113 UNIT 13: MARKET COVERED BY INTERNATIONAL FINANCE
CONTENTS 1.0 Introduction 2.0 Objectives 3.0 Main Content
3.1 Market covered by International Finance 3.1.1 The Foreign Exchange Market 3.1.2 Euro-currency Market and Lending 3.1.3 International Bond Market
3.2 Bond Market Volatility
3.2.1 Bond Market Influence 3.2.2 Bond Valuation and Analysis
3.2.3 Keeping Tabs on Market Interest Rates 3.3 International Equity Market
3.3.1 Size of the Market 3.3.2 Stock Exchange
3.3.3 Importance of Stock Exchange 4.0 Conclusions
5.0 Summary
6.0 Tutor-Marked Assignment 7.0 Reference/Further Reading 1.0 INTRODUCTION
This unit will introduce you to market covered by International Finance, Bond Market Volatility and International Equity Market as it relates to international finance.
2.0 OBJECTIVES
After reading this unit, the student should be able to :
Explain Markets covered by International Finance
Examine Bond Market Volatility
Identify International Equity Market
114 The Foreign Exchange Market
Eurocurrency Markets and Lending International Bond Markets
International Equity Markets
3.1.1 The Foreign Exchange Market
The foreign exchange market facilitates economic interaction among different countries.
Foreign exchange markets constitute a globally-connected network of currency broker dealers who make the market for the buying and selling of currencies from around the world. The advent of the Internet fostered unprecedented growth in the foreign exchange market worldwide. With practical applications for international trade, the foreign exchange market also boosts phenomenal speculative opportunities for day traders as a source of potential profit.
In terms of a commodity, foreign exchange, or Forex, broadly refers to the currencies issued by the countries of the world. The relative value of a given currency against that of another forms the basis for the exchange of one currency for another. The price at which this exchange occurs is called an exchange rate. This exchange occurs via currency broker-dealers in the global foreign exchange market.
Bid and Ask Prices
In order to cover service commissions of foreign exchange trades, currency broker-dealers frequently adjust the market exchange. For this reason, a broker-dealer offers to buy and sell a given currency at two different prices. A broker-dealer buys a currency at a bid price (exchange rate adjusted downward) and offers to sell a currency at an ask price (exchange rate adjusted upward).
Practical Considerations
Despite the many changes and innovations experienced by the foreign exchange market, its most basic function remains unchanged. It functions to facilitate transactions of goods and services across national borders. This includes activities which range from changing money before traveling abroad to payment deliveries on industrial imports. The foreign exchange market also allows portfolio investors to buy and sell offshore securities.
Currency Speculation
Apart from its practical applications, the foreign exchange market is a viable source of potential profits for speculative short-term investors. Speculation has accounted for the vast majority of currency trades since the growth in web-based currency trading which began in the early 2000s.
Though it is now possible for nearly anyone with a bank debit card and an internet connection to easily engage in currency trading, the practice itself carries extremely high risk and can result in phenomenal losses as well as gains.
115 3.1.2 Euro-Currency Market and Lending
Definition of 'Eurocurrency Market'
The money market in which Eurocurrency, currency held in banks outside of the country where it is legal tender, is borrowed and lent by banks in Europe. The Eurocurrency market is utilized by large firms and extremely wealthy individuals who wish to circumvent regulatory requirements, tax laws and interest rate caps that are often present in domestic banking, particularly in the United States.
Rates on deposits in the Eurocurrency market are typically higher than in the domestic market, because the depositor is not protected by domestic banking laws and does not have governmental deposit insurance. Rates on loans in the Eurocurrency market are typically lower than those in the domestic market, because banks are not subject to reserve requirements on Eurocurrency and do not have to pay deposit insurance premiums.
3.1.3 International Bond Market
The bond market (also debt market or credit market) is a financial market where participants can issue new debt, known as the primary market, or buy and sell debt securities, known as the secondary market. This is usually in the form of bonds, but it may include notes, bills, and so on. The primary goal of the bond market is to provide a mechanism for long term funding of public and private expenditures.
References to the "bond market" usually refer to the government bond market, because of its size, liquidity, relative lack of credit risk and, therefore, sensitivity to interest rates. Because of the inverse relationship between bond valuation and interest rates, the bond market is often used to indicate changes in interest rates or the shape of the yield curve. The yield curve is the measure of "cost of funding".
Types of bond markets
The Securities Industry and Financial Markets Association (SIFMA) classifies the broader bond market into five specific bond markets.
Corporate
Government & agency Municipal
Mortgage backed, asset backed, and collateralized debt obligation Funding
Bond market participants
Bond market participants are similar to participants in most financial markets and are essentially either buyers (debt issuer) of funds or sellers (institution) of funds and often both.
Participants include:
116 Institutional investors
Governments Traders Individuals
Because of the specificity of individual bond issues, and the lack of liquidity in many smaller issues, the majority of outstanding bonds are held by institutions like pension funds, banks and mutual funds. In the United States, approximately 10% of the market is currently held by private individuals.