small number of industries.
Motives for Providing Credit in Foreign Markets
Creditors and investors who purchase debt securities
have one or more of the following motives for providing credit
in foreign markets:

 High Foreign Interest Rates

- Foreign creditors may attempt to capitalize on their
rates, thereby providing capital to overseas markets.
Yet a relatively high interest rates are often perceived
to reflect relatively high inflationary expectations in
that country – to the extent that inflation can cause
depreciation of the local currency against others, high
interest rates in the country may be somewhat offset by
a weakening of the local currency over the time period
concern. A country’s expected inflation and its local
currency movements is not precise, and several other
factors can influence currency movements. Thus, some
creditors may believe that the interest rate advantage
in a particular country will not be offset by a local
currency depreciation over the period of concern.
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 Exchange Rate Expectations
- Creditors may consider supplying capital to countries
whose currencies are expected to appreciate against
their own; the creditor benefits when the currency of
denomination apreciates against the creditor’s home
currency.
 International Diversification
- Creditors may reduce the probability of simultaneous
bankruptcy across borrowers. However, the effectiveness
of such a strategy depends on the correlation.
Motives for Borrowing in Foreign Market
Borrowers may have one or more of the following motives
for borrowing in foreign markets:

 Low Interest Rates

- A country with relatively low interest rates is often
expected to have a relatively low rate of inflation,
which can place upward pressure on the foreign
currency’s value and offset any advantage of lower
interest rates. Although the relation between expected
inflation differentials and currency movements is not
precise, so some borrowers will choose to borrow from a
market where nomina interest rates are low, since they
do not expect an adverse currency movement to fully
offset this advantage.
 Exchange Rate Expectations
- When a foreign subsidiary of a MNC remits to its parent,
the funds must be converted to dollar and subject to
exchange rate risk, which will adversely affect the MNC
if the foreign currency depreciates at that time. But is
the MNC expects that the foreign currency may depreciate
against the home currency may depreciate against the
dollar, it can reduce the exchange rate risk by having
the subsidiary borro funds locally to support its
business – the subsidiary will remit less funds to the
parent if it must pay interest on local debt before
remitting the funds. Thus, the amount of funds converted
to dollars will be smaller, resulting in less exposure
to exchange rate risk.
- If the parent needs to borrow funds for its own purposes,
it may pursue a more aggressive strategy and borrow a
foreign currency that is expected to depreciate – the
parent would borrow that currency and convert it to its
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home currency for use. The value of the foreign currency
when converted would exceed the value when the MNC
repurchases the currency to repay the loan. The
favorable currency effect can offset part or all of the
interest owed on the funds borrowed. Such strategy may
be especially desirable if the foreign currency has a
low interest rate compared to the interest rate.

SOURCES:
Campbell, J.Y., Lo, W.A., MacKinlay, A.C., 1997, The
Econometrics of Financial Markets, Princeton University
Press, Princeton New Jersey;
Becchetti, L., Ciciretti, R., Trenta, U., 2007, Modelli di
Asset Pricing I: Titoli Azionari, in Il Sistema Finanziario
Internazionale, Michele Bagella, a cura di, Giappichelli,
Torino.
Borad, Sanjay B., 2009, "Financial Management Concepts in
Layman's Terms", retrieved from
https://efinancemanagement.com/international-financial
management/international-vs-domestic-finance
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QUIZ:
PART I: True or False
Instruction: Write F if the statement is True and T if the
stament is False.
1. In 20th Century the Financial Capital was highly mobile.
Answer: T - 19th Century
2. Technological Innovation lowered the costs of
international transactions.
Answer: F
3. International Finance when an inventor's entire portfolio
does not depend solely on a singular country's economy, cross-
border differences in economic conditions can allow for risk-
reduction benefits.
Answer: T- International Diversification
4. The National Financial Market is the place where financial
wealth is traded between individuals and/or between
countries.
Answer: T - International
5. Exchange Rate Expectations when some investors purchase
financial securities denominated in a currency that is
expected to appreciate against their own.
Answer: Answer: F
6. Economic Finance, when investors may expect firms in a
particular foreign country to achieve more favorable
performance than those in the investor's home country.
Answer: T - Economic Conditions
7. Financial Innovation undermined the effectiveness of
capital controls.
Answer: F
8. Domestic Finance involves a lot of currency derivatives.
Answer: T - International Finance
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9. In 19th Century the International Financial Markets became
fragmented and reduced its capital mobility.
Answer: - 20th Century
10. International Finance aims at minimizing the cost of
capital while raising funds and try optimizing the returns
Answer: - Domestic Finance

PART II: Identification

Instruction: Identify the following word/s that is/are being
defined or described in each number.
11. ________ must understand the various international
financial markets that are available.
Answer: Financial Managers
12. _________ it is a network of people, firms, financial
institutions, and governments borrowing and investing
internationally.
Answer: International Financial Market
13. __________ it lowered the costs of international
transactions.
Answer: Technological Innovation
14. __________ borrowers may attempt to borrow funds from
creditors in these countries because the interest rate
charged is lower.
Answer: Low Interest Rates
15. ___________ when a foreign subsidiary of a U.S.-based MNC
remits funds to its U.S. parent, the funds must be converted
to dollars and are subject to exchange rate risk. The MNC
will be adversely affected if the foreign currency
depreciates at that time.
Answer: Exchange Rate Expectations
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PART III: Enumeration

Instruction: (For questions 16 to 20) Enumerate the
WORDS/PHRASES based on what is being asked.
16 - 18. Enumerate the International Financial Market Drivers
ANSWER: (in any order)
• Information Technology
• Deregulation
• Financial Instruments
19 - 20. Enumirate the Motives for Borrowing in Foreign
Markets.
Answer: (in any order)
• Low Interest Rates
• Exchange Rate Expectations