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CHAPTER 21
INTERNATIONAL FINANCIAL MARKETS AND INSTRUMENTS:
An Introduction
Learning Objectives:
■ Summarize the fundamental components of international bank lending.
■ Examine the size and structure of international bond and stock markets.
■ Describe the linkages, types, and roles of various international currency and monetary
instruments.
■ Summarize the growth and composition of the global derivatives market.
I. Outline
Introduction
– Financial Globalization: A Recent Phenomenon?
International Bank Lending
Summary
II. Special Chapter Features
In the Real World: Interest Rates across Countries
In the Real World: U.S. Domestic and Eurodollar Deposit and Lending Rates,
1989-2014
Concept Box 1: Eurodollar Interest Rate Futures Market Quotations
III. Purpose of the Chapter
The purpose of this chapter is to introduce students to the characteristics and size of the
many financial assets that are currently exchanged internationally. With the importance of
international finance growing every day, it is important that students have a familiarity with the
range of financial instruments available for transferring wealth across country borders and the
nature of the investment decision that lies behind such movements.
IV. Teaching Tips
A. Students today accept as conventional wisdom that globalization is a new phenomenon
that will continue throughout their lifetimes. The opening vignette can be used to make the point
that increased interdependence among nations has occurred in previous times and that various
forces can slow down or sometimes even reverse the phenomenon.
V. Answers to End-of-Chapter Questions and Problems
1. The growth in the eurodollar markets was the result of a number of factors. For example,
on the supply side, the oil shock in the 1970s and the accompanying build up of petrodollars
abroad was a key factor, as well as the sustained balance-of-payments deficits of the United
States in the 1960s. In addition, European banks were able to offer relatively higher interest
2. Since the interest rate in the United States is less than that in England, the pound should
be at discount (the U.S. dollar at premium) such that, in financial equilibrium, the difference in
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3. One would expect the eurodollar deposit rate to be above 6½ percent and the lending rate
to be below 8½ percent. Because the eurodollar deposits are not subject to the reserve
4. Because eurodollar accounts are not subject to a reserve requirement or the 10 basis
5. Bonds are initially issued for a specific face value, with a specific maturity date and a
specific annual interest rate. The bond thus earns an amount each year equal to the stated interest
6. A negative nominal rate of interest would indicate that people were willing to pay
someone to have use of their money, i.e., they want the nominal value or absolute size of their
savings to decline over time, not increase. [Note: In fact, some central banks (e.g., the European
Central Bank) did have negative nominal rates on commercial bank deposits held with them in
7. Eurodollar interest rate futures are sold in $1 million units. Therefore if one wishes a
futures contract for more than $1 million, e.g., $10 million, one simply negotiates a contract
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containing 10 such units. If investors wish to hedge against interest rate changes for more than a
three-month period, for example nine months, they would simply acquire a series of successive
eurodollar interest rate futures contracts which would cover the nine months in question. This
could be done for a nine-month period starting in December 2012 by acquiring a March 2013
futures contract, a June 2013 futures contract, and a September 2013 futures contract. When the
March contract came to an end, it would be rolled over into the June contract. Similarly, when
the June contract came to an end, it would be rolled over into the September contract. The
individual in question would thus be hedged against changes in the interest rate for the nine-
month period ending on the September contract date. This type of collection of eurodollar
interest rate futures contracts is referred to as a eurodollar strip.
8. A characteristic of any futures contract is that gains or losses of the contracting parties
are settled on a daily basis, and not on the final maturity date. Thus, for example in a currency
futures contract, if a particular currency begins to depreciate (move away from the contract rate)
the party agreeing to supply (taking a short position) the other (appreciating) currency at the
9. A eurodollar interest rate swap involves the exchange of interest rates by the two
contracting parties for several periods in the future. This generally involves the exchange of a
fixed rate by one party for a floating rate held by the other party, and is most often written in
terms of LIBOR. This type of contract can benefit both parties in that a person holding a fixed-
10. In futures contracts, both the writer and the buyer of the contract can potentially lose,
depending on what happens to the market interest rate. In the case of options contracts, the
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writer of the options contract bears all the risk associated with interest rate changes. This
asymmetry is dealt with through the size of the up-front cost of the futures contract (the option
price), which is paid by the purchaser of the options contract. The greater the risk, the higher the
option price.
11. The growth in loan syndicates has fostered growth in international lending by reducing
the credit risk to any one single lender, particularly in the case of very large loans to sovereign
borrowers. In addition, syndication has resulted in a reduction in the time for processing loans
VI. Sample Exam Questions
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1. Several people have argued that a surge in international lending and the increase in
eurodollar accounts and derivatives will contribute to economic instability. Do you agree or
disagree with their concerns? Why?
2. Discuss why an investor might be interested in foreign stocks and bonds instead of
domestic financial instruments. What are the dangers of such purchases?