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International Money Market
Welcome everyone to our course on International Business. So, as you know in the lastlecture we were discussing about the financial markets and there we talked on what is afinancial market. What are the basically the major components of the financial market.Where we talked about the money market and capital market right and how they are thefinancial markets are classified on basis of certain you know certain measures. Forexample, the primary market, secondary market, then exchange traded market and overthe counter market right.So, on basis of certain ways we can classify the market, but to understand largely it is themajor two ways are one is the money and the other is the capital market. And then wetried to understand what is this money market, what is its importance right.(Refer Slide Time: 01:17)So, we understood that money market is a market where lending and borrowing isgenerally done on short term funds right. And it comprises the short-term creditinstruments and the institutions and individuals who participate in the lending andborrowing business.So, what it is saying basically? The money market is that for example, where there is alike an immediate requirement or a urgency of funds is required, in that case it is thefund may be required for a very short term duration right. So, when it is required for ashort-term duration, one would not go for a long term borrowing rather would go for ashort term borrowing right.So, in this when you say a short-term borrowing, lending or borrowing whatever so inthat case we would say that it is a money market right. So, the money market has someinstruments these are not all, but there are few more also. But some of the instruments inthe money market are for example, the Euro credits, commercial paper, certificate ofdeposit, treasury bills, etcetera right. And here I am talking largely about those you knowall those short term basically, instruments right.(Refer Slide Time: 02:22)So, what is let us start with the first one; the Euro credits right. So, Euro credits arebasically short to medium term loans of Euro currency. Now, what is a Euro currency? Ifyou remember, in the last class we discussed. The Euro currency has got nothing to dowith the euro, it is just a prefix right. So, here you can see the definition is there. Eurocurrency is any foreign currency denominated, deposited by national governments orinstitutions in banks outside their home market.So, suppose for example, the US bank the US government would like to deposit someamount of some dollars in UK right, then you would be called Euro you know it is a partof the Euro currency right. So, Euro dollars or Euro yen we say that.So, Euro is not related with Europe right, it is only a prefix right. So, the loans aredenominated in currencies other than the home currency of the European, Euro banksright and these loans are too large to be handled by a single bank, because these loans aretoo large to be handled by a single bank Euro banks will band together to form a banklending syndicate to share the risk.So, Euro credits are basically you know they talk about large values right, they are theloans are of large values and the Euro credits feature an adjustable rate in which interestrate are settled at pre decided intervals in the basis of LIBOR. So, you remember in thelast lecture we discussed about LIBOR; the London Interbank Offered Rate, in which wealso understood how to calculate the LIBOR right. So, once you calculate the LIBOR,the LIBOR is changes frequently. So, the LIBOR plus the lending margin right, everybank would add to that. So, that is what is finally, the rate, final rate right.(Refer Slide Time: 04:21)How does the Euro credit work? Let us see. The Euro currency market is a major sourceof finance for all international trade, because of ease of convertibility and the absence ofdomestic restrictions on trading.So, we have understood the government interactions interventions are not there right.The banks involved in the Euro credit and Euro currency markets are the same. Whatyou are saying? The banks involved in the Euro credit and the Euro currency markets arethe same, then what is the difference, but the difference is that the loans involved in theEuro credit is typically much larger and long term in nature then those of the Eurocurrency market right.So, it is a long term and it is a large valued loan right. Euro credit helps the flow ofcapital between countries and the financing of investments at home and abroad. A majorfunction of the banks is matching surplus with deficit units.So, this is you have understood. This is basically the major reason why financial marketshave come into play. The most common type of Euro credit is the Euro dollar, dollardenominated deposits or loans held by non US banks right. So, Euro dollar is the dollardeposited by US government in maybe some other country, parked in some othercountry. So, this is for example, the US right, this is the UK.So, US dollars are in some UK bank for example, now India for example, wants a loan inUS dollars. So, they can get this loan from this either directly here or they can directlyget it from here even right, looking at the condition so