International Business Quiz

Chapter 11 - The Global Capital Market

Chapter 11The Global Capital Market

True / False Questions

1. (p. 388) The rapid globalization of capital markets enables individuals and institutions based in one nation to invest in corporations based elsewhere with relative ease. TRUE

Difficulty: Easy

2. (p. 388) Today, substantial regulatory barriers separate national capital markets from each other. FALSE

Difficulty: Medium

3. (p. 388) Market makers are the financial service companies that connect investors and borrowers, either directly or indirectly. TRUE

Difficulty: Easy

4. (p. 389) Commercial banks take cash deposits from corporations and individuals and pay them a rate of interest in return. TRUE

Difficulty: Easy

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5. (p. 389) Commercial banks bring investors and borrowers together but do not charge any commissions for doing so. FALSE

Difficulty: Medium

6. (p. 389) A debt loan requires a corporation to repay a predetermined portion of the loan amount at regular intervals regardless of how much profit it is making. TRUE

Difficulty: Medium

7. (p. 389) One of the most important drawbacks of the limited liquidity of an international capital market is that the cost of capital tends to be higher than it is in a purely domestic market. FALSE

Difficulty: Medium

8. (p. 390) Problems of limited liquidity are strictly restricted to less developed nations, which tend to have smaller domestic capital markets. FALSE

Difficulty: Medium

9. (p. 390) By using the global capital market investors can diversify their portfolios internationally, thereby reducing their risk to below what could be achieved in a purely domestic capital market. TRUE

Difficulty: Medium

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10. (p. 392) By holding a variety of stocks in a diversified portfolio, the losses incurred when some stocks fail to live up to their promises are offset by the gains enjoyed when other stocks exceed their promise. TRUE

Difficulty: Easy

11. (p. 392) Systematic risk refers to movements in a stock portfolio's value that are attributable to macroeconomic forces affecting all firms in an economy, rather than factors specific to an individual firm. TRUE

Difficulty: Easy

12. (p. 392) The systematic risk is the level of diversifiable risk in an economy. FALSE

Difficulty: Medium

13. (p. 393) According to recent studies different national stock markets appear to be only moderately correlated. TRUE

Difficulty: Easy

14. (p. 393) The relatively low correlation between the movements of stock markets in different countries reflects that different stock markets are still somewhat segmented from each other by capital controls. TRUE

Difficulty: Medium

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15. (p. 393) Barriers to cross-border capital flows limit the ability of capital to roam the world freely in search of the highest risk-adjusted return, consequently, at any one time, there may be too much capital invested in some markets and too little in others. TRUE

Difficulty: Medium

16. (p. 394) Floating exchange rates reduce the element of risk involved in investing in foreign assets. FALSE

Difficulty: Medium

17. (p. 394) Adverse exchange rate movements can transform otherwise profitable investments into unprofitable investments. TRUE

Difficulty: Easy

18. (p. 394) The Financial services industry is information-intensive. TRUE

Difficulty: Easy

19. (p. 395) Governments around the world have traditionally kept other countries' financial service firms from entering their capital markets. TRUE

Difficulty: Medium

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20. (p. 395) Deregulation in a number of key countries has facilitated the growth of the international capital market. TRUE

Difficulty: Easy

21. (p. 395) Historically, many countries have limited the ability of foreign investors to purchase significant equity positions in domestic companies. TRUE

Difficulty: Medium

22. (p. 396) As of 2007, the trends toward deregulation of financial services and removal of capital controls are still not firmly in place. FALSE

Difficulty: Easy

23. (p. 396) According to some analysts, deregulation and reduced controls on cross-border capital flows are making individual nations more vulnerable to speculative capital flows. TRUE

Difficulty: Medium

24. (p. 396) Harvard economist Martin Feldstein argues that short-term capital is still relatively rare, primarily because although capital is free to move internationally, its owners and managers still prefer to keep most of it at home. FALSE

Difficulty: Medium

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25. (p. 398) A eurocurrency is the currency used by the countries of the European Union. FALSE

Difficulty: Medium

26. (p. 398) The term eurocurrency is actually a misnomer because a eurocurrency can be created anywhere in the world. TRUE

Difficulty: Easy

27. (p. 398) Eurodollars, which account for about two-thirds of all eurocurrencies, are dollars banked outside of the United States. TRUE

