Ol 125 personal leadership reflection template

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

There are two primary means by which companies obtain external financing: debt and equity . Capital markets function to help them obtain both types of financing. However, to understand the international capital market fully, we need to review the purposes of capital markets in domestic economies. Quite simply, national capital markets help individuals and institutions borrow the money that other individuals and institutions want to lend. Although in theory borrowers could search individually for various parties who are willing to lend or invest, this would be an extremely inefficient process.

Role of Debt

Debt consists of loans, for which the borrower promises to repay the borrowed amount (the principal) plus a predetermined rate of interest. Company debt normally takes the form of bonds —instruments that specify the timing of principal and interest payments. The holder of a bond (the lender) can force the borrower into bankruptcy if the borrower fails to pay on a timely basis. Bonds issued for the purpose of funding investments are commonly issued by private-sector companies and by municipal, regional, and national governments.

debt

Loan in which the borrower promises to repay the borrowed amount (the principal) plus a predetermined rate of interest.

bond

Debt instrument that specifies the timing of principal and interest payments.

Role of Equity

Equity is part ownership of a company in which the equity holder participates with other part owners in the company’s financial gains and losses. Equity normally takes the form of stock —shares of ownership in a company’s assets that give shareholders (stockholders) a claim on the company’s future cash flows. Shareholders may be rewarded with dividends—payments made out of surplus funds—or by increases in the value of their shares. Of course, they may also suffer losses due to poor company performance—and thus decreases in the value of their shares. Dividend payments are not guaranteed, but are determined by the company’s board of directors and based on financial performance. In capital markets, shareholders can sell one company’s stock for that of another or liquidate them—exchange them for cash. Liquidity , which is a feature of both debt and equity markets, refers to the ease with which bondholders and shareholders may convert their investments into cash.

equity

Part ownership of a company in which the equity holder participates with other part owners in the company’s financial gains and losses.

stock

Shares of ownership in a company’s assets that give shareholders a claim on the company’s future cash flows.

liquidity

Ease with which bondholders and shareholders may convert their investments into cash.

Large financial institutions benefit borrowers and lenders worldwide in many ways. They underwrite securities and as asset managers they are caretakers of the personal financial savings of individuals. Pictured here, Citibank’s business director Weng Linnguo poses with lion dance troupes at the opening of a new Citibank branch in Beijing. Citibank has a truly global reach, with 200 million customer accounts in more than 100 countries.

Source: STR/AFP–Getty Images.

Purposes of the International Capital Market

The international capital market is a network of individuals, companies, financial institutions, and governments that invest and borrow across national boundaries. It consists of both formal exchanges (in which buyers and sellers meet to trade financial instruments) and electronic networks (in which trading occurs anonymously). This market makes use of unique and innovative financial instruments specially designed to fit the needs of investors and borrowers located in different countries that are doing business with one another. Large international banks play a central role in the international capital market. They gather the excess cash of investors and savers around the world and then channel this cash to borrowers across the globe.

international capital market

Network of individuals, companies, financial institutions, and governments that invest and borrow across national boundaries.

Expands the Money Supply for Borrowers

The international capital market is a conduit for joining borrowers and lenders in different national capital markets. A company that is unable to obtain funds from investors in its own nation can seek financing from investors elsewhere, making it possible for the company to undertake an otherwise impossible project. The option of going outside the home nation is particularly important to firms in countries with small or developing capital markets of their own. An expanded supply of money also benefits small but promising companies that might not otherwise get financing if there is intense competition for capital.

Reduces the Cost of Money for Borrowers

An expanded money supply reduces the cost of borrowing. Similar to the prices of potatoes, wheat, and other commodities, the “price” of money is determined by supply and demand. If its supply increases, its price— in the form of interest rates—falls. That is why excess supply creates a borrower’s market, forcing down interest rates and the cost of borrowing. Projects regarded as infeasible because of low expected returns might be viable at a lower cost of financing.

Reduces Risk for Lenders

The international capital market expands the available set of lending opportunities. In turn, an expanded set of opportunities helps reduce risk for lenders (investors) in two ways:

1. Investors enjoy a greater set of opportunities from which to choose. They can thus reduce overall portfolio risk by spreading their money over a greater number of debt and equity instruments. In other words, if one investment loses money, the loss can be offset by gains elsewhere.

2. Investing in international securities benefits investors because some economies are growing while others are in decline. For example, the prices of bonds in Thailand do not follow bond-price fluctuations in the United States, which are independent of prices in Hungary. In short, investors reduce risk by holding international securities whose prices move independently.

Small, would-be borrowers still face some serious problems in trying to secure loans. Interest rates are often high and many entrepreneurs have nothing to put up as collateral. For some unique methods of getting capital into the hands of small businesspeople (particularly in developing nations), see this chapter’s Entrepreneur’s Toolkit titled, “Microfinance Makes a Big Impression.”

ENTREPRENEUR’S TOOLKIT: Microfinance Makes a Big Impression

Wealthy nations are not the only places where entrepreneurs thrive. Developing nations are teeming with budding entrepreneurs who need just a bit of startup capital to get off the ground. Here are the key characteristics of microfinance.