Chapter 12 – The Global Capital Market
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The Global Capital Market
Learning objectives
• Describe the benefits of the
global capital market.
• Identify why the global capital
market has grown so rapidly
over the last quarter century.
• Understand the risks associated
with the globalization of capital
markets.
• Compare and contrast the risks
and benefits associated with the
Eurocurrency market, the
global bond market, and the
global equity markets.
• Understand how foreign
exchange risk impacts upon 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
their risk.
Advances in information technology, together with the
deregulation of financial services and the relaxation of
regulations on cross-border capital flows have contributed
to the growth of the global capital market.
The chapter explores the nature of the Eurocurrency
market, the global bond market, and the international
equities market.
The opening case explores the factors contributing to the
2008 global financial crisis. The closing case describes
how ICBC, China’s largest bank, raised $21 billion in the
international equities market.
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Chapter 12 – The Global Capital Market
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OUTLINE OF CHAPTER 12: THE GLOBAL CAPITAL MARKET
Opening Case: Global Capital Markets in Crisis
Introduction
Benefits of the Global Capital Market
Functions of a Generic Capital Market
Attractions of the Global Capital Market
The Borrower’s Perspective: Lower Cost of Capital
The Investor’s Perspective: Portfolio Diversification
Growth of the Global Capital Market
Information Technology
Deregulation
Global Capital Market Risks
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
Attractions of the Eurocurrency Market
Drawbacks of the Eurocurrency Market
The Global Bond Market
Attractions of the Eurobond Market
Regulatory Interference
Disclosure Requirements
Favorable Tax Status
The Global Equity Market
Pegged Exchange Rates
Currency Boards
Country Focus: The Search for Capital in the Czech Republic
Foreign Exchange Risk and the Cost of Capital
Implications for Managers
Chapter Summary
Critical Thinking and Discussion Questions
Closing Case: Industrial and Commercial Bank of China
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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.
Encourage students to comprehend the significance and implications of the growth of the
global capital market by asking them to imagine a world where firms were limited to
their domestic market as a source of funds or investment opportunities.
Ask students to identify the advantages of this type of world, and then the disadvantages.
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: Industrial and Commercial Bank of China
Summary
The opening case explores the factors contributing to the financial crisis that swept
through global capital markets in 2008. After the U.S. government failed to save Lehman
Brothers, capital markets plunged into crisis. Several national governments worked in a
coordinated fashion to stabilize markets once again. Discussion of the case can revolve
around the following questions:
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?
3. What does the fact that it took the efforts of several governments to shore up the
commercial paper market imply about global capital markets? What does this suggest
about the future of global capital markets?
Another Perspective: To learn more about G-20 efforts to prevent future financial crises
consider the iGLOBE G-20 To Replace G-8 As Economic Forum and also
{http://www.businessweek.com/news/2011-09-22/el-erian-says-world-is–on-eve-of–
another-financial-crisis.html}. In addition, consider Europe’s efforts to maintain a stable
financial environment with the iGLOBE How Severe Is Europe’s Intertwined Debt
Crisis?
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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.
Slides 12-3-12-4 Why Do Global Capital Markets Exist?
The rapid globalization of capital markets facilitates the free flow of money around the
world. Traditionally, national capital markets have been separated by regulatory barriers.
Capital markets bring together investors (corporations with surplus cash, individuals, and
non-bank financial institutions) and borrowers (individuals, companies, and
governments).
Slides 12-5-12–8 Attractions of the Global Capital Market
Borrowers benefit from the global capital market’s lower cost of capital and greater
investment options.
Slides 12-9-12-12 Growth of the Global Capital Markets
Since 1990, the stock of cross-border bank loans has grown from just $3,600 billion to
$32,430 in 2010. The international bond market shows a similar pattern of growth.
Another Perspective: McKinsey & Company have been following the growth of the
global capital markets. Detailed analysis can be found at
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.
Slide 12-14 The Eurocurrency Market
A eurocurrency is any currency banked outside of its country of origin.