Difficulty: Easy

28. (p. 398) The main factor that makes the eurocurrency market attractive to both depositors and borrowers is its lack of government regulation. TRUE

Difficulty: Easy

29. (p. 399) The spread between the eurocurrency deposit rate and the eurocurrency lending rate is less than the spread between the domestic deposit and lending rates. TRUE

Difficulty: Medium

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30. (p. 399) Domestic currency deposits are regulated in all industrialized countries. TRUE

Difficulty: Easy

31. (p. 399) Regulated domestic currency deposits ensure that banks have enough liquid funds to satisfy demand if large numbers of domestic depositors should suddenly decide to withdraw their money. TRUE

Difficulty: Medium

32. (p. 400) In an unregulated system such as the eurocurrency market, the probability of a bank failure that would cause depositors to lose their money is greater as compared to a regulated system. TRUE

Difficulty: Medium

33. (p. 400) The lower interest rate received on home-country deposits reflect the costs of insuring against bank failure. TRUE

Difficulty: Easy

34. (p. 400) Many companies borrow funds in their domestic currency to avoid foreign exchange risk, even though the eurocurrency markets may offer more attractive interest rates. TRUE

Difficulty: Easy

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35. (p. 401) Eurobonds are usually offered simultaneously in several national capital markets, but neither in the capital market of the country, nor to residents of the country, in whose currency they are denominated. TRUE

Difficulty: Medium

36. (p. 402) An interesting consequence of the trend toward international equity investment is the internationalization of corporate ownership. TRUE

Difficulty: Easy

37. (p. 402) Adverse movements in foreign exchange rates can substantially increase the cost of foreign currency loans. TRUE

Difficulty: Easy

38. (p. 404) When a firm borrows funds from the global capital market, it must weigh the benefits of a lower interest rate against the risks of an increase in the real cost of capital due to adverse exchange rate movements. TRUE

Difficulty: Medium

39. (p. 404) By using the global capital market, firms can often borrow funds at a lower cost than is possible in a purely domestic capital market. TRUE

Difficulty: Easy

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40. (p. 404) By holding a diverse portfolio of stocks and bonds in different nations, an investor can reduce total risk to a lower level than can be achieved in a purely domestic setting. TRUE

Difficulty: Medium

Multiple Choice Questions

41. (p. 388) Market makers are A. Financial service companies that connect investors and borrowersB. Those who want to borrow money including individuals, companies and governmentsC. Nonbank financial institutions who want to invest moneyD. High net worth individuals with surplus cash to reinvest

Difficulty: Easy

42. (p. 388) A(n) _____ brings together those who want to invest money and those who want to borrow money. A. Capital marketB. High net worth investorC. Consumer marketD. Retailer

Difficulty: Medium

43. (p. 389) Which of the following are among the best examples of market makers? A. IndividualsB. Regulatory agenciesC. GovernmentsD. Commercial banks

Difficulty: Medium

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44. (p. 389) Identify the incorrect statement pertaining to commercial banks. A. They perform an indirect connection functionB. They lend investors money to borrowers at a higher rate of interest, making a profit from the difference in interest ratesC. They bring investors and borrowers together but do not charge commissions for itD. They take cash deposits from corporations and individuals and pay them a rate of interest in return

Difficulty: Medium

45. (p. 389) An equity loan A. Such as a share of stock does not give its holder a claim to a firm's profit streamB. Is made when a corporation sells stock to investorsC. Includes cash loans from banks and funds raised from the sale of corporate bonds to investorsD. Requires the corporation to repay a predetermined portion of the loan amount at regular intervals regardless of how much profit it is making

Difficulty: Hard

46. (p. 389) Identify the incorrect statement regarding debit loans. A. They are made when a corporation sells stock to investors and gives its holders a claim to the firm's profit streamB. Management has no discretion as to the amount it will pay investorsC. They include cash loans from banks and funds raised from the sale of corporate bonds to investorsD. They require the corporation to repay a predetermined portion of the loan amount at regular intervals regardless of how much profit it is making

Difficulty: Medium

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47. (p. 389) All of the following are benefits of global capital markets, except that they A. Increase the supply of funds available to borrowersB. Lower the cost of capitalC. Provide a wider range of investment opportunities to investorsD. Have higher cost of capital as compared to purely domestic capital markets

