🏏International Accounting Unit 8 – International Financial Markets & Instruments

Global Financial Landscape

• Interconnected network of financial markets, institutions, and instruments facilitating cross-border flow of capital
• Globalization has led to increased integration of financial systems across countries (United States, European Union, Japan)
• Technological advancements have enabled faster and more efficient transactions across borders
  • Electronic trading platforms connect investors worldwide
  • Real-time data dissemination enhances market transparency
• Liberalization of capital markets has removed barriers to foreign investment in many countries
• Emerging markets play an increasingly important role in the global financial landscape (China, India, Brazil)
• Interdependence of economies can lead to contagion effects during financial crises
  • Global financial crisis of 2008-2009 highlighted systemic risks
• International accounting standards (IFRS) aim to harmonize financial reporting across countries

Key Players in International Markets

• Central banks set monetary policy and regulate financial institutions within their jurisdiction (Federal Reserve, European Central Bank)
• Commercial banks facilitate cross-border transactions and provide international banking services
  • Offer foreign currency accounts and international wire transfers
  • Provide trade finance and letters of credit for international trade
• Investment banks underwrite and trade securities in international markets (IPOs, bonds)
• Multinational corporations engage in cross-border investments and operate in multiple countries
• Sovereign wealth funds are state-owned investment vehicles that invest in foreign assets (Norway Government Pension Fund, Abu Dhabi Investment Authority)
• Hedge funds and private equity firms actively invest in international markets
• Supranational organizations provide financial assistance and promote economic cooperation (International Monetary Fund, World Bank)

Types of Financial Instruments

• Equities represent ownership in a company and are traded on stock exchanges worldwide
• Bonds are debt securities issued by governments, corporations, or other entities to raise capital
  • Government bonds (U.S. Treasuries, German Bunds)
  • Corporate bonds issued by companies to finance operations or expansion
• Currencies are traded in foreign exchange markets, enabling cross-border transactions and investments
• Derivatives are financial contracts whose value is derived from an underlying asset or benchmark
  • Futures contracts obligate parties to buy or sell an asset at a predetermined price and date
  • Options give the holder the right, but not the obligation, to buy (call) or sell (put) an asset at a specific price
• Exchange-traded funds (ETFs) track indices, commodities, or baskets of assets and are traded on exchanges like stocks
• American Depositary Receipts (ADRs) represent ownership in foreign companies and are traded on U.S. exchanges
• Global Depositary Receipts (GDRs) are similar to ADRs but are traded on multiple exchanges worldwide

Exchange Rates and Currency Markets

• Exchange rates determine the value of one currency relative to another
  • Floating exchange rates are determined by market forces of supply and demand
  • Fixed exchange rates are pegged to another currency or a basket of currencies
• Currency markets, also known as foreign exchange (forex) markets, facilitate the buying and selling of currencies
• Spot transactions involve the immediate exchange of currencies at the current market rate
• Forward contracts allow parties to lock in an exchange rate for a future transaction
• Central banks intervene in currency markets to stabilize exchange rates or achieve policy objectives
• Factors influencing exchange rates include interest rates, inflation, economic growth, and geopolitical events
• Businesses engaged in international trade face exchange rate risk and may hedge their exposure using derivatives

International Stock Markets

• Stock exchanges provide platforms for trading equities of companies from various countries (New York Stock Exchange, London Stock Exchange, Tokyo Stock Exchange)
• Market capitalization reflects the total value of a company's outstanding shares
• Developed markets have well-established stock exchanges and regulatory frameworks (United States, United Kingdom, Japan)
• Emerging markets offer growth potential but may have higher risks and less developed infrastructure (China, Brazil, India)
• Cross-listing allows companies to list their shares on multiple exchanges to access a wider investor base
• Stock indices track the performance of a group of stocks representing a market or sector (S&P 500, FTSE 100, Nikkei 225)
• Factors affecting stock prices include company performance, economic conditions, and investor sentiment

Bond Markets Across Borders

• International bond markets enable governments and corporations to raise debt capital from foreign investors
• Sovereign bonds are issued by national governments to finance public spending or budget deficits
  • Credit ratings assess the creditworthiness of sovereign issuers (AAA, AA, A, BBB)
  • Higher yields on sovereign bonds may indicate higher perceived risk
• Corporate bonds are issued by companies to fund operations, expansions, or acquisitions
• Eurobonds are bonds issued in a currency different from the issuer's domestic currency
• Emerging market bonds offer higher yields but carry additional risks (currency fluctuations, political instability)
• Bond prices have an inverse relationship with interest rates
  • Rising interest rates lead to falling bond prices
  • Falling interest rates result in rising bond prices
• Yield curves depict the relationship between bond maturities and their yields

Derivatives and Risk Management

• Derivatives are used to hedge against various risks in international markets (currency risk, interest rate risk, commodity price risk)
• Forward contracts lock in a future price for buying or selling an asset
• Futures contracts are standardized forward contracts traded on exchanges
• Options provide the right, but not the obligation, to buy (call) or sell (put) an underlying asset at a predetermined price
  • Call options benefit from price increases, while put options benefit from price decreases
• Swaps involve the exchange of cash flows between two parties
  • Interest rate swaps exchange fixed-rate and floating-rate cash flows
  • Currency swaps exchange principal and interest payments in different currencies
• Credit derivatives, such as credit default swaps (CDS), transfer credit risk between parties
• Derivatives can be used for speculation, taking advantage of price movements for profit
• Misuse or inadequate understanding of derivatives can lead to significant losses (Barings Bank collapse, Long-Term Capital Management crisis)

Regulatory Framework and Challenges

• International financial markets are subject to a complex web of regulations and oversight
• National regulators oversee financial institutions and markets within their jurisdiction (Securities and Exchange Commission in the U.S., Financial Conduct Authority in the U.K.)
• Basel Accords set global standards for bank capital requirements and risk management
• Anti-money laundering (AML) and know-your-customer (KYC) regulations combat financial crimes and terrorist financing
• Divergent regulations across countries can create compliance challenges for international financial institutions
• Regulatory arbitrage occurs when firms exploit differences in regulations across jurisdictions
• Harmonization efforts aim to align regulations and promote a level playing field (MiFID II in the European Union)
• Challenges in international financial markets include:
  • Systemic risk and contagion effects during financial crises
  • Regulatory gaps and inconsistencies across borders
  • Geopolitical risks and economic uncertainties
  • Technological disruptions and cyber threats