they can get it from anywhere.So, suppose they find that this is preferable so, what they would do is the interest ratecharged, when the India ah borrower is borrowing the money would be that the LIBORright which is calculated as we have seen and plus the X which is the margin right. So, Xis the lending margin.So, since LIBOR, but keeps changing, LIBOR is constantly changing; obviously,because we are calculating continuously. Euro banks lend loans on roll over basis; that isif loan is extended for suppose 6 months you have taken a loan and is extended for 6months, the LIBOR will be, but changed for every 3 months. So, the value changes,because the LIBOR is constantly changing, it is calculated every 3 months so, the valuethat you have the loan that you have taken the rate would continuously be changing right.(Refer Slide Time: 07:05)The next instrument in the international money market that is largely used is the moneymarket is the commercial paper. Now, what is this? What is this commercial paper?Now, you can look at this right and you may get an idea also.So, unsecured it is an unsecured short-term debt instrument, it is an unsecured short termdebt instrument issued by corporations and banks to raise short term cash; for financingof the accounts payable and inventories and meeting short term liabilities. They say thatin the 2008, 7 to 8 crisis when the subprime crisis happened, the one of the major reasonsfor the crisis was this commercial paper which frozen got frozen down at that time,because of people got scared and they were worried the about the financial market, theabout the movement of the market.So, this was one of the major causes for the 2008 crisis and Lehman brothers downfallright. It is placed directly with the public through a dealer and matures typically range,the maturity typically ranges between one to six months, it maximum goes up to 270days ok.In India it was introduced in 1990 as it is the maturity period and it is issued in thedomination of 5 lakh or multiples right. Commercial paper needs to obtain the creditrating, it has to be it has to obtain the credit rating right and it is not backed by collateral.So, this is the danger which since, it is not backed by collateral. So, this was also a veryprominent reason why it was instrumental in that 2008 crisis, financial crisis ok.(Refer Slide Time: 08:56)The next is the certificate of deposit now, what is the certificate of deposit? It is anegotiable instrument right, evidencing a deposit with the bank. So, you can see this rightit is a short term security instrument with a high interest rate and maturity date issued bya bank that seeks to raise funds from the secondary market during; the period of tightliquidity, when liquidity is not when the market is not highly liquid and there is notenough funds available.So at that time a certificate of deposit is issued which is with a high interest rate right,because money is not available so; obviously, the lender would charge a higher interestrate right. It can be issued by scheduled commercial banks right and selected All IndiaFinancial Institutions.Minimum amount is 100000 maturity period, issued at a discount on the face value andbanks have to maintain CRR right and SLR on issue amount of CD’s the corporate, thecertificate of deposits right.(Refer Slide Time: 10:05)Then the next is the treasury bill right. The treasury bill is just again a short terminstrument, issued by the central bank on behalf of the government right. It is used toraise short term funds to bridge short term mismatches between receipts and expenditureright. So, if there is a mismatch, you can raise short term funds ok.Highly liquid due to short maturity, it is very highly liquid, issued at a discount andrepaid at par on maturity. Treasury bills are often, this is very important part of thetreasury bill it is issued at a discount right and would be paid repaid at par during thematurity right, held on the negotiated dealing system.It is in India 91 day T-bills or treasury bills are auctioned, every week on Friday. 182 dayand 364 day treasury bills are auctioned every alternate week on Wednesday’s. Treasurybills are available for a minimum amount of rupees 25000 and in multiples of it. It is alsoissued at a discount and redeemed at par right. Now, this is all what we discussed wasabout the money market right.So, the money market we understood that it has a lot of importance, because it takes careof the short term requirements of any borrower right or any let us say industrialists or inany industry for that. So, they want money at a short term notice or even the governmentor anybody. And this is; obviously, at a higher generally, the interest rates are high rightand ah, but it supports and helps in the regular day to day expenses right.