Chapter 12 – The Global Capital Market
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The Global Capital Market
Learning objectives
• Understand the risks associated
with the globalization of capital
markets.
• Understand how foreign
exchange risks affect the cost
of capital.
This chapter discusses the form and function of the global
capital market. The market is attractive because its size
lowers the cost of capital for borrowers, and allows
investors to diversify their portfolios, thereby reducing
The chapter explores the nature of the Eurocurrency
market, the global bond market, and the international
equities market.
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OUTLINE OF CHAPTER 12: THE GLOBAL CAPITAL MARKET
Opening Case: Declining Cross-Border Capital Flows: Retreat or Reset?
Introduction
Benefits of the Global Capital Market
Functions of a Generic Capital Market
Attractions of the Global Capital Market
Management Focus: Deutsche Telekom Taps the Global Capital Market
Country Focus: Did the Global Capital Markets Fail Mexico?
The Eurocurrency Market
Genesis and Growth of the Market
The Global Equity Market
Foreign Exchange Risk and the Cost of Capital
Implications for Managers
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CLASSROOM DISCUSSION POINT
Many of today’s students may be unaware of the limitations faced by companies that
wanted to raise capital just a couple of decades ago.
Finally, ask students to consider which type of system is better – the one that was in place
twenty years ago, or the current system.
OPENING CASE: Declining Cross-Border Capital Flows: Retreat or Reset?
Summary
The opening case explores the factors contributing to the decline of cross-border capital
flows after the 2008-2009 global economic crisis. Recall that after the U.S. government
1. What signal did the failure of Lehman Brothers send to global capital markets? How
did the failure to act by the U.S. government exacerbate the financial crisis? In your
opinion, should the U.S. government have intervened to save Lehman Brothers?
2. Why did LIBOR rates spike following the collapse of Lehman Brothers? What effect
did the spike have on the value of the U.S. dollar?
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LECTURE OUTLINE
This lecture outline follows the Power Point Presentation (PPT) provided along with this
instructor’s manual. The PPT slides include additional notes that can be viewed by
clicking on “view,” then on “notes.” The following provides a brief overview of each
Power Point slide along with teaching tips, and additional perspectives.
Capital markets bring together investors (corporations with surplus cash, individuals, and
non-bank financial institutions) and borrowers (individuals, companies, and
governments).
Slides 12-5 through 12-8 Attractions of the Global Capital Market
Borrowers benefit from the global capital market’s lower cost of capital and greater
investment options.
Slides 12-9 through 12-12 Growth of the Global Capital Markets
Since 1990, the stock of cross-border bank loans has grown from just $3,600 billion to
$33,913 billion in late 2012. The international bond market shows a similar pattern of
growth.
Slide 12-13 Global Capital Market Risks
A key risk of an unregulated capital market and looser control on cross-border capital
flows is that individual nations may be more vulnerable to the destabilizing effects of
speculative capital flows.
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Slides 12-15 through 12-18 Genesis and Growth of the Eurocurrency Market
The Eurocurrency market began in the 1950s when the Eastern bloc countries were afraid
the United States might seize their holdings of dollars. Today, London is the center of the
market.
Slides 12-23 and 12-24 The Global Bond Market
There are two types of international bonds:
1. Foreign bonds are sold outside the borrower’s country and are denominated in the
currency of the country in which they are issued.
Slide 12-25 Attractions of the Eurobond Market
The Eurobond market is attractive because:
• It lacks regulatory interference
Slides 12-26 and 12-27 The Global Equity Market
The largest equity markets are in the United States, Britain, and Japan.
Slide 12-28 Foreign Exchange Risk and the Cost of Capital
While it may initially seem attractive to borrow foreign currencies, when the exchange
rate risk is factored in, that situation can change.
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CRITICAL THINKING AND DISCUSSION QUESTIONS
QUESTION 1: Why has the global capital market grown so rapidly in recent decades?
Do you think this growth will continue throughout the next decade? Why?
ANSWER 1: The global capital market has experienced rapid growth in recent decades.
By late 2012, the stock of cross-border bank loans stood at $33,913 billion compared to
$7,859 billion in 2000 and $3,600 billion in 1990. Similarly, outstanding international
QUESTION 2: In 2008-2009, the world economy retrenched in the wake of a global
financial crisis. Did the globalization of capital markets contribute to this crisis? If so,
what can be done to stop global financial contagion in the future?
ANSWER 2: Most students will probably agree that the globalization of capital markets
was a significant contributing factor to the 2008 financial crisis. If markets still operated
QUESTION 3: A firm based in Mexico has found that its growth is restricted by the
limited liquidity of the Mexican capital market. List the firm’s options for raising money
on the global capital market. Discuss the pros and cons of each option, and make a
recommendation. How might your recommended options be affected if the Mexican peso
depreciates significantly on the foreign exchange markets over the next two years?
