What is International Financial Markets? Instruments

What is International Financial Markets?

The International Financial Market are financial markets where individuals buy and sell foreign assets such as stock, Bonds, currencies. Its also a place where institutions lay down rules.

Brigham and Eugene defined the financial market as a place where people and organizations wanting to borrow money are brought together with those having surplus funds.

Financial market does not refer to a physical location. Market participants are linked by formal trading rules and communication networks for originating and trading financial securities link market participants.

Transferring of funds from the surplus sector to the deficit sector is the main function of the financial market. The credit requirements of the corporate sector are greater than their savings. The savings of the household sector are channelized into the corporate and public sectors for productive purposes.

The market participants in financial markets are investors or buyers of securities, borrowers or sellers of securities, intermediaries and regulatory bodies. Securities are financial instruments that represent the holder’s claim on a stream of income or a fixed amount from a corporate or government.

Instruments of International Financial Markets

It is the market for instruments denominated in foreign currencies with a maturity of different periods from one day to one year. This includes borrowing and lending of funds, of short-term nature.

It includes internationally traded instruments like treasury bills, bank certificates of deposits, commercial paper, bankers’ acceptances and repurchase agreements and other short-term asset-backed claims. This market is needed for MNC’s operations as it provides liquidity to them.

  1. Foreign Exchange Market
  2. Derivative Products
  3. International Currency Market
  4. Eurocurrency Market
  5. European Monetary System – EMS
  6. Money Market Instruments
  7. Equity Financing in the International Markets
  8. Balance of Payments
Instruments of International Financial Markets
Instruments of International Financial Markets

Foreign Exchange Market

The foreign exchange market is the market in which currencies of various countries are bought and sold against each other. The foreign exchange market is an over-the-counter market. It is one of the largest markets in the world. Geographically, the foreign exchange markets span all time zones from New Zealand to the West Coast of United States of America.

The retail market for foreign exchange deals with transactions involving travelers and tourists exchanging one currency for another in the form of currency notes or travellers’ cheques. The wholesale market often referred to as the inter-bank market is entirely different and the participants in this market are commercial banks, corporations and central banks.

The foreign exchange market is unique because of the following characteristics:

  • its huge trading volume, representing the largest asset class in the world leading to high liquidity;
  • its geographical dispersion;
  • its continuous operation: 24 hours a day except for weekends, i.e., trading from 22:00 GMT on Sunday (Sydney) until 22:00 GMT Friday (New York);
  • the variety of factors that affect exchange rates;
  • the low margins of relative profit compared with other markets of fixed income; and the use of leverage to enhance profit and loss margins and with respect to account size.

Around-the-clock market

Important foreign exchange trading centres are located in Hong Kong, Singapore, Paris and Frankfurt, amongst others, while the biggest three are New York, Tokyo and London, of which London is the largest. The foreign exchange market is open 24 hours per day throughout the week (Monday to Friday at each centre).

Market Size

According to the Bank for International Settlements, the preliminary global results from the 2019 Triennial Central Bank Survey of Foreign Exchange and OTC Derivatives Markets Activity show that trading in foreign exchange markets averaged $6.6 trillion per day in April 2019.

This is up from $5.1 trillion in April 2016. Measured by value, foreign exchange swaps were traded more than any other instrument in April 2019, at $3.2 trillion per day, followed by spot trading at $2 trillion.

The $6.6 trillion break-down is as follows:

  • $2 trillion in spot transactions
  • $1 trillion in outright forwards
  • $3.2 trillion in foreign exchange swaps
  • $108 billion currency swaps
  • $294 billion in options and other products

The foreign exchange market is the largest in the world, Global Foreign Exchange Market to Reach US$ 10.2 Trillion by 2026, Bolstered by Growing International Trading Activities.

Derivative Products

A derivative is a financial instrument whose value depends on other, more basic, underlying variables. The variables underlying could be prices of traded securities and stock, prices of gold or copper, prices of oranges to even the amount of rainfall in a particular area. Derivatives have become increasingly important in the field of finance.

Options and futures are traded actively on many exchanges. Forward contracts, swaps and different types of options are regularly traded outside exchanges by financial institutions, banks and their corporate clients in what are termed as over-the-counter markets – in other words, there is no single marketplace or an organized exchange.

International Currency Market

An important aspect of the internationalization of financial services has been the emergence of international banking consortia. Since the 1960s various banks started forming international syndicates. Multinational banks are responsible for huge international transfers of capital not only for investment purposes but also for hedging and speculating against exchange rate changes.

The main players who are involved in international finance are commercial banks, pension funds, hedge funds and private equity funds.

Eurocurrency Market

This represents the money market in which Eurocurrency, that is currency held in banks outside of the country where it is legal tender, is borrowed and lent by banks in Europe. The Eurocurrency market allows for more convenient borrowing, which improves the international flow of capital for trade and investment between countries and companies.

For example, an Indian company borrowing U.S. dollars from a bank in Germany is using the Eurocurrency market.

  • London Inter-bank Bid Rate – LIBID: This is the rate bid by banks on eurocurrecy deposits.

  • London Inter-bank Offer Rate – LIBOR: This is the rate of interest at which banks borrow funds, in marketable size, from other banks in the London inter-bank market. This is the most widely used benchmark or reference rate for short-term interest rates.

