Transcript Document

Chapter21
The Global Capital Market
Performance and Policy Problems
The international Capital Market
And The Gains From Trade
 Three
Types Of Gain From Trade
Trades of goods or services for goods or
services
 Trades of goods or services for assets
 Trades of assets for assets

The international Capital Market
And The Gains From Trade
Goods and
services
Goods and
services
assets
assets
The International Capital Market
And The Gains From Trade
 Risk-averse investors in foreign currency
assets base their demand for a particular
asset on its riskiness in addition to its
expected return.This observation is basic to
understanding why countries exchange
assets.
The International Capital Market
And The Gains From Trade
 Portfolio
diversification as a motive for
international asset trade.When an economy
is opened to the international capital
market,it can reduce the riskiness of its
wealth by placing some of its”eggs” in
additional foreign “baskets”.
The international Capital Market
And The Gains From Trade
 The
menu of international
assets:debt versus equity

Debt instruments must repay a fixed value
regardless of the economic circumstances.
The international Capital Market
And The Gains From Trade
Equity instruments is a claim to a firm`s
profits,rather than to a fixed payment,and
its payoff will vary according to
circumstances.
 By choosing how to divide their
portfolios between debt and equity
instruments,individuals and nations can
arrange to stay close to desired
consumption and investment levels.

International Banking And The
International Capital Market
The structure of the international capital
market
 Commercial banks:the center of the
international capital market.
 Corporations:finance their investments by
drawing on foreign sources of funds.
 Nonbank financial institutions:move into
foreign assets to diversify their portfolios.

International Banking And The
International Capital Market



Growth of the international capital
market
An important reason for that development
is related to exchange rate systems.
A country can`t have more than two items
from the following list:
International Banking And The
International Capital Market
1.
2.
3.
Fixed exchange rate
Monetary policy oriented toward
domestic goals
Freedom of international capital
movements
International Banking And The
International Capital Market


Offshore banking and offshore currency
trading
Offshore banking is to describe the
business that banks ` foreign offices
conduct outside of their home
countries.Bank may conduct foreign
business through three types of institution:
International Banking And The
International Capital Market
1.
2.
3.
An agency office located abroad
A subsidiary bank located abroad
A foreign branch
Eurodollar And Other
Eurocurrencies
How big is the eurocurrency market?
 In the mid-1990s,the size of the currency
market stood at around $8 trillion.

Eurodollar And Other
Eurocurrencies
How eurocurrencies are created?
 The typical eurocurrency deposit is a
nonnegotiable time deposit with a fixed
term to maturity ranging from overnight to
five years.
 Take a example to explain the creating
process of eurocurrencies.

Eurodollar And Other
Eurocurrencies


1.
2.
3.
The growth of eurocurrency trading
The main reasons for the growth of
offshore banking activities:
The growth of world trade
Government financial
regulations(including taxes)
Political considerations
Eurodollar And Other
Eurocurrencies
The importance of regulatory asymmetries
 The major factor behind the continuing
profitability of Eurocurrency trading is
regulatory.
 Freedom from reserve requirements is
probably the most important regulatory factor
that makes eurocurrency trading attractive to
banks and their customers.

Eurodollar And Other
Eurocurrencies
Eurocurrencies and macroeconomic
stability
 Eurocurrencies and World inflation:the
possibility that creation of eurocurrencies
has had some inflationary effect,but it has
never set off the protracted inflation that
some worried observers of the eurocurrency
system seem to fear.

Eurodollar And Other
Eurocurrencies

Eurocurrencies and monetary control:The
fear that eurodollars can come “flooding
back” into the United States is highly
exaggerated.
Regulating International Banking
1.The Problem of Bank Failure
The reason for bank failures
 Consequences of banking collapse
 Precautionary bank regulation measures
Deposit insurance
Reserve requirement
Capital requirement
Bank examination
Lender of the last resort facilities
The banking safeguards listed above
are interdependent
Regulating International Banking
2.Difficuties in Regulating International
Banking
Why is an international banking system harder
to regulate?
 The absence of deposit insurance
 The absence of reserve requirement
 The difficulties of bank examination and
enforcing capital requirement and asset
restrictions
Regulating International Banking
Uncertainty over the central bank’s
responsibility for providing LLR assistance
3.International Regulatory Cooperation
 In 1974 , Basle Committee was set up. Its
job was to achieve “ a better coordination of
the surveillance exercised by national
authorities over the international banking
system ……”