ANSWER 3: Companies seeking to raise money in the global capital markets can pursue
equity loans or debt loans. Equity loans involve selling stock to investors, while debt
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QUESTION 4: Happy Company wants to raise $2 million with debt financing. The
funds are needed to finance working capital, and the firm will repay them with interest in
one year. Happy Company’s treasurer is considering three options:
a. Borrowing U.S. dollars from Security Pacific Bank at 8 percent.
b. Borrowing British pounds from Midland Bank at 14 percent.
c. Borrowing Japanese yen from Sanwa Bank at 5 percent.
If Happy borrows foreign currency, it will not cover it; that is, it will simply change
foreign currency for dollars at today’s spot rate and buy the same foreign currency a year
later at the spot rate that is in effect. Happy Company estimates the pound will depreciate
by 5 percent relative to the dollar and the yen will appreciate 3 percent relative to the
dollar in the next year. From which bank should Happy Company borrow?
ANSWER 4: Happy Company needs to consider both the cost of capital and foreign
exchange risk. If Happy Company borrows $2 million from Security Pacific Bank in one
year it will owe the bank $2 million plus 8 percent. If Happy Company borrows British
CLOSING CASE: Industrial and Commercial Bank of China
Summary
The closing case discusses the effort by the Industrial and Commercial Bank of China, or
ICBC, to raise money in the global capital market. ICBC raised a record $21 billion
dollars with its Initial Public Offering (IPO). In fact, the offering was hugely
oversubscribed! Tapping into global capital markets is becoming more common for
Chinese companies. Since 2000, they have raised over $100 billion dollars from global
equity markets. Discussion of the case can revolve around the following questions:
QUESTION 1: Why did ICBC feel it was necessary to issue equity outside of China?
What are the advantages of such a move? Can you see any disadvantages?
ANSWER 1: ICBC listed its IPO shares on both the Shanghai stock exchange and the
Hong Kong stock exchange. ICBC felt that it was necessary to list the shares on the Hong
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QUESTION 2: What was the attraction of the ICBC listing to foreign investors? What do
you think are the risks for a foreigner associated with investing in ICBC?
ANSWER 2: The equity listing by ICBC was a tremendous success. In fact, the listing
was so oversubscribed, the bank was able to raise its price and therefore return. Foreign
investors were attracted to the listing because it gave them a piece of China’s booming
economy. As one of the largest banks in China, ICBC was an attractive option. Most
INTEGRATING iGLOBES
There are several iGLOBE video clips that can be integrated with the material presented
in this chapter. In particular, you might consider the following:
Title: In China, Factory Workers Allege Poisoning from iPhone Production
Run Time: 7:53
Abstract: This video explores the alleged human rights violations at a factory in China
that supplies products to many well-known multinational companies including Apple,
Nokia, and Garmin.
Key Concepts: labor abuse, human rights, ethics, corporate social responsibility,
globalization, global supply chain, global economy, global production
Notes: Questions over the treatment of workers in a factory in China made headlines
recently after some employees complained that they had been poisoned by their
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chemical made from crude oil. Now, some of the employees are suffering from
neurological disorders including dizziness and paralysis.
Human rights activists have frequently voiced concern that China’s rapid pace of
industrialization may come with human costs. Some worry that as the country establishes
itself as the factory floor for the world, it is not ensuring that proper safety measures are
being taken by companies. Moreover, as factories skirt safety issues in favor of producing
cheap products for the Western world, Chinese workers feel trapped. They worry that
they will not be able to find new jobs because of the health problems brought on by their
current jobs. The workers involved in the situation at Wintek for example, are finding it
difficult to find new jobs because of their occupational disorders. Apple, more than a year
Discussion Questions and Answers:
1. The factory in China that recently made headlines when workers claimed they were
being forced to come into direct contact with toxic chemicals supplied iPhone screens to
Apple. Reflect on this situation. Is it unethical for companies to use suppliers that exploit
their workers? Is it ever acceptable to buy from a company that mistreats its workers?
Answer: Claims of worker abuse like those made by the workers at the factory in China
touch a nerve for many people. In fact, most students will probably agree that it is indeed
unethical to use suppliers that exploit their workers. What many students may find
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2. Consider the situation involving Wintek and Apple. Is Wintek actually breaking the
law by requiring employees to come into contact with toxic chemicals? Which standards
should be applied to the issue? Should it be China’s or the United States’?
Answer: The question of which country’s legal standards should apply to a situation in
another country is a difficult one and should provide the basis for a lively classroom
debate. Most students will probably argue that if Wintek was not breaking the law in
3. Do you as a consumer of iPhones have a responsibility to ensure that the companies
that you are buying from act in an ethical manner? Why might some consumers take an
“out of sight, out of mind” approach to this issue?
Answer: The role of the consumer in ensuring that companies act in an ethical manner is
not always clear. Consumers typically want to purchase quality products at a reasonable
price. Most consumers would probably prefer to make their purchases from companies
4. What steps should multinational companies take to ensure that their subcontractors are
behaving in an ethical manner towards employees? How should companies make human
rights issues part of their overall policy?
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Answer: Multinational companies that subcontract production to companies in emerging
economies like China can proactively try to ensure that their suppliers act in an ethical
and socially responsible manner by developing subcontracting policies designed to ensure
INTEGRATING VIDEOS
There are also several longer video clips that can be integrated with the material
presented in this chapter. In particular, you might consider the following from
International Business DVD Volume 6:
Title: Developing World Hit By Recession, but Microfinance Grows
Learning Objectives
The purpose of this video is to help you:
❖ Recognize the difference between developing and developed countries.