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Slides 12-15-12-18 Genesis and Growth of the Eurocurrency Market
The eurocurrency market began in the 1950s when the Eastern bloc countries were afraid
Slides 12-19-12-21 Attractions of the Eurocurrency Market
The eurocurrency market is attractive to depositors and borrowers because it is not
regulated by the government.
Slide 12-22 Drawbacks of the Eurocurrency Market
The eurocurrency market has two drawbacks.
Slide 12-23-12-24 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
• it has less stringent disclosure requirements than domestic bond markets
• it is more favorable from a tax perspective.
Slides 12-26-12-27 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 exchange rate
risk is factored in, that can change.
Slides 12-29-12-30 Implications for Managers
Firms can often borrow in global capital markets at a lower cost than in the domestic
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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.
In 2000, for example, the stock of cross-border loans was just $7,859 billion. By 2010,
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: Reread the Country Focus on the search for capital in the Czech Republic.
What are the advantages to Czech firms of listing their equity on the London stock
exchange? Can you see any disadvantages?
ANSWER 3: Because of the improprieties surrounding the Prague stock exchange, Czech
firms have little choice but to go outside the country to raise capital. By listing on the
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QUESTION 4: A firm based in Mexico has found 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 market over the next two years?
ANSWER 4: 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
QUESTION 5: 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 5: 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 pounds from Midland it has to factor in the higher interest rate (14 percent), and
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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. In fact, the offering was hugely oversubscribed!
Tapping in 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 Kong exchange because of the strict reporting and governance standards it requires,
and the message this would send to potential investors. By issuing equity shares, ICBC is
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
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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: As Obama Kicks Off Trip, How Far-Reaching Is Europe’s Economic
Crisis?
Run Time: 11:30
Abstract: This video explores the financial crisis threatening the long term survival of
the world’s largest trading bloc, the European Union.
Key Concepts: European Union, economic integration, political economy,
International Monetary Fund (IMF), international trade, the euro, global economy,
globalization, rational for foreign direct investment, impact of the multinational on the
host country
Notes: President Obama’s recent trip to Europe brought new attention to the severe
financial difficulties faced by several European countries and highlighted the challenges
the European Union must overcome if it is to survive in its current form. Obama began
his trip with a visit to one of the hardest hit countries, Ireland. Ireland was forced to
accept a bailout from the International Monetary Fun and European Central Bank late last
year after its banking sector found itself on the verge of total collapse. Other European
Now, there is concern as to how the precarious situations in these countries could affect
the stability of the European Union as a whole, and perhaps more importantly the value
and sustainability of the bloc’s common currency, the euro. Some wonder whether
countries like Greece and Italy really have the ability to repay their debts, and if they do
not, whether their richer northern neighbors will be willing to step in to help. There is
considerable concern about contagion and the potential for the problems in these
U.S. leaders are worried about the impact of the European Union’s financial crisis on the
United States. They know firsthand that in today’s global economy, a crisis in one part of
the world can quickly spread to other parts. The United States is only just emerging from
its own recession, a recession that also had a significant impact on Europe. So far, the
efforts to fix the European Union’s problems have been temporary short-term solutions at
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best. So for now, questions about the long term viability of the European Union continue
to be asked. In the end, the bloc could be fragmented into a richer northern bloc and a
poorer southern bloc.
Discussion Questions:
1. U.S. leaders have expressed concern over the financial crisis in the European Union.
Why should the United States be concerned? How could the European Union’s problems
affect the U.S. economy and U.S. companies?
2. How have the changes in the global economy over the last two decades contributed to
the financial crisis within the European Union? What do these changes imply about the
European Union’s ability to overcome it current difficulties?
3. Reflect on the fundamental differences between members of the European Union.
How might different approaches to economic policy, different cultures, and different
legal systems influence how member countries face the current financial crisis affecting
the trading bloc?
4. Discuss the loss of political and economic sovereignty that is associated with economic
integration. Do countries in the European Union have the right to reject suggestions on
how to solve the bloc’s current financial crisis simply because the recommendations have
a negative impact on their own situation?
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.
❖ Understand the implications of the global economic recession on the developing
world.
❖ Explain the effects of globalization on developing countries.
❖ Discuss microfinance and why it is important to developing markets.