(Refer Slide Time: 11:43)Then the other part of the financial market, as we said financial market is largely on twobasis can be divided into two parts the money market and the capital market. So, moneymarket we have understood. So, all the commercial paper, certificate of deposit, bankacceptance, deposits, treasury bills, all these short term once which are within 1 to within1 year are part of the money market. Now, we will go to the long ones or the highervalued long term you know long duration once instruments right.A capital market often refers to the market for long term funds right. So, that was a shorttermfund, it is a long term fund. It deals with long term securities which have a maturityperiod of above 1 year or and goes up to 10 years. To do this the company raises moneythrough the sale of securities, stocks, and bonds in the company’s name which arebought and sold in the capital market. So, capital market again you must, the capitalmarket also has a primary market and secondary market right.The international capital market is a network of individuals, companies, financialinstitutions and government that invest and borrow across the national boundaries. Largebanks international banks gather excess cash of investors and savers around the worldand then channel it to global borrowers across the world. So, in forms of debt, it can bein forms of debt so, bond and mortgages or equity through the stock market at two majorcomponents of the capital market right. So, features of an international capital market.(Refer Slide Time: 13:24)So, the finance can be direct or indirect right. For example, let us say if Shivam puts hismoney in a savings account at a bank, and then the bank lends the money to a company,the bank is an intermediary. This we have also learnt in the last lecture also. Capitalmarkets promote economic efficiency by shifting the money from who do not have animmediate productive use.So, you had some money and you had no immediate use. So, you can give it tosomebody and you know where he can or she can use it or the company can use it byissuing productive use for it to those who do by issuing debt or equity securities. Let ussee this example; the beverage company wants to invest its 100,000 dollar productively,a beverage company has got off lot has lot of cash reserves so it wants to use it. Therenumber of firms around the world are eager to borrow funds by issuing debt security orequity security.So, it can implement a great business idea. So, some companies want to use this money.The beverage company will get the maximum extent or benefits by shifting its fromfunds then just keeping it in the low yielding saving account. Similarly, as you can thinkof for example, your own account you can suppose you have money you can either keepit in a saving account or a fixed deposit for example, the fixed deposit is giving you alarger interest, but the point is the liquidity is little rigid right.The saving account is more liquid, because you can anytime liquidate and you can getthe money, but the fixed deposit if you break it, then you will not get the requiredamount. Reducing risk for lenders; the international capital market expands the availableset of lending opportunities. Investors reduce portfolio risk by spreading their moneyover many debt and equity instruments. What it is saying? It is spreading the risk ordividing the risk by you know spreading the money over large number of debt and equityinstruments.So, the what are the debt instruments and what are the equity instruments we can talkabout it right. A vibrant capital market is a prerequisite for the development of industryand commerce for example, I can take some equities in the stock market for example,right another component of the international capital market is the international bondmarket.(Refer Slide Time: 15:47)What is a bond? I you all must have heard about bonds right. Bonds are basically as itsays the most common form of debt instrument right, which is basically a loan from theholder to the issuer of the bond. So, it is a loan from the holder to the issuer of the bond.It consists of all bonds sold by issuing companies governments and other organizationsoutside their own countries so; that means, if you buy a bond at a 10 percent, let us sayrate so at the, after certain period of time the owner would the holder of the bond wouldget a desired sum of money right. Instruments must pay a fixed value or rate regardless,the economic circumstances right. Types of international bonds are foreign bonds, Eurobonds ok.(Refer Slide Time: 16:40)Now, what is a foreign bond? A bond which is sold outside the borrowers country; thatmeans, let us say the it is sold outside a borrower some other country and denominated incurrency of country in which it is sold; that means, in dollars or Euro or pound, sterling.Foreign bonds are typically subject to the same rules and guidelines as domestic bonds inthe country in which they are issued for example, if it is issued in India it will be, it willbe following all the rules and regulations of India right.For example, a Yen-denominated bond issued by a German car maker BMW in Japan’sbond market and called as Samurai bonds right, a Yen-denominated bond issued byGerman car maker BMW in Japans bond market right. Foreign bonds sold in the UnitedStates and denominated in US dollars are called Yankee bonds right.What do you saying foreign bonds sold in the United States and denominated in USdollars are called Yankee bonds. In the United Kingdom this bonds are called bulldogbonds bulldog right. Foreign bonds issued and traded throughout Asia except Japan arecalled dragon bonds. So, there are different names given right.