81.
What is a capital market? Define market makers.
A capital market brings together those who want to invest money and those
who want to borrow money. Those who want to invest money include
corporations with surplus cash, individuals, and nonbank financial
institutions. Those who want to borrow money include individuals,
companies, and governments. Between these two groups are the market
makers. Market makers are the financial service companies that connect
investors and borrowers, either directly or indirectly. They include
commercial banks and investment banks.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Describe the benefits of the global capital market.
Topic: Benefits of the Global Capital Market
82.
Explain various types of capital market loans.
Capital market loans to corporations are either equity loans or debt loans.
An equity loan is made when a corporation sells stock to investors. The
money the corporation receives in return for its stock can be used to
purchase plants and equipment, fund R&D projects, pay wages, and so on.
A debt loan requires the corporation to repay a predetermined portion of the
loan amount at regular intervals regardless of how much profit it is making.
Management has no discretion as to the amount it will pay investors. Debt
loans include cash loans from banks and funds raised from the sale of
corporate bonds to investors.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Describe the benefits of the global capital market.
Topic: Benefits of the Global Capital Market
83.
Explain how equity loans and debt loans differ in terms of attractiveness to
businesses.
Investors purchase stock both for their dividend yield and in anticipation of
gains in the price of the stock, which in theory reflects future dividend
yields. An organization need not pay back this loan if they are at a loss. But
the organization should pay more if the profits are high.
Debt loans require a corporation to repay a predetermined portion of the
loan amount. Here, the risk is more for businesses as payments are to be
made regardless of the profits. Management has no discretion as to the
amount it will pay investors.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Describe the benefits of the global capital market.
Topic: Benefits of the Global Capital Market
84.
How does a global capital market, as compared to a purely domestic
market, benefit investors?
A global capital market benefits investors by providing a wider range of
investment opportunities, thereby allowing them to build portfolios of
international investments that diversify their risks. Investors can diversify
their portfolios internationally, thereby reducing their risk to below what
could be achieved in a purely domestic capital market.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-01 Describe the benefits of the global capital market.
Topic: Benefits of the Global Capital Market
85.
What are the advantages of global capital market in comparison with a
purely domestic capital market?
In a purely domestic capital market, the pool of investors is limited to
residents of the country. This places an upper limit on the supply of funds
available to borrowers. In other words, the liquidity of the market is limited.
A global capital market, with its much larger pool of investors, provides a
larger supply of funds for borrowers to draw on. An important drawback of
the limited liquidity of a purely domestic capital market is that the cost of
capital tends to be higher than it is in an international market.
In a purely domestic market, the limited pool of investors implies that
borrowers must pay more to persuade investors to lend them their money.
The larger pool of investors in an international market implies that
borrowers will be able to pay less.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-01 Describe the benefits of the global capital market.
Topic: Benefits of the Global Capital Market
86.
What is systematic risk?
Systematic risk refers to movements in a stock portfolio’s value that are
attributable to macroeconomic forces affecting all firms in an economy,
rather than factors specific to an individual firm. The systematic risk is the
level of non-diversifiable risk in an economy.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-01 Describe the benefits of the global capital market.
Topic: Benefits of the Global Capital Market
87.
Explain the changes observed in the risk of investments when an investor
increases the number of stocks in her portfolio.
As an investor increases the number of stocks in her portfolio, the
portfolio’s risk declines. At first this decline is rapid. Soon, however, the rate
of decline falls off and asymptotically approaches the systematic risk of the
market.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-01 Describe the benefits of the global capital market.
Topic: Benefits of the Global Capital Market
88.
Explain the two basic factors reflected by the relatively low correlation
between the movements of stock markets in different countries.
The relatively low correlation between the movement of stock markets in
different countries reflects two basic factors. First, countries pursue
different macroeconomic policies and face different economic conditions, so
their stock markets respond to different forces and can move in different
ways.
