INBU 4200: Lecture 8

Sourcing Globally

Important Announcements

• Project 4: Due Thursday, April 8th

Upcoming “events”

• Quiz 4: Thursday, April 15th

• Exam 2: Thursday, April 22nd

The International Capital Markets

International markets span the entire globe. Thus they represent potentially enormous pools of capital for borrowers.

The major advantage of the international capital markets is that the “cost of capital” tends to be lower in these markets than in smaller domestic markets.

If a firm has access to global capital markets:

It can borrow more funds more cheaply in international markets than in domestic markets.

What are the International Capital Markets?

• Eurocurrency markets– Short term borrowing (loans) opportunities

• Global Bond markets– Long term borrowing (debt) opportunities

• Global Equity markets– Ownership (common stock) funding

Eurocurrency Markets

Eurocurrency deposit:Short term time deposit of a currency in an international bank located in a country other than the country which issued the currency!

Example: U.S. dollar deposits in commercial banks outside of the United States

Eurocurrency Loans

• International banks having received Eurocurrency deposits, will lend these out to borrowers on a short basis.

• Borrowers include multinational firms.

• Loan maturities generally 3 to 6 months.

• Borrowing rates typically lower than domestic borrowing rates.

Attraction of the Eurocurrency Markets

Because of the absence of regulations:

• The markets offer higher deposit rates.

• The markets charge lower loan rates.

These banks operate on smaller spreads (or margins) than do domestic banks.

 

Rate of interest

Domestic lendingrate

Domesticdeposit rate

Eurocurrencylending rate

Eurocurrencydeposit rate

%

Interest Rate Spreads in

Domestic and Eurocurrency

Markets

Global Bond Markets

These are international markets for long term debt borrowing. There are two basic types of global bond markets:

• Foreign Bond market

• Eurobond (Offshore) market

Foreign Bond Market

• A bond issued by a foreign borrower to investors in a country other than that of the foreign borrower.

• The bond will also be denominated (payable) in the home currency of the investor.

• Example: A Chinese company issuing a U.S. dollar denominated bond in the United States.

Foreign Bond Market

• Corporations usually issue foreign bonds because of the low interest rates (borrowing costs) in foreign capital markets compared to their own domestic markets.

• In recent years, many non-Japanese companies have issued yen denominated bonds in Japan because of the very low borrowing costs in Japan.

Eurobond Market

• A bond issued by any borrower to investors. • The bond will be denominated (payable) in a

currency which is different from the home currency of the investor.

• The bond will NOT be offered in the capital market of the country whose currency it is denominated in.

• Example: A Chinese company issuing a U.S. dollar denominated bond in Japan. This bond will NOT be issued in the United States.

Eurobond market

• Corporations generally issue eurobonds because of their relatively low interest rates.

• Corporations are also potentially attracted to eurobonds because they can borrow their home currency and generally at rates lower than back home.

For Example: A U.S. corporation issuing a U.S. dollar denominated eurobond in Japan.

Eurobond Market

• Another attractive feature of this market is the absence of government regulations.

• Thus companies can raise money in the eurobond market with less disclosure requirements than in domestic markets.

• This means less cost for compliance and probably quicker transactions.

Global Equity Markets

• There is no international equity market as there is for Eurocurrencies and bonds.

• Individual countries have their own markets to trade corporate stocks.

• The most important of these stock markets are also open to foreign companies for the purpose of raising capital.

Two Important Trends in Equity Markets:

• Internationalization of corporate ownership.– Non-residents buying equity positions

companies.• Global companies widening their stock

ownership by listing their stock on many foreign stock exchanges.– Referred to as cross-listing.

Cross Listing

Refers to a company having its shares listed on one or more foreign stock exchanges.

Has become very popular in recent years.

In 2001, there were 2,461 cross listings on the world’s 51 major stock exchanges.

Why Cross Listing

Cross listing is done for a variety of reasons:

• Establishing name recognition for the company in a new capital market– Paves the way for new sources of funds.– Facilitates future acquisitions in that

country.

• Establishing name recognition for the company in a new consumer market.

Global Firms and Stock Markets

Global companies are turning to foreign stock markets to raise capital.

They are attracted to foreign stock markets because of the potential ability to raise large amounts of capital (and more than they could at home).

The United States is a favorite market for doing so.

Foreign Firms and The United States Stock Markets (2001)

Exchange Number of Foreign Firms

America 48

New York 461

NASDAQ 445

Total 954

How are Cross Listed Stocks Traded

A company can have its stock traded on foreign stock markets through two methods:

• Stock can be traded directly, or

• Stock can be traded in the form of a depository receipt.– This is the most popular method.

Depository Receipts

Represents a claim against a number of shares of stock of a foreign company.

The actual shares of stock are held by a custodian bank in the country of the foreign company.

The depository receipt is cross listed and trades on various stock markets.

American Depository Receipts (ADRs)

Foreign firms trade on American stock exchanges through American Depository Receipts (ADRs).

In 2002, there were 600 ADR listings, representing companies from 80 countries, trading on United States stock exchanges.

Global Depository Receipts (GDRs)

Other major stock markets have depository receipt programs similar to ADRs.

In London, foreign stocks trade through a program called Global Depository Receipts. It is similar to the ADR program in the United States.

Growth of International Capital Markets

• By most accounts, these international capital markets are growing at a rapid pace.

• From 1994 to 2001, international bonds rose from $600 billion to $7.0 trillion.

• From 1990 to 2000, international equity offerings rose from $20 billion to $315 billion.

• From 1990 to 2002, cross border bank loans rose from $3.6 billion to $9.5 billion.

Impact of Global Capital Markets for Managers of International Firms

• Access to global capital markets should offer firms the opportunity for sourcing lower cost funds.– Both debt (long and short term) and equity.

• Lower cost funds can reduce a firm’s cost of capital.– The firm can become more competitive