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Key Words
❖ Levels of economic development
❖ Microfinance
❖ Exports
❖ G-7
❖ Globalization
❖ The World Bank
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
repossessions are rising. However, in much of the developing world, the effects of the
recession may be much worse. According to the World Bank, 53 million more people
could be trapped in poverty, earning less than $2 per day. Moreover, infant mortality is
rising with some 200,000 – 400,000 more babies dying every year. Compounding the
problems for the developing world is the decline in private sector capital flows from
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.
Like many developed countries, developing countries, and particularly those countries in
Southeast Asia, have experienced significant job loss. Many people in Southeast Asia
work in factories that produce clothing that is exported to developed countries. However,
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
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?
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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?
3. Reflect on what globalization means for developing countries. In your opinion, has it
been advantageous to lower income countries? Has the gap between the developed world
and the developing countries increased or decreased as a result of globalization?
4. Explain the significance of microfinance to the developing world. Why is it so
important to ensure that the industry continues to grow? How can multinational
companies capitalize on the microfinance trend?
INCORPORATING globalEDGE™ EXERCISES
Use the globalEDGE™ site {http://globalEDGE.msu.edu/} to complete the following
exercises:
Exercise 1
The top management team of your not-for-profit organization would like to find out more
concerning socially responsible companies in Europe. Remembering the FTSE index
company has a responsible investment index that addresses this issue, you decide to use
the index’s factsheet for your analysis. Evaluate the risk categories, countries, and
industries represented in this index’s leading companies.
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
the amount of direct investment by multinational corporations in the U.S. and abroad.
Prepare a brief report regarding the direct investments of other countries in the U.S.
Which are the leading countries in foreign direct investment in your report?
Answers to the Exercises
Exercise 1
The different indices available via FTSE is accessible by searching with the phrase
“FTSE” at http://globaledge.msu.edu/ResourceDesk/. This resource is found under the
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Exercise 2
The investment positions of foreign direct investment by multinational corporations in
the US can be found at the Bureau of Economic Analysis resource. The webpage can be
accessed by searching the term “Bureau of Economic Analysis” at
Chapter 12 – The Global Capital Market
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End of Part Case Notes
Part Four:
Hyundai and Kia
1. Explain how the rise in the value of the Korean currency, the won, against the dollar
impacts upon the competitiveness of Hyundai and Kia’s exports to the United States.
Answer: Both Hyundai and Kia rely on exports for much of their sales. Consequently,
the companies are highly vulnerable to changes in exchange rates. When the South
Korean currency, the won, rises relative to the U.S. dollar, cars sold in the United States
are recorded at a lower price when translated back into won. This of course hurts
Hyundai’s and Kia’s profits, and forces the two companies to sell more units just to stay
even.
2. Hyundai and Kia are both expanding their presence in the United States. How does
this hedge against adverse currency movements? What other reasons might these
companies have for investing in the United States? What are the drawbacks of such a
strategy?
Answer: Both Hyundai and Kia announced plans to expand production in the United
States. Hyundai already has a plant in Alabama, and Kia will soon be opening a plant in
Georgia. Both companies hope that having a U.S. manufacturing site will help protect
them against adverse currency movements. Most students will probably recognize that
having the U.S. production locations allows the firms to shift production during times of
sustained currency movements. Some students may also note that since both companies
rely on the U.S. market for a substantial share of their profits, having a U.S. presence
may be beneficial simply because they are closer to an important market, and because
U.S. consumers might be more inclined to purchase cars made by Americans. At the
same time though, students will probably point out that manufacturing in the United
States where wages are higher could make it more difficult for the companies to
implement their low cost strategies.
3. If Hyundai expects the value of the won to strengthen appreciably against the U.S.
dollar over the next decade, should it still expand its presence in the United States?
Answer: If Hyundai expects the won to appreciate, Hyundai should consider expansion
in the United States. A stronger won implies a weaker dollar, which in turn implies that
U.S. consumers would need more dollars to buy a Hyundai exported from South Korea
which could mean a drop in sales. Moreover, a stronger won means that cars that are
exported from South Korea will be recorded at a lower value when translated from
dollars back to won. Hyundai experienced this very situation in 2006 when the won hit a
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10 year high against the dollar. Even with rising unit sales, Hyundai saws its profits fall
that year by 35 percent.