(Refer Slide Time: 17:59)The next is after the foreign bond, there is the Eurobond. Eurobonds are bonds which aredenominated in currencies other than that of the country in which the bonds are soldagain like the first one only. The Eurobonds are not usually subject to taxes orregulations of any one government which can make it cheaper to borrow it in theEurobond market as compared to other debt markets, example let us see the example.A bond, which is denominated in US dollars and issued in Japan by an Australiancompany. So, there are three countries right; one is US dollars three things US dollarsissued where in Japan, by whom? An Australian company. Note that the Australiancompany can issue the Eurodollar bond in any country other than the United States right.This is what it says.A bond issued by a Japanese company, denominated in us dollars and sold only in theUnited Kingdom and France is also an example of a Eurobond right. Let us read again, abond issued by a Japanese company, denominated in the US dollars right, here it wasissued by a Australian company and sold only in the United Kingdom, Britain or Franceis an example of a Eurobond.So, what it is saying? Eurobonds are denominated in currencies other than that of thecountry in which the bonds are sold right.(Refer Slide Time: 19:31)International equity market; so, equity market when we talk about so, is it is a equitywhat is an equity instrument? It is an instrument to claim to the firms profits, but it is notonly profits, it is it can be the losses also. Suppose, you are since, equity as a equityholder you are a part of the company, part owner of the company right.So, if there is a profit you own the profit if there is a loss you take the loss rather than toa fixed payment and its pay off vary according to the circumstances ok. It consists of allstocks bought and sold outside the issuers home country, let us see. Companies andgovernments issue equity and buyers include other companies banks, mutual funds,pension funds and individuals. What it is saying?Companies and governments issue equity and buyers include banks for example, whenthe government issues equity or companies for example, Reliance or Tata or let us sayany company Infosys is has its own equity in the stock market.So, who are the major buyers? Retail investors like you and me, companies, other banks,mutual fund agencies, etcetera. The benefits of this international equity financingincludes diversification, reduced regulation, improvements in computer andcommunication technology right, increased demand from MNCs for global issuance.So, what are the benefits it says? Basically, the benefits is it has helped in diversificationand reduced regulation and how it has improved, because there has been a significantimprove not it this is not an advantage right this is this is happened, because there hasbeen a significant improvement in computer and communication technology nowadays.So, one can take easily the advantage right of these international equity financing rightand there has been increased demand for from MNCs on this. Here, when we talk aboutthe equity market there is one term which is very important which is called the crosslisting of shares.(Refer Slide Time: 21:28)What is this cross listing? Cross listing of shares is when a firm lists it equity shares onone or more foreign stock exchange; that means, suppose Infosys stock is listed in Indiaand US and let us say Japan right so, or India and US. So, cross listing helps inincreasing fund avenues, alternate source of capital, diversified investors, large pool ofliquidity. So, this as we understood here so, benefits of international it is diversificationand reduced regulation. So, the regulations it is all standardized, normalized basicallyright ok.This is the example Infosys is also listed on NASDAQ along with the Bombay StockExchange right and also NYSE and other places. Wipro is a dual listed India technologygiant on BSE and New York Stock Exchange and in many more like L&T, ITC, etcetera.(Refer Slide Time: 22:33)So, the next instrument in the you know we will talk about is the depository receipt.Now, depository receipt is a mechanism right through which a domestic company canraise finance from the international equity market. You must have heard of ADRs andGDRs right. So, these are very popular terms; the American depository receipt andglobal depository receipt. We will see what are they. First let us understand thedepository receipts.Depository receipts are negotiable securities, issued outside India by a depository bankon behalf of an India company right. So, there are two parties let us say so, that is adepository bank and an India company for example, who this bank would help in issuingthe stock in some other market.Now, these receipts are listed on the stock exchanges. Each depository receipt hasspecific number of company shares as underlying. For example, HDFC bank ADR, ADRstands for American Depository Receipt, has three shares representing one ADR. Thisratio is known as depository receipts or underlying share ratio. No hard and fast ruleregarding the number of underlying shares representing one depository receipt. There isno hard and fast rule.