Second, different stock markets are still somewhat segmented from each
other by capital controls—that is, by restrictions on cross-border capital
flows (although as noted earlier, such restrictions are declining rapidly). The
most common restrictions include limits on the amount of a firm’s stock that
a foreigner can own and limits on the ability of a country’s citizens to invest
their money outside that country.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-01 Describe the benefits of the global capital market.
Topic: Benefits of the Global Capital Market
89.
Briefly describe the trends observed in the global deregulation of financial
services.
In country after country, financial services has historically been the most
tightly regulated of all industries. Governments around the world have
traditionally kept other countries’ financial service firms from entering their
capital markets. In some cases, they have also restricted the overseas
expansion of their domestic financial services firms. In many countries, the
law has also segmented the domestic financial services industry.
Many of these restrictions have been crumbling since the early 1980s. In
part, this has been a response to the development of the Eurocurrency
market, which from the beginning was outside of national control. It has
also been a response to pressure from financial services companies, which
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-02 Identify why the global capital market has grown so rapidly.
Topic: Benefits of the Global Capital Market
90.
Identify the risks associated with global capital markets.
According to some analysts, deregulation and reduced controls on cross-
border capital flows are making individual nations more vulnerable to
speculative capital flows. This is seen as having a destabilizing effect on
national economies.
The capital that moves internationally may be pursuing temporary gains,
and it shifts in and out of countries as quickly as conditions change. A lack
of information about the fundamental quality of foreign investments is often
seen as encouraging speculative flows in the global capital market. Faced
with a lack of quality information, investors may react to dramatic news
events in foreign nations and pull their money out too quickly.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-03 Understand the risks associated with the globalization of capital markets.
Topic: Benefits of the Global Capital Market
91.
What is a Eurocurrency?
A Eurocurrency is any currency banked outside of its country of origin.
Eurodollars, which account for about two-thirds of all Eurocurrencies, are
dollars banked outside of the United States. Other important Eurocurrencies
include the Euro-yen, the Euro-pound, and the Euro-Euro. A Eurocurrency
can be created anywhere in the world; the persistent Euro- prefix reflects
the European origin of the market.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-04 Compare and contrast the benefits and risks associated with the Eurocurrency market; the
global bond market; and the global equity market.
Topic: The Eurocurrency Market
92.
What are the financial advantages that make the Eurocurrency market
attractive to both depositors and borrowers?
The main factor that makes the Eurocurrency market attractive to both
depositors and borrowers is its lack of government regulation. This means
that the spread between the Eurocurrency deposit rate and the
Eurocurrency lending rate is less than the spread between the domestic
deposit and lending rates. Companies have strong financial motivations to
use the Eurocurrency market. By doing so, they receive a higher interest
rate on deposits and pay less for loans.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-04 Compare and contrast the benefits and risks associated with the Eurocurrency market; the
global bond market; and the global equity market.
Topic: The Eurocurrency Market
93.
What are the drawbacks of the Eurocurrency market?
The Eurocurrency market has two drawbacks. In an unregulated system,
such as the Eurocurrency market, the probability of a bank failure that
would cause depositors to lose their money is greater. Thus, the lower
interest rate received on home-country deposits reflects the costs of
insuring against bank failure.
Second, borrowing funds internationally can expose a company to foreign
exchange risk. Consequently, many companies borrow funds in their
domestic currency to avoid foreign exchange risk, even though the
Eurocurrency markets may offer more attractive interest rates.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-04 Compare and contrast the benefits and risks associated with the Eurocurrency market; the
global bond market; and the global equity market.
Topic: The Eurocurrency Market
94.
Describe a fixed-rate bond.
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-04 Compare and contrast the benefits and risks associated with the Eurocurrency market; the
global bond market; and the global equity market.
Topic: The Global Bond Market
95.
What are foreign bonds?
