International Financial Markets and Instruments

Introduction

Rise of globalization has caused tremendous growth in the financial markets. This is because there is increase in international trade. This has consequently resulted to an increase in number of international transaction. Financial assets trade at the financial markets. According to Newage Publishers, “international financial markets undertake intermediation by transferring purchasing power from lenders and investors to parties who desire to acquire financial assets that they expect to yield future benefits” (Newage Publishers, 2003). International financial transactions are the exchange of financial assets between people of various nations. Financial markets carry out three functions. The first function is the determination of prices of the financial assets. The market also controls liquidity in the economy by creating a platform for buying and selling the financial instruments. Therefore, from these functions, it is apparent that the financial markets enhance efficiency for the players. The key players in the financial markets are brokers, dealers, investment banks and financial intermediaries. This treatise identifies, examines and explains the international financial markets and instruments.

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International Markets and Instruments

There are various international markets and instruments. This section discusses some of the international markets and instruments such as international bank lending, derivatives, international bonds and International stock markets.

International bank lending

The domestic approach of analyzing bank transaction is not adequate. This is because there are enormous international transactions. Besides, with globalization even small scale traders to some extent also engage in international trade. International bank lending exists in various forms. For instance, “foreign banks can borrow working balances of domestic currency from domestic banks” (Levi, 2009). Secondly, “domestic banks can purchase foreign financial instruments if the returns are higher than at home” (Levi, 2009). Finally, “domestic banks can lend to private firms abroad who are making real investments” (Levi, 2009). Bank for International Settlements (BIS) is the “clearing house for central bank settlements, deals with international banking matters and promotes international financial cooperation” (Bank for International Settlements, 2012). From the BIS website, the total cross border banks claims amounted to $14,944.3 billion in 2003 while Net international bank lending amounted to $6605.0 billion (Bank for International Settlements, 2012). This has significantly grown over the years. There are three components of international bank lending. The fist one is the traditional bank lending where “domestic banks issue loans in domestic currency to non residents” (Levi, 2009). The second component is the Eurocurrency (Eurodollar) market. This is where the domestic banks issue loans in foreign currency to non residents. Also, domestic banks give loans to domestic residents in foreign currency.

Eurocurrency market

It denotes a market for currencies other than the home country currency. Eurodollar was the initial name of the market. This is because European banks traded in US dollars. This occurred after the Second World War. After the War, the US dollars became necessary in Europe. During this period, the US controlled interest rates that were paid on deposits. In 1960’s, the US came up with policies that impacted upward pressure on the demand for Eurodollars. For instance, US introduced lending guidelines which discouraged advancing loans to foreigners. Further, they introduced taxes on loans to foreigners. Other than the policies, Vietnam War also enabled the US to strengthen money supply at home. This resulted to cheaper US dollars in Europe than in the US. Further, oils shock that occurred between 1973 and 1974 caused an increase in oil prices up to about four times. US dollar was the denomination of the oil price. The increased oil price created a high demand for the Eurodollar market. This is because the OPEC countries deposited dollars in the European banks to hedge against the currency fluctuations. The fluctuations in the economy and globalization cause the growth of Eurodollars. Therefore, since its formation, the Eurodollar market has enormously grown (Moorad, Joannas, Pereira, and Pienaar, 2003).

Eurocurrency Market uses London Interbank Offered Rate (LIBOR) as the interest rate on loans. LIBOR is the “average of the rate of interest that major markets use when lending money to each other.” Eurobanks are the international banks dealing with financial instruments in foreign currencies. It is apparent that Euromarkets have made international transaction easy and cheaper. Also, they have encouraged capital flow between nations since there are limited barriers.

International Bond Market

Bonds are instruments which have long maturity period say 10 years or more. Government and companies are the issuers of bonds. They are a way of borrowing fixed amounts for a specified period of time and with a predetermined interest rate. Maturity value and annual interest payments are the common characteristics of bonds. Financial institutions are the bond underwriters. The financial institutions buy the bonds and resell to interested buyers. They earn commission from this exercise. Commonly confused terms in the bond market are the foreign bond and Eurobond market. Foreign bond market is a scenario when a borrower in one country issues bonds in a second country. On the other hand, Eurobond market is a market where a borrower in one country issues bonds in many countries. In 2003, international bond market was $11,681.4 billion (Bank for International Settlements, 2012).

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International stock market

International stock market allows people to take a percentage of ownership in companies other than home countries. It is difficult to measure the magnitude of international stock market. This is because of lack of adequate information for small organizations. Such organizations do not have significant global presence. From few data collected, there is evidence of growth in this market. Developing countries plays a key role in this market because they issue international stock with an attempt to open their economies to foreign direct investments. Demand for international stock behaves in an unpredictable way. This is because the demand takes the form of the leader follower plan. This is a scenario where one person leads and a magnitude of people follows to invest in such stock. This behavior highly depends on the leader and not the company. It also depends on price expectation. Price expectation is the anticipated change in price of a stock (Park and Buljevich, 2008).

Conclusion

Other international market instruments include money market securities such call and notice money, treasury bills, term money, commercial paper, and certificate of deposit. There are also capital market instruments such as debentures and warrants. There are also hybrid of money market and capital market such as convertible debentures. There are new instruments in the international market arena such as options on swaps. This instrument grants options to swap interest rates. In conclusion, there is tremendous growth in the international financial market (Park and Buljevich, 2008).

References

Bank for International Settlement, (2012). Statistics. Web.

Levi, D. (2009). International Finance. New York, USA: Routledge.

Moorad, C., Joannas, D., Pereira, R. and Pienaar, R. (2003). Capital Market Instruments: Analysis and Valuation. London: Pearson Education Limited.

Newage International Publishers, (2012). International financial markets. Web.

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Park, Y. and Buljevich, E. (2008). Project Financing and the International Financial Markets. USA: Newage Publishers.

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