European Monetary System – EMS

A 1979 arrangement between several European countries to link their currencies in an attempt to stabilize the exchange rate. This system was succeeded by the European Monetary Union (EMU), an institution of the European Union (EU), which established a common currency called the euro.

Money Market Instruments

The money market is the securities market dealing in short-term debt and monetary instruments. Money market instruments are forms of debt that mature in less than one year and are very liquid and relatively risk free. Treasury bills make up the bulk of the money market instruments.

  • Commercial Paper: This is an unsecured, short-term instrument issued by a corporation, typically for financing accounts receivables and inventories. It is usually issued at a discount reflecting prevailing market interest rates. Maturities on commercial paper are usually up to a maximum maturity 270 days.

  • Eurocommercial Paper: This is an unsecured, short-term paper issued by a bank or corporation in the international money market, denominated in a currency that differs from the corporation’s domestic currency.

  • Certificate of Deposit: This is a savings certificate entitling the bearer to receive interest. A Certificate of Deposit bears a maturity date, a specified interest rate and can be issued in any denomination. CDs are generally issued by commercial banks.

  • Banker’s Acceptance: This is a short-term credit investment created by a non-financial firm and guaranteed by a bank. Such acceptances are traded at a discount from face value on the secondary market.

Bond and Note Issues

A note is a debt security, usually maturing in one to 10 years. In comparison, bills mature in less than one year and bonds typically mature in more than 10 years. Often the terms ‘notes’ and ‘bonds’ are used interchangeably.

Supranational agencies like the World Bank and Asian Development Bank raise bonds in the international market. National Governments issue government bonds. Municipal or other local authorities issue municipal bonds, while companies issue corporate bonds.

There are different types of bonds including fixed-rate bonds, floating-rate notes and convertible bonds.

  • Fixed rate bonds have a coupon that remains constant throughout the life of the bond.
  • Floating rate notes (FRNs) have a coupon that is linked to a money market index, such as
  • LIBOR. The coupon is then reset periodically, normally every three months

Convertible bonds can be converted, on the maturity date, into another kind of security, usually common stock in the company that issued the bonds. A convertible bond is a hybrid security, that is a security that combines elements of debt and of equity Foreign Currency.

  • Convertible Bond (FCCB) is a type of convertible bond issued in a currency different than the issuer’s domestic currency Zero coupon bonds do not pay any interest. They trade at a substantial discount from par. The bond holder receives the full principal amount on the maturity date.

  • A Medium Term Note (MTN) is a debt note that usually matures in 5-10 years, but the term may be as short as one year. They are normally issued on a floating basis. A corporate note can be continuously offered by a company to investors through a dealer. Investors can choose from differing maturities, ranging from nine months to 30 years.

    This type of debt programme is used by a company so it can have constant cash flows coming in from its debt issuance. The structure allows a company to tailor its debt issuance to meet its financing needs as per requirements.

  • Eurobond: This is a bond issued in a currency other than the currency of the country or market in which it is issued. Foreign Bond: This is a bond that is issued in a domestic market by a foreign entity, in the domestic market’s currency.

  • Foreign bonds are regulated by the domestic market authorities and are usually given nicknames that refer to the domestic market in which they are being offered. Types of foreign bonds include bulldog bonds, matilda bonds, and samurai bonds.

  • Junk Bond: This is a bond rated BB or lower because of its high default risk. It is also known as a high-yield bond, or speculative bond.

  • Note Issuance Facility (NIF): This consists of a syndicate of commercial banks that have agreed to purchase any short to medium-term notes that a borrower is unable to sell in the eurocurrency market. The NIF acts as an underwriter. If the borrower is unable to sell all notes, the syndicate is obliged to purchase all the remaining notes from the borrower, thus providing credit.

  • Revolving Underwriting Facility (RUF): This is a form of revolving credit in which a group of underwriters agrees to provide loans in the event that a borrower is unable to sell its securities in the Eurocurrency market. These loans are generally provided through the purchase of short-term Euronotes.

    A revolving underwriting facility differs from a note issuance facility (NIF) in that the underwriters provide loans instead of purchasing the outstanding notes that failed to sell. In either case, both RUF and NIF provide shortto medium-term credit in the Eurocurrency market.

Equity Financing in the International Markets

Cross border equity investment has been increasing. There is also a global trend of institutional investors from developed countries increasing their exposure to equity from emerging markets. Shares of these overseas firms are often traded in stock exchanges like New York and London.

Shares of such overseas firms are traded indirectly in the form of ‘depository receipts’. Under this mechanism the shares issued by the firm are held by a depository in the form of ‘depository receipts’. In the case of US markets, this type of issue is known as ‘American Depository Receipts or ADRs, while ‘Global Depository Receipts or GDRs are used to tap multiple markets using a single instrument

Balance of Payments

International trade and other international transactions result in a flow of funds between countries. All transactions relating to the flow of goods, services and funds across national boundaries are recorded in the balance of payments of the countries concerned.

Balance of payments (BoPs) is a systematic statement that systematically summarizes, for a specified period of time, the monetary transactions of an economy with the rest of the world.

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