Difficulty: Hard

48. (p. 390) The cost of capital A. Is the price of borrowing money, which is the rate of return that borrowers must pay investorsB. Tends to be higher in an international capital market than it is in a purely domestic marketC. In a purely domestic market implies that borrowers must pay less to persuade investors to lend them their moneyD. In an international market implies that borrowers will be able to pay more to persuade investors to lend them their money

Difficulty: Medium

49. (p. 390) Which of the following is not likely to be a reason for investors to use the global capital market? A. They have a higher cost of capital as compared to purely domestic capital marketsB. They have a much wider range of investment opportunities than in a purely domestic capital marketC. They can diversify their portfolios internationallyD. They can reduce their risk through portfolio diversification to below what could be achieved in a purely domestic capital market

Difficulty: Medium

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50. (p. 392) As an investor increases the number of stocks in her portfolio, the portfolio's risk: A. Increases initiallyB. Does not changeC. Declines rapidly in the beginningD. Increases exponentially beyond a point

Difficulty: Medium

51. (p. 392) _____ refers to movements in a stock portfolio's value that are attributable to macroeconomic forces affecting all firms in an economy, rather than factors specific to an individual firm. A. Financial riskB. Portfolio riskC. Systematic riskD. Unplanned risk

Difficulty: Easy

52. (p. 392) Systematic risk A. Refers to movements in a stock portfolio's value that are not attributable to macroeconomic forces affecting all firms in an economyB. Refers to movements in a stock portfolio's value that are attributable to factors specific to an individual firmC. Is the level of non-diversifiable risk in an economyD. Is the price of borrowing money, which is the rate of return that borrowers must pay investors

Difficulty: Hard

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53. (p. 393) The relatively low correlation between the movements of stock markets in different countries reflects all of the following basic factors except A. Countries pursue different macroeconomic policies and face different economic conditions, so their stock markets respond to different forces and can move in different waysB. Different stock markets are still somewhat segmented from each other by capital controlsC. Restrictions on cross-border capital flows still separate different stock marketsD. Barriers to cross-border capital flows drastically increase the ability of capital to roam the world freely in search of the highest risk-adjusted return

Difficulty: Hard

54. (p. 393) Which of the following statements regarding barriers to cross-border capital flows is not true? A. They limit the ability of capital to roam the world freely in search of the highest risk-adjusted returnB. They can lead to too much capital being invested in some markets and too little in others, at any one timeC. They are no longer responsible for the relatively low correlation between the movements of stock markets in different countriesD. They include limits on the amount of a firm's stock that a foreigner can own and limits on the ability of a country's citizens to invest their money outside that country

Difficulty: Medium

55. (p. 393-394) According to a study by Bruno Solnik, A. A fully diversified portfolio of international stocks is only about 75 percent as risky as a typical individual stockB. A fully diversified portfolio of U.S. stocks is about 2 percent as risky as a typical individual stockC. A fully diversified portfolio that contains stocks from many countries is less than half as risky as a fully diversified portfolio that contains only U.S. stocksD. There is no relationship between international diversification and risk

Difficulty: Medium

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56. (p. 394) All of the following statements regarding the effects of exchange rates on international portfolio diversification are true, except A. The volatile exchange rates associated with the current floating exchange rate regime increase the risk-reducing effects of international portfolio diversificationB. Floating exchange rates introduce an additional element of risk into investing in foreign assetsC. Adverse exchange rate movements can transform otherwise profitable investments into unprofitable investmentsD. Uncertainty engendered by volatile exchange rates may act as a brake on the otherwise rapid growth of the international capital market

Difficulty: Hard

57. (p. 394) According to data from the Bank for International Settlements, A. By late 2006, the stocks of cross-border bank loans were significantly less as compared to those in 1990B. The global capital market is growing at a rapid paceC. Outstanding international bonds in late 2006 were down from those in 1997D. The international capital market was in recession from the 1980s to the early 2000s

Difficulty: Hard

58. (p. 394) Which of the following statements about the financial services industry is not true? A. It is an information-intensive industryB. It has been revolutionized more than any other industry by advances in information technology since the 1970sC. It is now technologically possible for financial services companies to engage in 24-hour-a-day tradingD. It saw the real cost of recording, transmitting and processing information increase by 25 percent between 1964 and 1990

Difficulty: Medium

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59. (p. 394) In the financial services industry, growth of international communications technology has facilitated all of the following except A. The emergence of a segregated international capital marketB. Companies to engage in 24-hour-a-day tradingC. The international capital market to never sleepD. Market makers to absorb and process large volumes of information from around the world