Foreign bonds are sold outside of the borrower’s country and are
denominated in the currency of the country in which they are issued. Many
foreign bonds have nicknames; foreign bonds sold in the United States are
called Yankee bonds, foreign bonds sold in Japan are Samurai bonds, and
foreign bonds sold in Great Britain are bulldogs. Companies will issue
international bonds if they believe that it will lower their cost of capital.
AACSB: Analytic
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 12-04 Compare and contrast the benefits and risks associated with the Eurocurrency market; the
global bond market; and the global equity market.
Topic: The Global Bond Market
96.
Explain Eurobonds with an example.
Eurobonds are normally underwritten by an international syndicate of banks
and placed in countries other than the one in whose currency the bond is
denominated. For example, a German corporation may issue a bond,
denominated in U.S. dollars, and an international syndicate of banks may
sell it to investors outside of the United States. Eurobonds are routinely
issued by multinational corporations, large domestic corporations, sovereign
governments, and international institutions. They are usually offered
simultaneously in several national capital markets, but neither in the capital
market of the country, nor to residents of the country, in whose currency
they are denominated.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-04 Compare and contrast the benefits and risks associated with the Eurocurrency market; the
global bond market; and the global equity market.
Topic: The Global Bond Market
97.
Describe the factors that make the Eurobond market attractive.
Three features of the Eurobond market make it an appealing alternative to
most major domestic bond markets. First, there is an absence of regulatory
interference. Government limitations are generally less stringent for
securities denominated in foreign currencies and sold to holders of those
foreign currencies. Second, there are less stringent disclosure requirements
than in most domestic bond markets. Eurobond market disclosure
requirements tend to be less stringent than those of several national
governments. Third, they have a favorable tax status.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-04 Compare and contrast the benefits and risks associated with the Eurocurrency market; the
global bond market; and the global equity market.
Topic: The Global Bond Market
98.
Write a brief note on foreign exchange risks and the cost of capital.
A firm can borrow funds at a lower cost on the global capital market than on
the domestic capital market. However, under a floating exchange rate
regime, foreign exchange risk can be high. Adverse movements in foreign
exchange rates can substantially increase the cost of foreign currency
loans. Unpredictable movements in exchange rates can inject risk into
foreign currency borrowing, making something that initially seems less
expensive ultimately much more expensive.
When a firm borrows funds from the global capital market, it must weigh the
benefits of a lower interest rate against the risks of an increase in the real
cost of capital due to adverse exchange rate movements.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-05 Understand how foreign exchange risks impacts upon the cost of capital.
Topic: Foreign Exchange Risk and the Cost of Capital
99.
How can a borrower hedge against unpredictable movements in exchange
rates?
A borrower can hedge against unpredictable movements in exchange rates
by entering into a forward contract to purchase the required amount of the
currency being borrowed at a predetermined exchange rate when the loan
comes due. Although this will raise the borrower’s cost of capital, the added
insurance limits the risk involved in such a transaction.
When a firm borrows funds from the global capital market, it must weigh the
benefits of a lower interest rate against the risks of an increase in the real
cost of capital due to adverse exchange rate movements. Although using
forward exchange markets may lower foreign exchange risk with short-term
borrowings, it cannot remove the risk. Most importantly, the forward
exchange market does not provide adequate coverage for long-term
borrowings.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-05 Understand how foreign exchange risks impacts upon the cost of capital.
Topic: Foreign Exchange Risk and the Cost of Capital
100.
How does the growth in the global capital markets affect investing firms?
On the investment side, the growth of the global capital market is providing
opportunities for firms, institutions, and individuals to diversify their
investments to limit risk. By holding a diverse portfolio of stocks and bonds
in different nations, an investor can reduce total risk to a lower level than
can be achieved in a purely domestic setting. Once again, however, foreign
exchange risk is a complicating factor.
AACSB: Analytic
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 12-05 Understand how foreign exchange risks impacts upon the cost of capital.
Topic: Foreign Exchange Risk and the Cost of Capital