The financial markets of the world consist of sources of finance, and uses for finance, in a number of different countries. Each of these is a capital market on its own. On the other hand, national capital markets are partially linked and partially segmented. National capital markets are of very different stages of development and size and depth, they have very different prices and availability of capital. Hence, the international financier has great opportunities for arbitrage – finding the cheapest source of funds, and the highest return, without adding to risk. It is because markets are imperfectly linked, the means and channels by which foreigners enter domestic capital markets and domestic sources or users of funds go abroad, are the essence of this aspect of international financial management.
The other aspect is the fact that domestic claims and liabilities are denominated in national currencies. These must be exchanged for another for capital to flow internationally; since relative values depend on supply and demand, the international financier faces exchange risk. Finally, the past few decades have seen a new phenomenon; the separation of currency of denomination of assets and liabilities from country of jurisdiction.
There are three sets of markets – home, foreign and euromarkets – faced by every investor or borrower, plus the fourth market, the foreign currency market, which must be crossed as one enters the world of finance. Each country has more or less imperfect linkages with every other country and with the euro market, both the segment in its own currency and Euro-market segments in other currencies. The linkages of each country with its Euromarkets segment are very important, since domestic and euromarkets instrument are close substitutes and no foreign exchange market comes between them. The links among segments of the euromarkets are also very important, since no national controls come between them – in other words, linkages within the euromarkets are perfect, being differentiated only by currency of denomination. They are linked through the spot and forward foreign exchange markets. Global financial markets are thus concerned with the following markets.
1. Domestic Capital Markets
The international role of a capital market and the regulatory climate that prevails are closely related. Appropriate regulation can and does make markets more attractive. However, the dividing line between regulatory measures that improve markets and those that have just the opposite effect is very thin.
2. Foreign Financial Markets
Major chunk of the savings and investments of a country take place in that country’s domestic financial markets. However, many financial markets have extensive links abroad – domestic investors purchase foreign securities and invest funds in foreign financial institutions. Conversely, domestic banks can lend to foreign residents and foreign residents can issue securities in the national market or deposit funds with resident financial intermediaries. The significant aspect of traditional foreign lending and borrowing is that all transactions take place under the rules, usances and institutional arrangements prevailing in the respective national markets. Most important, all these transactions are directly subject to public policy governing foreign transactions in a particular market. For example, when savers, purchase securities in a foreign market, they do so according to the rules, market practices and regulatory percepts that govern such transactions in that particular market.
Likewise, foreign borrowers who wish to issue securities in a national market must follow the rules and regulations of that market. Frequently, these rules are discriminatory and restrictive. The same is true with respect to financial intermediaries; the borrower who approaches a foreign financial institution for a loan obtains funds at rates and conditions imposed by the financial institutions of the foreign country and is directly affected to foreign residents.
Euro currencies – which are neither currencies nor are they necessarily connected with Europe – represent the separation of currency of denomination from the country of jurisdiction. Banks and clients make this separation simply by locating the market for credit denominated in a particular currency outside the country where that currency is legal tender. For example, markets for dollar denominated loans, deposits and securities in jurisdictions other than in the United States effectively avoid US banking and securities regulations. These markets are referred to as “Euro” or, more properly, as external markets in order to indicate that they are not part of the domestic or national financial system. As in the domestic markets, the euromarkets consist of intermediated funds and direct funds. Intermediated credit in channel through banks is called the “Euro Currency Market”.
A domestic market, usually with special and unique aspects and institutions stemming from historical and regulatory differences. A foreign segment attached to the national market, where non-residents participate as supplier and takers of funds, frequently playing both roles simultaneously, but always under the specific conditions, rules and regulations established for foreign participants in a particular national market. An external segment that is characterized by being in a different political jurisdiction, with only the currency used to determine the financial claims being the essential link to the national market. As a result, the various external markets have more features in common with each other than with the respective national markets. Therefore, they are properly discussed as a common, integrated market where claims denominated in different currencies are exchanged.