International International Financial Financial SystemSystem

4

Chapter: IV

MKT-305

Chapter ObjectivesChapter Objectives

Discuss the purposes, development, and financial centers of the international capital market

Describe the international bond, international equity, and Eurocurrency markets

Discuss the four primary functions of the foreign exchange market

Explain how currencies are quoted and the different rates given

Identify the main instruments and institutions of the foreign exchange market

Explain why and how governments restrict currency convertibility

International Capital MarketInternational Capital Market

A capital market is a system that allocates financial resources in the form of debt and equity according to their most efficient uses.

Its purpose is to provide a mechanism through which those who wish to barrow or invest money can do so efficiently.

Individuals, companies, Governments, Mutual funds, pension funds participate in capital market.

Purpose of National Capital Purpose of National Capital MarketMarket

National Capital market help individuals and institutions borrow the money that other individuals and institutions want to lend. This is done through Debt and Equity.

Debt: consists of loans, for which the borrower promises to repay the borrowed amount (Principal) plus a pre-determined rate of interest.

Equity: Is part ownership of a company in which the equity holder participates with other part owners in the companie’s financial gains and losses.

Purpose of International Purpose of International Capital MarketCapital Market

The International Capital Market is a network of Individuals, Companies, Financial Institutions and governments that invest and barrow across national boundaries.

Large International Banks play a central role in the international capital market. They gather the excess cash of investors and savers around the world, and then channel this cash to borrowers across the globe.

Expands the money supply for borrowers

Reduces the cost of money and borrowers

Reduces the risk for lenders

Forces Expanding the Forces Expanding the International Capital MarketInternational Capital Market

Three forces are expanding the International Capital Market:

1.Information Technology

2.Deregulation (removing restrictions and regulations)

3.Financial Instruments - A document (such as a check, draft, bond, share, bill of exchange, futures or options contract) that has a monetary value or represents a legally enforceable (binding) agreement between two or more parties regarding a right to payment of money

World Financial CentersWorld Financial Centers

World’s three most important financial centers are:

1. London,

2.New York

3.Tokyo.

Main Components of the Main Components of the International Capital MarketInternational Capital Market

Main components of International Capital Market are:

1.The international Bond

2.International Equity

3.Eurocurrency markets

Main Components of the Main Components of the International Capital MarketInternational Capital Market

1.The international Bond consists of all bonds sold by issuing companies, governments, or other organizations outside their own countries.

2.International Equity Market consist of all stocks brought and sold outside the issuer’s home country . Buyers include banks, mutual funds, pension funds etc.

3.All the world’s currencies that are banked outside their countries of origin are referred to as Eurocurrency and traded on the Eurocurrency Market. Eurodollers, Europounds, Euroyen are examples.

Foreign Exchange MarketForeign Exchange Market

Foreign Exchange Market is a market in which currencies are brought and sold and their prices are determined.

Financial Institutions convert one currency into another at a specific exchange rate

Functions of Foreign Exchange Functions of Foreign Exchange MarketMarket

there are four functions of foreign exchange market

1. Currency Conversion

2. Currency Hedging

3. Currency Arbitrage

4. Currency Speculation

Foreign Exchange Market Foreign Exchange Market TodayToday

Foreign Exchange market is actually an electronic network that connects the world’s major financial centers. In turn, each of these centers is a network of foreign exchange traders, currency trading banks, and investment firms.

The daily trading volume on the foreign exchange market is estimated to be $4.0 trillion.

Institutions of the Foreign Institutions of the Foreign Exchange MarketExchange Market

The main components of foreign exchange market are:

1. The Interbank Market

2. Securities Exchange

3. Over-the Counter Market

Institutions of the Foreign Institutions of the Foreign Exchange MarketExchange Market

1. Interbank Market: It is in the interbank market the world’s largest banks exchange currencies at spot and forward rates. Companies tend to obtain foreign exchange services from the bank where they do most of their business.

2. Securities Exchange: it specialize in currency futures and options transactions. Buying and selling currencies on these exchanges entails the use of securities brokers, who facilitate transactions by transmitting and executing clients’ orders.

3. Over-the Counter Market: It is a decentralized exchange encompassing a global computer network of foreign exchange traders and other market participants.

Currency ConvertibilityCurrency Convertibility

currency Convertibility means converting the currency of one country into the currency of another country and its price is determined by the forces of supply and demand.

Countries that allow full convertibility are those that are in strong financial positions and have adequate reserves of foreign currencies.

Such countries have no reason to fear that people will sell their own currency for that of another.

Goals of Currency RestrictionsGoals of Currency Restrictions

The goals of currency restrictions are:

1. Preserve the country’s reserve of hard currencies with which to repay debts owed to other nations.

2. Preserve hard currencies to pay for imports and to finance trade deficits.

3. Protect a currency from Speculators

4. To keep resident individuals and businesses from investing in other nations.

Policies for Restricting Policies for Restricting CurrenciesCurrencies

Certain Government policies are frequently used to restrict currency convertibility.

All foreign transactions be performed at or approved by the country’s central bank.

Import licenses for some or all import transactions

Certain countries require import deposit requirements before granting import licenses.

One more policy is countertrade , as Boeing has sold aircraft to Saudi Arabia in return for oil.

International Financial International Financial InstitutionsInstitutions

Multilateral development bank

-World Bank

-Islamic Development Bank

Bretton Woods institutions (International Monetary Fund)

Regional development banks

Bilateral development banks and agencies

Other regional financial institutions

World BankWorld Bank

The World Bank is an international financial institution that provides loans to developing countries for capital programs.

it was created in 1944

Located in Washington (US)

Reduction of poverty is the main goal of World Bank.

It comprises of two institutions:

-International Bank for Reconstruction and Development (IBRD) and International Development Association (IDA)

International Monetary FundInternational Monetary Fund

it was officially created in 1945.

Its headquarter is in Washington US.

Working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world

Islamic Development BankIslamic Development Bank

It is a multilateral development Financial Institution

Located in Jeddah, Saudi Arabia

Founded in 1973

On the basis of paid-up capital, major shareholders include:-Saudi Arabia (26.5%)

-Libya (10.7%)

-Iran (9.32%)

-Egypt (9.22%)

-Turkey (8.41%)

-United Arab Emirates (7.54%)

-Kuwait (7.11%)

-Pakistan (3.31%)

-Algeria (3.31%)

-Indonesia (2.93%)

Mini ProjectMini Project

Write a detailed note on any three of the following:

1. Islamic Development Bank

2.  Islamic Research & Training Institute (IRTI),

3. Islamic Corporation for Development of the Private Sector (ICD),

4. Islamic Corporation for Insurance of Investment and Export Credit (ICIEC)

5. International Islamic Trade Finance Corporation (ITFC).