Regulating International Banking
The failure of nonbank financial institutions
also has serious consequences. It’s time to
take actions to regulate the international
activities of them.
Case study :

Regulating International Banking
It gives us an example of the nightmare
that the global investment fund , Long
Term Capital Management , nearly
collapsed in September 1998. The near
failure of this institution always haunts
global regulator’s sleep.
How Well Has the International
Capital Market Performed ?
1.The Extent of International Portfolio
Diversification
 Though the extent of international
portfolio diversification is low at present
time , the world capital market has
certainly contributed to a rise in the
diversification since the early 1970s.
How Well Has the International
Capital Market Performed ?
2.The Extent of Intertemporal Trade
 Martin Feldtein and Charles Horioka
suggested an alternative way of evaluating
the performance of the world capital
market : in a smoothly working
international capital market , countries’
domestic investment rates can widely
diverge from their saving rates .
How Well Has the International
Capital Market Performed ?
For many countries , differences between
national saving and domestic investment
rates (that is , current account balances )
have not been large since world war Ⅱ .
 However , in industrialized countries such
as United States , Germany and Japan , the
external imbalances have been historically
high recently .

How Well Has the International
Capital Market Performed ?
3.Onshore-Offshore Interest Differentials
 A quite different barometer of the
international capital market’s performance is
the relationship between onshore and
offshore interest rates on similar assets
denominated in the same currency .
How Well Has the International
Capital Market Performed ?
If the world capital market is doing its job
of communicating information about global
investment opportunities , these interest
rates should move closely together and not
differ too greatly.
 Countries with long-standing open capital
market show an approximate equality
between onshore and offshore interest rates.

How Well Has the International
Capital Market Performed ?
4.The Efficiency of the Foreign Exchange
Market
Studies of the foreign exchange market’s
use of available information are potentially
important in judging whether the
international capital market is sending the
right signals to markets .
How Well Has the International
Capital Market Performed ?

Studies based on interest parity
The interest parity condition is :Rt – Rt* =
(Et+1e – Et)/Et
Ι Statistical studies of the relationship
between interest rate
differences
and actual depreciation rates show that the
interest difference has been a very bad
predictor .
How Well Has the International
Capital Market Performed ?
Ⅱ Forecast error in predicting depreciation ,
ut+1 , can be expressed as : ut+1 = (Et+1 –
Et)/Et - (Et+1e – Et)/Et = (Et+1 – Et)/Et – (Rt –
Rt* )
A number of researches have shown that
forecast errors , defined above , can be
predicted .
These two tests prove that the foreign
exchange market is not doing a good job of
using current information to forecast
exchange rates.
How Well Has the International
Capital Market Performed ?
The role of risk premiums
If the people are risk-adverse and bonds
denominated in different currencies are
imperfect substitutes , the interest rate
difference equals expected currency
depreciation plus a risk premium , ρt ,
Rt – Rt* = (Et+1e – Et)/Et+ ρt

How Well Has the International
Capital Market Performed ?
The reasons for why the interest difference
has been a very bad predictor:
ΙRisk premiums are important in
exchange rate determination . ( It awaits
solid statistical confirmation. )
ⅡThe foreign exchange market has been
ignoring the opportunity to profit from
easily available information . ( It seems
unlikely in the light of foreign exchange
traders’ powerful incentives to make
profits.)
How Well Has the International
Capital Market Performed ?

Tests for excessive volatility
Exchange rates have been excessively
volatile perhaps because the foreign
exchange market overreacts to events .
How volatile must an exchange rate be
before its volatility becomes excessive?
How Well Has the International
Capital Market Performed ?
There are some underlying factors that
move exchange rates – such as money
supplies , national outputs and fiscal
variables . Attempts to compare
exchange rates’ volatilities with those of
their underlying determinants have
produced inconclusive results . It is
very hard to test the excessive volatility .
How Well Has the International
Capital Market Performed ?
The bottom line
The ambiguous evidence on the foreign
exchange market’s performance warrants
an open-minded view .
The stakes are high , and more researches
and experience are needed before a firm
conclusion can be reached .

Question
Thanks