(Refer Slide Time: 23:54)Let us see how; what is the procedure of issue of this DRs or depository receipts. In thissystem the shares of the company domiciled in one country that is example Infosys orsomething are held by the depository, that is the Overseas Depository Bank. So, theanother bank Overseas is holding the stocks and issues claim against this shares. Suchclaims are known as Depository Receipts and are denominated in the convertiblecurrency.Now, take this India and there is an overseas market right, some country. Let us say USor something there is an India company and there is an overseas depository there is adepository agreement. So, what is this there is a domestic custodian of the equity sharesright of this India company and there is an Overseas Depository and overseas investorsright. So, what is happening? This is a custodian agreement between these OverseasDepository and this domestic custodian right.(Refer Slide Time: 24:53)So, let us look at this two; American depository receipt and global depository receipt.So, equity is highlyvolatile, we all know that. So, according to Solnik, the factors affecting internationalequity return is the effect of the exchange rate changes, the interest rate differentials, thelevel of domestic interest rate, and changes in domestic inflation expectations. So, whatis it happening? So, the four factors that affect the international equity returns are theexchange rate change.So, there is a change in the exchange rate one, there is a difference in the interest rate inbetween different countries, let us say India the interest rate is different, US it isdifferent, U K it is different, so that effects. The level of wherever the you know we aremore, because of the difference in interest rate the investors would like to find out thebest locality or the best location where they could park their funds ok.The level of domestic interest rate, the current the home country and domestic inflation,what is going to be the inflation? So, we have also learned that when inflation is going toincrease so fund the investors would like to take away the fund from the home market tosome other market right.(Refer Slide Time: 28:54)Economic growth and low inflation usually mean positive equity returns, while recessionand high interest rates mean flat or negative right. The high interest rates or highinflation for that also mean flat negative returns. How does interest rate differentialshelp? If interest rates rise, it becomes unattractive to borrow and equities are likely todrop right. People cannot borrow money followed by the overall economy. Declininginterest rates are a positive sign for equity returns right.Although, if interest rates decline, because you see, if interest rates are declining peoplewould tend to go for the equity market right, but if the interest rates are high, if I amgetting more interest, why will I go for the equity market right. So, although if interestrates decline too far, it shows lack of economic demand so, this is a connection right.So, there has to be some steadiness, some equilibrium among them and can lead todeflation. Lack of demand and deflation again has a negative effect on equity returns. So,it is not necessary that interest rate should go down and the stock equity market will goup. Because there is up to a certain level, it may you know it will when the interest ratesare declining, maybe the equity market will go up, but after a certain level when it growsto a very low level let us say, then from here the equity market also does not gain,because the economy is itself not doing well.So, it will fall further maybe right. Again, government policy for example, taxationdecrease in government spending can also have the opposite effect on equity prices right.So, basically the equity is nothing, but a feeling or it is a pulse of the people about theeconomy at large. Suppose, the Indian citizens feel good about India and so, the investorsare also feeling good about India, then India it is a very lucrative market. Automatically,it will have a good effect on the India equity market right.Employment rate; when employment levels are low and more people have jobs, demandwould pick up for both essential and non essential goods, which will again lead to apositive equity returns. So, this is all we had. So, today we talked about the moneymarket, a bit of the capital market.So, money market we did a bit and then the capital market we discussed. And wediscussed what are the different you know instruments in the capital market and how theequity international equity market gets effected by certain factors like interest rate,employment and you know for example, the inflation in a country and all. So, looking atall these things what is the how do they issue or what is an ADR we learnt about what isthe difference between ADRs American Depository Receipts and GDRs right.So, Global Depository Receipts and what is basically a depository receipt; we alsoexplained that. So, I think you got at least somewhat idea about what we discussed. Asyou go further and try to read it, read this, you know slides, you will get fair amount ofidea and in case you have questions, because obviously, it is a little slightly complicated.So, if you have questions and whenever you want to you can write to me or you knowduring some interaction we can discuss.Thank you very much.