Difficulty: Easy

60. (p. 394) The international capital market boom in the 1980s, 1990s and 2000s can be attributed to the A. Advances in information technologyB. Increased regulations by governmentsC. Increase in real cost of recording, transmitting and processing informationD. Decreased acceptance of the free market ideology

Difficulty: Easy

61. (p. 395) Which of the following is an adverse effect of the integration of international capital market facilitated by technology? A. "Shocks" that occur in one financial center now spread around the globe very quicklyB. Due to advances in communications and data processing technology, the international capital market never sleepsC. Shocks in national financial markets have extensive long-term impact on other markets due to high correlation between movements in national equity marketsD. The real cost of recording, transmitting and processing information has gone up by 95 percent between 1964 and 1990

Difficulty: Medium

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62. (p. 395) The global trend toward the deregulation of financial markets has been facilitated by all of the following developments, except A. The development of the Eurocurrency marketB. Pressure from financial services companies wanting to operate in a less regulated environmentC. Increasing rejection of the free market ideology associated with an individualistic political philosophyD. Changes In the U.S. that allowed foreign banks to enter the U.S. capital market and domestic banks to expand their operations overseas

Difficulty: Easy

63. (p. 395) In late 1997, a deal brokered by the _____ removed many of the restrictions on cross-border trade in financial services and facilitated further growth in the size of the global capital market. A. European UnionB. World Trade OrganizationC. International Monetary FundD. World Bank

Difficulty: Easy

64. (p. 395) Which of the following is not a trend toward deregulation that facilitated the growth of the international capital market? A. The U.S., in 1970s and early 80s, allowing foreign banks to enter the U.S. capital market and domestic banks to expand their operations overseasB. Great Britain's removal of barriers, in October 1986, that had existed between banks and stockbrokers and allowed foreign financial service companies to enter the British stock marketC. Restrictions on the entry of foreign securities houses in Japan and Japanese banks not being allowed to open international banking facilitiesD. In Germany, foreign banks being allowed to lend and manage foreign euro issues, subject to reciprocity agreements

Difficulty: Easy

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65. (p. 396) Analysts who believe that the globalization of capital has serious inherent risks argue that A. Due to deregulation and reduced controls on cross-border capital flows, individual nations are becoming more vulnerable to speculative capitalB. Most of the capital that moves internationally is pursuing long term gains and it does not shift in and out of countries as quickly as conditions changeC. "Hot money" is still relatively rare, primarily because although capital is free to move internationally, its owners and managers still prefer to keep most of it at homeD. The lack of short-term capital is due to the relative paucity of information that investors have about foreign investments

Difficulty: Hard

66. (p. 396) According to Harvard economist Martin Feldstein, "patient money" A. Is relatively abundantB. Implies short-term capitalC. Is another term for "hot money"D. Is still relatively rare

Difficulty: Medium

67. (p. 396) According to Harvard economist Martin Feldstein _____ supports long-term cross-border capital flows. A. Hot moneyB. Patient moneyC. Short-term capitalD. Investment capital

Difficulty: Easy

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68. (p. 396) Economist Martin Feldstein argues that the lack of patient money is due to the A. Relative paucity of information that investors have about foreign investmentsB. Relative abundance of hot moneyC. Restrictions on international capital movementsD. Increasing trend of excessive intra-day volatility in global capital markets

Difficulty: Medium

69. (p. 398) A(n) _____ is any currency banked outside of its country of origin. A. EurocurrencyB. Global currencyC. International currencyD. Dollar amount

Difficulty: Medium

70. (p. 398) A eurocurrency A. Can be created anywhere in the worldB. Should be created and banked in EuropeC. Can be created only in its country of originD. Refers to any former national currency of EU members

Difficulty: Easy

71. (p. 398) Which event was initially responsible for London becoming the leading center of eurocurrency trading? A. Regulations that discouraged British banks from trading in the eurocurrency marketB. Strengthening of the British pound against major European currencies in the 1960sC. Collapse of the Bretton Woods systemD. Prohibition of British banks from lending British pounds to finance non-British trade

