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9 International Financial Markets

Learning Objectives

Wild, John J., Kenneth L. Wild & Jerry C.Y. Han. International Business: The Challenges of Globalization, 5th Edition. Pearson Learning Solutions

After studying this chapter, you should be able to

1 Discuss the purposes, development, and financial centers of the international capital market.

2 Describe the international bond, international equity, and Eurocurrency markets.

3 Discuss the four primary functions of the foreign exchange market.

4 Explain how currencies are quoted and the different rates given.

5 Identify the main instruments and institutions of the foreign exchange market.

6 Explain why and how governments restrict currency convertibility.

A LOOKBACK

Chapter 8 introduced the most prominent efforts at regional economic integration occurring around the world. We saw how international companies are responding to the challenges and opportunities that regional integration is creating.

A LOOK AT THIS CHAPTER

This chapter introduces us to the international financial system by describing the structure of international financial markets. We learn first about the international capital market and its main components. We then turn to the foreign exchange market, explaining how it works and outlining its structure.

A LOOK AHEAD

Chapter 10 concludes our study of the international financial system. We discuss the factors that influence exchange rates and explain why and how governments and other institutions try to manage exchange rates. We also present recent monetary problems in emerging markets worldwide.

Wii Is the Champion

Kyoto, Japan — Nintendo (www.nintendo.com) has been feeding the addiction of video gaming fans worldwide since 1989. More than 100 years earlier, in 1889, Fusajiro Yamauchi started Nintendo when he began manufacturing Hanafuda playing cards in Kyoto, Japan. Today, Nintendo produces and sells video game systems, including Wii, Nintendo DS, GameCube, and Game Boy Advance that feature global icons Mario, Donkey Kong, Pokémon, and others.

Nintendo took the global gaming industry by storm when it introduced the Wii game console. With wireless motion-sensitive remote controllers, built-in Wi-Fi capability, and other features, the Wii outdoes Sony’s Playstation and Microsoft’s Xbox game consoles. Nintendo’s game called Wii Fit cleverly forces player activity through 40 exercises consisting of yoga, strength training, cardio, and even doing the hula-hoop. Pictured at right, Nintendo employees perform a song together as they demonstrate the game “Wii Music.”

Yet Nintendo’s marketing and game-design talents are not all that affect its performance—so too do exchange rates between the Japanese yen (¥) and other currencies. The earnings of Nintendo’s subsidiaries and affiliates outside Japan must be integrated into consolidated financial statements at the end of each year. Translating subsidiaries’ earnings from other currencies into a strong yen decreases Nintendo’s stated earnings in yen.

Source: Fred Prouser/Reuters–CORBIS-NY.

Nintendo reported net income in 2008 of ¥ 257.3 billion ($2.6 billion), but also reported that its income included a foreign exchange loss of ¥ 92.3 billion ($923.5 million). A rise of the yen against foreign currencies prior to the translation of subsidiaries’ earnings into yen caused the loss. As you read this chapter, consider how shifting currency values affect financial performance and how managers can reduce their impact.1

Well-functioning financial markets are an essential element of the international business environment. They funnel money from organizations and economies with excess funds to those with shortages. International financial markets also allow companies to exchange one currency for another. The trading of currencies and the rates at which they are exchanged are crucial to international business.

Suppose you purchase an MP3 player imported from a company based in the Philippines. Whether you realize it or not, the price you paid for that MP3 player was affected by the exchange rate between your country’s currency and the Philippine peso. Ultimately, the Filipino company that sold you the MP3 player must convert the purchase made in your currency into Philippine pesos. Thus the profit earned by the Filipino company is also influenced by the exchange rate between your currency and the peso. Managers must understand how changes in currency values—and thus in exchange rates—affect the profitability of their international business activities. Among other things, our hypothetical company in the Philippines must know how much to charge you for its MP3 player.

In this chapter, we launch our study of the international financial system by exploring the structure of the international financial markets. The two interrelated systems that comprise the international financial markets are the international capital market and foreign exchange market. We start by examining the purposes of the international capital market and tracing its recent development. We then take a detailed look at the international bond, equity, and Eurocurrency markets, each of which helps companies to borrow and lend money internationally. Later, we take a look at the functioning of the foreign exchange market—an international market for currencies that facilitates international business transactions. We close this chapter by exploring how currency convertibility affects international transactions.

International Capital Market

A capital market is a system that allocates financial resources in the form of debt and equity according to their most efficient uses. Its main purpose is to provide a mechanism through which those who wish to borrow or invest money can do so efficiently. Individuals, companies, governments, mutual funds, pension funds, and all types of nonprofit organizations participate in capital markets. For example, an individual might want to buy her first home, a midsized company might want to add production capacity, and a government might want to develop a new wireless communications system. Sometimes these individuals and organizations have excess cash to lend and at other times they need funds.

capital market

System that allocates financial resources in the form of debt and equity according to their most efficient uses.

Purposes of National Capital Markets