Key Words
❖ Levels of economic development
❖ Microfinance
Synopsis
The effects of the recent global recession are still being felt across much of the developed
world. High unemployment continues to plague many countries, credit is tight, and
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developed countries. The World Bank expects inflows of capital to developing countries
to fall 50 percent from their 2007 levels, a reduction of $500 billion.
The developing countries have asked developed nations like the United States for
assistance, but so far, the response has been lukewarm at best. What may be more
promising though is the burgeoning microfinance industry. Microfinance providers make
small, low interest loans to the world’s poorest people. The industry began in the 1970s
and today is worth more than $25 billion. Now, the back to basics, relationship approach
of microfinance is being hailed as a potential model for the developed world as well. In a
tight credit market, the loans made by microfinance providers are often the only option
open to individuals.
Discussion Questions
1. How would you classify countries like Zambia and the Democratic Republic of
Congo? Explain how developing countries differ from developed countries. Do you think
developed countries have a responsibility to help poorer countries?
2. How has the recent global recession affected the developing world? What does your
response tell you about the interdependent nature of the global economy?
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INCORPORATING globalEDGE™ EXERCISES
Exercise 1
The top management team of your not-for-profit organization would like to find out more
about investing in environmentally responsible companies in Europe. FTSE develops
various indexes for the global financial markets. A series of indexes, called ESG, cover
social, environmental, and good governance standards. One of these is the Environmental
Europe 40 Index. Download the index’s factsheet for your analysis. Evaluate the top 10
companies, countries, and industries represented in this index. What patterns do you see?
Exercise 1 Answer
Search phrase: FTSE
Exercise 2
The Bureau of Economic Analysis is an agency of the U.S. Department of Commerce. It
lists data about the U.S. economic accounts, including current investment positions and
Exercise 2 Answer
Search phrase: Bureau of Economic Analysis
Resource Name: United States: Bureau of Economic Analysis
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End of Part Case Notes
Part Four
The South Korean Currency Crisis
1. What role did the Korean government play in creating the 1997 crisis?
Answer: The Korean government played multiple roles in the 1997 crisis beginning with
the 1993 decision of the then newly elected president Kim-Young Sam’s decision to urge
2. What role did Korean enterprises play in creating the 1997 crisis?
Answer: Korean companies contributed to the country’s 1997 financial crisis by making
large, relatively risky investments. During the mid-1990s, at the urging of the
taken over by the state.
3. Why was the Korean central bank unable to stop the decline in the value of the won?
Answer: The central bank began to implement policies designed to prop up the ailing
won in mid-1997. Many troubled companies were filing for bankruptcy pushing the value
4. In late 1997, the IMF stepped in with a rescue package that included $55 billion in
emergency loans to support the currency. These loans had the effect of stabilizing the
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won and over the next few years South Korea enjoyed a strong recovery. If the IMF had
not stepped in, what might have occurred?
Answer: Many students will probably agree that without the assistance of the IMF the
situation in South Korea would have continued to deteriorate. When the central bank
The Russian Ruble Crisis and Its Aftermath
1. What were the causes of the surge in inflation in Russia during the early 1990s? Could
this have been avoided? How?
Answer: Inflation in Russia surged in the 1990s following the removal of traditional
price controls. During the Communist regime, ongoing shortages of many goods in the
2. What does the decline in the value of the ruble against the dollar between 1992 and
1998 teach you about the relationship between inflation rates and currency values?
Answer: The decline in the value of the ruble against the dollar between 1992 and 1998
3. During the mid 1990s, the IMF wanted Russia to raise tax rates, close loopholes in the
tax system, and cut public spending. Russia was unable to do this. Why?
Answer: Russia was unable to follow the IMF prescription in the mid 1990s in part
4. In the early 2000s Russia cut tax rates for individuals and corporations, and
government tax revenues surged. Why? Does this result suggest that the IMF policy
prescriptions were wrong?
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Answer: After the IMF effectively turned its back on Russia, the government looked for
ways to improve its financial state. In addition to cutting government spending, the IMF
Caterpillar: Competing in a World of Fluctuating Currencies
1. In the 1980s a stronger dollar hurt Caterpillar’s competitive position, but in 2008 a
stronger dollar did not seem to have the same effect. What had changed?
Answer: Between the 1980s and 2000s Caterpillar was able to reduce its economic
exposure by completely changing its global strategy. In the 1980s, much of Caterpillar’s
2. How did Caterpillar use strategy as a “real hedge” to reduce its exposure to foreign
exchange risk? What is the downside of its approach?
Answer: To reduce its economic exposure Caterpillar established a significant number of
foreign manufacturing facilities. These were important to the company because they
3. Explain the difference between transaction exposure and translation exposure using the
material in the Caterpillar case to illustrate your answer.
Answer: Transaction exposure refers to the extent to which the income from individual
transactions is affected by fluctuations in foreign exchange rates while economic
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