Difficulty: Medium

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72. (p. 398-399) The main factor that makes the eurocurrency market attractive to both depositors and borrowers is that A. It allows banks to offer lower interest rates to cash depositor on home currency deposits than on deposits made in eurocurrencyB. It lacks government regulation and banks are given much more freedom in their dealings in foreign currenciesC. It allows banks to charge borrowers a lower interest rate for borrowings in the home currency than for borrowings in eurocurrencyD. The spread between the eurocurrency deposit rate and lending rate is more than the spread between the domestic deposit and lending rates

Difficulty: Hard

73. (p. 399) A bank based in New York faces a 10 percent reserve requirement, has annual operating costs of $1 per $100 of deposits and it charges 10 percent interest on loans. The highest interest this bank can offer to a depositor, making a $100 deposit and still cover its costs is 8 percent per year. A euro bank in the same position but with no reserve requirements regarding dollar deposits can offer an interest of _____ percent per year, after covering its costs. A. 7B. 8C. 9D. 10

Difficulty: Hard

74. (p. 400) Which of the following is a drawback of the eurocurrency market? A. High reserve ratio requirementsB. Higher cost of transactionC. Lower interest rates on depositsD. It exposes a company to foreign exchange risk

Difficulty: Medium

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75. (p. 400) Which of the following is a drawback of the eurocurrency market? A. High reserve ratio requirementsB. Probability of failure resulting in loss of depositsC. Increased regulatory burdenD. Higher cost of transaction

Difficulty: Medium

76. (p. 400) Why do many companies borrow funds in their domestic currency even though the eurocurrency markets may offer more attractive interest rates? A. To reduce operational expensesB. To avoid systemic riskC. To avoid reinvestment riskD. To avoid foreign exchange risk

Difficulty: Medium

77. (p. 400) _____ are sold outside of the borrower's country and are denominated in the currency of the country in which they are issued. A. EurobondsB. Convertible bondsC. Foreign bondsD. Regulatory bonds

Difficulty: Easy

78. (p. 400) These are international bonds, normally underwritten by an international syndicate of banks and placed in countries other than the one in whose currency the bond is denominated. A. EurobondsB. Convertible bondsC. Foreign bondsD. Regulatory bonds

Difficulty: Easy

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79. (p. 401) All of the following are features of the eurobond market that make it an appealing alternative to most major domestic bond markets, except A. An absence of regulatory interferenceB. Ability to offer to residents of the country, in whose currency they are denominatedC. Less stringent disclosure requirements than in most domestic bond marketsD. A favorable tax status

Difficulty: Medium

80. (p. 402) Companies with historic roots in one nation are broadening their stock ownership by listing their stock in the equity markets of other nations because of all of the following reasons, except A. Listing stock on a foreign market is often a prelude to issuing stock in that market to raise capitalB. They can tap into the liquidity of foreign markets, thereby increasing the funds available for investment and lowering the firm's cost of capitalC. It facilitates future acquisitions of foreign companiesD. It helps in decreasing the company's visibility with local employees, customers, suppliers and bankers

Difficulty: Hard

Essay Questions

81. (p. 388) What is a capital market? Define Market makers.

A capital market brings together those who want to invest money and those who want to borrow money. Those who want to invest money include corporations with surplus cash, individuals and nonbank financial institutions. Those who want to borrow money include individuals, companies and governments. Between these two groups are the market makers. Market makers are the financial service companies that connect investors and borrowers, either directly or indirectly. They include commercial banks and investment banks.

Difficulty: Easy

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82. (p. 389) What are the various types of capital market loans?

Capital market loans to corporations are either equity loans or debt loans. An equity loan is made when a corporation sells stock to investors. The money the corporation receives in return for its stock can be used to purchase plants and equipment, fund R&D projects, pay wages and so on.A debt loan requires the corporation to repay a predetermined portion of the loan amount at regular intervals regardless of how much profit it is making. Management has no discretion as to the amount it will pay investors. Debt loans include cash loans from banks and funds raised from the sale of corporate bonds to investors.

Difficulty: Medium

83. (p. 389-390) What are the benefits of a global capital market as compared to a purely domestic capital market?

In a purely domestic capital market, the pool of investors is limited to residents of the country. This places an upper limit on the supply of funds available to borrowers. In other words, the liquidity of the market is limited. A global capital market, with its much larger pool of investors, provides a larger supply of funds for borrowers to draw on. An important drawback of the limited liquidity of a purely domestic capital market is that the cost of capital tends to be higher than it is in an international market.In a purely domestic market, the limited pool of investors implies that borrowers must pay more to persuade investors to lend them their money. The larger pool of investors in an international market implies that borrowers will be able to pay less.