4. In 2008 the Korean won depreciated 28 percent against the U.S. dollar. Does this
imply that Hyundai and Kia were wrong to invest in the United States? How does this
explain the relative strength of car sales from Hyundai and Kia in the U.S. market during
early 2009?
Answer: Most students will probably suggest that the rise in Hyundai’s and Kia’s sales
during early 2009 can be attributed to a combination of Hyundai’s and Kia’s low cost
strategies and the fact that the won tumbled 28 percent against the U.S. dollar in 2008.
Many students will probably agree that Hyundai’s and Kia’s investments in U.S.
production are still worthwhile despite the drop in the value of the won because they
offer the companies a hedge against future exchange rate movements. Both automakers
have indicated that the United States features prominently in their future growth plans.
Having the ability to shift production is an example of the strategic flexibility that is
important in dealing with economic exposure.
Another Perspective: Students can further explore Hyundai’s and Kia’s strategies and
operations at {http://www.hyundaiusa.com/index.aspx} and
{http://www.kiamotors.com/}.
Another Perspective: Students can also explore the value of the South Korean won over
time at {http://www.forecasts.org/won.htm}.
Anatomy of a 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
businesses to invest in export-oriented industries as a means of pulling the country out of
its mild recession. Later, when it became clear that many of the investments were in
trouble, the country’s central bank stepped in to try to prop up the rapidly depreciating
won. At this point, the government decided to take some troubled companies into state-
ownership, but was then hampered by the skyrocketing cost of supporting distressed
firms. Eventually, in 1997, the central bank gave up its fight to maintain the won,
allowing it to plunge in value to just Won1,500 = $1, a considerable departure from
earlier values where Won840 = $1.
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
government, South Korea’s chaebol began making significant investments using
borrowed funds, often denominated in dollars. However, many of the investments were
Chapter 12 – The Global Capital Market
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based on unrealistic demand projects. When the anticipated demand failed to materialize,
the companies were left with excess capacity and falling prices making it difficult for
them to meet their debt obligations. Many were forced into bankruptcy, while others
were 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 of the currency down. The central bank, hoping to restore investor confidence,
used its dollar reserves to buy up won. However, Standard & Poor’s downgrade of the
country’s sovereign debt caused the won to tumble even further as worried investors
pulled their funds out of the market. Despite pushing short-term interest rates to 12
percent, the carnage continued. Finally, after depleting nearly half of its dollar reserves,
the central bank was forced to admit defeat and accept help from the IMF.
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
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
gave up its fight to defend the won, the currency had already dropped to about half of its
previous value, resulting in foreign exchange losses of more than $15 billion for South
Korean companies. Instead, with the assistance of the IMF, the country was able to
stabilize its economy, and reassure investors.
Russian Ruble Crisis
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
market led to currency hording. When price controls were lifted, but supplies of goods
were still limited, inflation soared as too much money chased too few goods. Adding to
the mess was the decision by the government to continue subsidizing many unprofitable
enterprises. Rather than fund this by raising taxes, the government simply printed more
money. Many students will probably suggest that the inflationary spike could have been
avoided by raising taxes, stopping subsidies to unprofitable enterprises, not increasing the
money supply, and trying to reduce the government budget deficit.
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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
illustrates how currency values are influenced by inflation rates. Students should
recognize that inflation leads to the devaluation of currencies.
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
because the oil price slump meant lower government revenues from taxes. In addition,
because a significant amount of economic activity was “underground,” collecting taxes
was difficult, and loopholes in the tax code allowed many to avoid paying taxes.
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?
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
replaced its complex tax code with a flat tax for individuals and corporations.
Corporations and individuals responded to the simpler tax code by paying their taxes
instead of avoiding them increasing the country’s tax revenues significantly. Many
students will see this as an indicator that the IMF policy was wrong. Other students may
suggest that the turnaround may be more of a case of Russia’s government finally
“getting it” — that massive reform was necessary for the situation to improve.