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OVERVIEW Financial markets are those markets that smooth the progress of rising of funds or the investment of assets, whichever is chosen. They also assist in handling of various risks. The financial markets can be divided into the following subtypes: 1. Capital Markets – It consists of stock markets and bond markets. 2. Money Markets – These markets provide short-term debt financing and investment. 3. Derivatives Markets – These markets provide instruments for handling of financial risks. 4. Futures Markets – They provide standard contracts for trading assets at a future date. 5. Insurance Markets – These markets facilitate handling of various risks. 6. Foreign Exchange Markets – These markets can be either primary or secondary markets. Owing to intensification of international business over the last 30 years, various international financial markets have been developed. The fact that borrowers (including governments) in one country access the financial markets of another is quite known; what is new is the degree of mobility of capital, the global dispersal of the finance industry, and the enormous diversity of markets and instruments which a firm seeking fund can tap. The decade of eighties ushered in a new phase in the evolution of international financial markets and transactions. Major OECD countries began deregulating and liberalizing their financial markets towards the end of seventies. The main objectives of this article basically revolve around international financial markets: •Motives for Investing in Foreign Markets •Motives
for Providing Credit in Foreign Markets Several barriers prevent the real markets or financial markets from becoming completely integrated. This may include tax disparity, tariffs, quotas, labor immobility, cultural differences, financial reporting differences, and significant costs of communicating information across countries. So far, the barriers can also create exclusive opportunities for specific geographic markets that will attract foreign creditors and investors. For example, tariffs barriers, quota restrictions and labor immobility can make a country’s economic conditions to be distinctly different from others. Investors and creditors may want to do business in that country to capitalize on favorable conditions unique to that country. The existence of imperfect markets has precipitated the internationalization of financial markets. MOTIVES FOR INVESTING IN FOREIGN MARKETS Investors have one or more of the following motives for investing in foreign markets: Economic Conditions Firms in one foreign country are expected to perform more favorably than those in the investor’s home country. For instance, the diminution of restrictions in Eastern European countries created favorable economic conditions there. Such conditions attracted foreign investors and creditors. Exchange Rate Expectations Some investors purchase financial securities denominated in a currency that is expected to appreciate against their own. From a foreign investor’s point of view, the performance of such an investment greatly depends on the movement in currency over the investment horizon. International Diversification Investors may achieve benefits from internationally diversifying their asset portfolio. Empirical evidence indicates considerable risk reduction from international diversification. The risk-reduction benefits can be explained by cross-border differences in economic conditions, so that an investor’s portfolio does not depend solely on a single country’s economy. Moreover, access to foreign markets allow investors to multiply their funds across a diverse group of industries that may not be available whose firms are concentrated in a relatively small number of industries. MOTIVES FOR PROVIDING CREDIT IN FOREIGN MARKETS Creditors have one or more of the following motives for providing credit in foreign markets: High Foreign Interest Rates A few countries face a shortage of loanable funds resulting into high market interest rates, even after considering default risk. Foreign creditors may capitalize on the higher rates and assist in providing capital to overseas markets. Until now, comparatively high interest rates are often perceived to be a sign of high inflationary expectations of that country. The extent to which inflation can cause depreciation of the local currency against others, the high interest rates in the country may be somewhat offset by a weakening of the local currency over the time period of concern. However, the relation between a country’s expected inflation and its local currency movement is not precise, since several other factors can influence currency movements as well. Thus, some creditors may believe that the interest rate advantage in a particular country will not be offset by local currency depreciation over the period of concern. Exchange Rate Expectations Creditors may consider supplying capital to countries whose currencies are expected to appreciate against their own. Whether the form of the transaction is a bond or a loan, the creditor benefits when the currency of denomination appreciates against the creditor’s home currency. International Diversification Creditors can benefit from international diversification, which may reduce the probability of simultaneous bankruptcy across borrowers. The effectiveness of such a strategy depends on the correlation between the economic conditions of countries. If countries experience similar business cycles to some extent, diversification across countries will be less effective. MOTIVES FOR BORROWING IN FOREIGN MARKETS Borrowers may have one or more of the following motives for borrowing in foreign markets: Low Interest Rates Some countries have a large supply of funds as compared to the demand for funds, resulting into low interest rates. Borrowers may try to borrow funds from creditors in these countries because the interest rate will be lower. A country with somewhat low interest rates is often expected to have a low rate of inflation, which can place upward pressure on the foreign currency’s value and offset any advantage of lower interest rates. However, since the relation between expected inflation differentials and currency movements is not precise, some borrowers may borrow from a market in which interest rates are low, because they do not expect an adverse currency movement to fully offset this advantage. Exchange Rate Expectations Borrowers who anticipate that a foreign currency will depreciate may consider borrowing that currency and converting it to their home currency for use. The value of the foreign currency, after getting converted into their local currency, would exceed the value as soon as the borrowers repurchase the currency to repay the loan. This favorable currency effect can offset part or all of the interest owed on the funds borrowed. Related
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