Difficulty: Medium

84. (p. 390-392) How does a global capital market, as compared to a purely domestic market, benefit investors?

A global capital market benefits investors by providing a wider range of investment opportunities, thereby allowing them to build portfolios of international investments that diversify their risks. Investors can diversify their portfolios internationally, thereby reducing their risk to below what could be achieved in a purely domestic capital market.

Difficulty: Hard

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85. (p. 392) What is systematic risk?

Systematic risk refers to movements in a stock portfolio's value that are attributable to macroeconomic forces affecting all firms in an economy, rather than factors specific to an individual firm. The systematic risk is the level of non-diversifiable risk in an economy.

Difficulty: Easy

86. (p. 393) What are the two basic factors reflected by the relatively low correlation between the movements of stock markets in different countries.

The first factor reflected by the relatively low correlation between the movements of stock markets in different countries is that countries pursue different macroeconomic policies and face different economic conditions, so their stock markets respond to different forces and can move in different ways.Second, different stock markets are still somewhat segmented from each other by capital controls—that is, by restrictions on cross-border capital flows.

Difficulty: Medium

87. (p. 394-395) What factors allowed the international capital market to bloom in the 1980s, 1990s and 2000s?

The growth of the global capital market during recent decades can be attributed to advances in information technology, the widespread deregulation of financial services and the relaxation of regulations governing cross-border capital flows.

Difficulty: Medium

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88. (p. 396) Identify the risks associated with global capital markets.

According to some analysts deregulation and reduced controls on cross-border capital flows are making individual nations more vulnerable to speculative capital flows. This is seen as having a destabilizing effect on national economies.Harvard economist Martin Feldstein, for example, has argued that most of the capital that moves internationally is pursuing temporary gains and it shifts in and out of countries as quickly as conditions change. A lack of information about the fundamental quality of foreign investments is often seen as encouraging speculative flows in the global capital market.

Difficulty: Hard

89. (p. 398) What is a Eurocurrency?

A eurocurrency is any currency banked outside of its country of origin. Eurodollars, which account for about two-thirds of all eurocurrencies, are dollars banked outside of the United States. Other important eurocurrencies include the euroyen, the euro pound and the euro-euro. A eurocurrency can be created anywhere in the world; the persistent euro-prefix reflects the European origin of the market.

Difficulty: Easy

90. (p. 398) Trace the genesis and growth of the eurocurrency market.

The eurocurrency market was born in the mid-1950s when Eastern European holders of dollars were afraid to deposit their holdings of dollars in the United States lest they be seized by the U.S. government to settle U.S. residents' claims resulting from business losses during the Communist takeover of Eastern Europe. The eurocurrency market received a major push in 1957 when the British government prohibited British banks from lending British pounds to finance non-British trade. The eurocurrency market received another push in the 1960s when the U.S. government enacted regulations that discouraged U.S. banks from lending to those who were not U.S. residents. A political event, the oil price increases engineered by OPEC in the 1973–74 and 1979–80 periods, gave the market another big shove.Although various political events contributed to the growth of the eurocurrency market, they alone were not responsible for it. The market grew because it offered real financial advantages

Difficulty: Easy

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91. (p. 398-400) What are the financial advantages that make the eurocurrency market attractive to both depositors and borrowers?

The main factor that makes the eurocurrency market attractive to both depositors and borrowers is its lack of government regulation. This means that the spread between the eurocurrency deposit rate and the eurocurrency lending rate is less than the spread between the domestic deposit and lending rates. Companies have strong financial motivations to use the eurocurrency market. By doing so, they receive a higher interest rate on deposits and pay less for loans.

Difficulty: Medium

92. (p. 400) What are the drawbacks of the eurocurrency market?

The eurocurrency market has two drawbacks. First, when depositors use a regulated banking system, they know that the probability of a bank failure that would cause them to lose their deposits is very low. In an unregulated system such as the eurocurrency market, the probability of a bank failure that would cause depositors to lose their money is greater. Thus, the lower interest rate received on home-country deposits reflects the costs of insuring against bank failure.Second, borrowing funds internationally can expose a company to foreign exchange risk. Consequently, many companies borrow funds in their domestic currency to avoid foreign exchange risk, even though the eurocurrency markets may offer more attractive interest rates.

Difficulty: Medium

93. (p. 400) What are foreign bonds?

Foreign bonds are sold outside of the borrower's country and are denominated in the currency of the country in which they are issued. Many foreign bonds have nicknames; foreign bonds sold in the United States are called Yankee bonds, foreign bonds sold in Japan are Samurai bonds and foreign bonds sold in Great Britain are bulldogs. Companies will issue international bonds if they believe that it will lower their cost of capital.

Difficulty: Easy

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94. (p. 400-401) What are Eurobonds? Explain with the help of an example.

Eurobonds are normally underwritten by an international syndicate of banks and placed in countries other than the one in whose currency the bond is denominated. For example, a German corporation may issue a bond, denominated in U.S. dollars and an international syndicate of banks may sell it to investors outside of the United States. Eurobonds are routinely issued by multinational corporations, large domestic corporations, sovereign governments and international institutions. They are usually offered simultaneously in several national capital markets, but neither in the capital market of the country, nor to residents of the country, in whose currency they are denominated.

Difficulty: Medium

95. (p. 401) What are the features of the eurobond market that make it an appealing alternative to most major domestic bond markets?

Three features of the eurobond market make it an appealing alternative to most major domestic bond markets. First, there is an absence of regulatory interference. Government limitations are generally less stringent for securities denominated in foreign currencies and sold to holders of those foreign currencies. Second, there are less stringent disclosure requirements than in most domestic bond markets. Eurobond market disclosure requirements tend to be less stringent than those of several national governments. Third, they have a favorable tax status.

Difficulty: Medium

96. (p. 402) Why are companies now listing their stock in the equity markets of other nations?

Many companies are now listing their stock in the equity markets of other nations, primarily as a prelude to issuing stock in those markets to raise additional capital. Other reasons for listing stock in another country's exchange are to facilitate future stock swaps; to enable the company to use its stock and stock options for compensating local management and employees; to satisfy local ownership desires and to increase the company's visibility among its local employees, customers, suppliers and bankers.

Difficulty: Hard

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97. (p. 402-404) Write a brief note on foreign exchange risks and the cost of capital.

A firm can borrow funds at a lower cost on the global capital market than on the domestic capital market. However, under a floating exchange rate regime, foreign exchange risk complicates this picture. Adverse movements in foreign exchange rates can substantially increase the cost of foreign currency loans. Unpredictable movements in exchange rates can inject risk into foreign currency borrowing, making something that initially seems less expensive ultimately much more expensive.When a firm borrows funds from the global capital market, it must weigh the benefits of a lower interest rate against the risks of an increase in the real cost of capital due to adverse exchange rate movements.

Difficulty: Hard

98. (p. 404) How can a borrower hedge against unpredictable movements in exchange rates?

The borrower can hedge against unpredictable movements in exchange rates by entering into a forward contract to purchase the required amount of the currency being borrowed at a predetermined exchange rate when the loan comes due. Although this will raise the borrower's cost of capital, the added insurance limits the risk involved in such a transaction.When a firm borrows funds from the global capital market, it must weigh the benefits of a lower interest rate against the risks of an increase in the real cost of capital due to adverse exchange rate movements. Although using forward exchange markets may lower foreign exchange risk with short-term borrowings, it cannot remove the risk. Most importantly, the forward exchange market does not provide adequate coverage for long-term borrowings.

Difficulty: Easy

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99. (p. 404) What are the implications of the growth of the global capital markets for international businesses that wish to borrow?

By using the global capital market, firms can often borrow funds at a lower cost than is possible in a purely domestic capital market. This conclusion holds no matter what form of borrowing a firm uses—equity, bonds or cash loans. The lower cost of capital on the global market reflects their greater liquidity and the general absence of government regulation. Government regulation tends to raise the cost of capital in most domestic capital markets. The global market, being transnational, escapes regulation. Balanced against this, however is the foreign exchange risk associated with borrowing in a foreign currency.

Difficulty: Hard

100. (p. 404) How does the growth in the global capital markets effect investing firms?

On the investment side, the growth of the global capital market is providing opportunities for firms, institutions and individuals to diversify their investments to limit risk. By holding a diverse portfolio of stocks and bonds in different nations, an investor can reduce total risk to a lower level than can be achieved in a purely domestic setting. Once again, however, foreign exchange risk is a complicating factor.

Difficulty: Hard

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International Business Quiz

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Transcript of International Business Quiz