Study On The International Financial Markets Finance Essay - Free Essay Example

The financial system and the commodity market play a vital in economic performance and development. In order to provide a clear understanding, we begin with definitions of international finance as the branch of economics that studies the variations of exchange rate, foreign investment and how these affect the international trade. We introduce financial market with direct transactions between the savers e.g. household, firms and the government and financial intermediaries which transform the direct obligation of savers into indirect obligation of financial which have attributes that savers prefer. Intermediaries engage in receiving funds from the savers and lending to borrowers by means of purchasing from borrowers primary debt, equity or mixed type securities. The main objective of international finance is the undisturbed flow of funds from savers to borrowers regardless of national borders. The second section begins with detail explanations of commodity market and the roles they played in the economics market and the opportunities in supporting an efficient financial sector. The financial sector mobilizes savings and allocates credit across space and time. It provides not only payment services, but more importantly products which enable firms and households to cope with economic uncertainties by hedging, pooling, sharing, and pricing risks. An efficient financial sector reduces t he cost and risk of producing and trading goods and services and thus makes an important contribution to raising standards of living, investment production and consumption. INTERNATIONAL FINANCE. International finance is defined as a branch of economics that studies the variation of exchange rates, foreign investment, and how these affect international trade. Money is moved and the credit made available to the promotion of trade, reconstruction and development across national boundaries. The scope of international finance is classified into three major parts. International Financial Economics which is concerned with causes and effects of financial flows among nations application of macroeconomic theory and policy to the global economy. International Financial Management is concerned with how individual economic units cope with the complex financial environment of international business. International Financial Markets which is concerned with international financial or investment instruments, foreign exchange markets, international banking, international securities markets, financial derivatives, etc. In international finance, Borrowers, primarily corporations raises cash in two principal ways by issuing equity or by issuing debt. The equity consists largely of common stocks, but companies may also issue preferred stocks. Internationally, the raising of cash takes primarily the form of international debt issuance in the form of international debt securities offerings or international equity issuance in the form of international share offerings to investors, often combined with a foreign stock exchange listing. INTERNATIONAL EQUITY FINANCE. Equity is an ownership claims to a share in the profit and assets of a firm. According to the journal of Legal Aspects of International Finance (LAIF) 2011, A share also referred to as equity share of stock represents a share of ownership in a corporation. Equity ownership represents an ownership interest in a corporation. It comes in several forms and the most important is Ordinary Shares (Common Stock) ownership of which entitles the holder of dividend and a share of net assets value of the company. Common stock typically carries voting rights that can be exercised in corporate decisions, the right to share in distributions of the companys income, the right to purchase new shares issued by the company, and the right to a companys assets during a liquidation of the company. With preferred shares, the holder is entitled to certain level dividend payment before any dividends are distributed to ordinary share holders. Preferred stock holders do not carry voting rights like common stocks holders and cannot place the firm into liquidation. As part of international finance, international equity finance involves the issuance and sale of shares of common stock to non-residents of the country regardless of the location of the shareholders. Firms usually use equity financing when they are unable to raise sufficient funds through retained earnings or when they have to raise additional equity capital to offset debt. 1.3. INTERNATIONAL DEBT FINANCE. Is the act of a business raising operating capital or other capital by borrowing for a specific purpose. When companies borrow money, they promise to make regular interest payments and to repay the principal amount of the borrowed funds. Debt financing is divided into two categories which include, long term Debt financing such as equipment, buildings, land, or machines. The scheduled repayment of the loan and the estimated useful life of the assets extend over more than one year and short term debt financing such as purchasing inventory, supplies, or paying the wages of employees usually applies to money needed for the day to day operations of the business. Short term financing is less than one year. As part of international finance, international debt issuance comes with a disconcerting choice of legal forms of debt such as international bank loans, commercial paper, senior unsecured bonds and debentures, subordinated and unsecured notes and debentures. Other types of debt i nstruments all reflect a basic agreement on behalf of the lender to advance the borrowed funds and a promise on behalf of the borrower to return the funds lent. INTERNATIONAL FINANCIAL MARKET. According to the McKinsey Global Institutes (MGI) annual analysis of long term trends that are reshaping global capital markets, the total value of the worlds financial assets including shares, private and government debt securities, and bank deposits. Financial markets such as stock market or bond market, issue claims on individual borrowers directly to savers. Savers surpluses are transferred to borrowers. FINANCIAL SYSTEM. Financial system provides channels to transfer funds from individuals and groups who have saved money to individuals and groups who want to borrow money. Savers (or lenders) are suppliers of funds, providing funds to borrowers in returns for promises of repayment of even more funds in the future. Borrowers are demanders of funds for consumers durables, houses or business, plants and equipment, promising to repay borrowed funds based on their expectation of higher incomes in future. (Hubbard (1996)). They channel household savings to the corporate sector and allocate investment funds among firms; they allow intertemporal smoothing of consumption by households and expenditures by firms; and they enable households and firms to share risks. FINANCE SYSTEM CHANNEL FUNDS This shows that the financial system channels flow of funds from savers or investors to borrowers and channels returns back to the savers, both directly and indirectly. Financial markets, such as the stock market or the bond market, issue claims on individual borrowers directly to savers. Financial institutions or intermediaries, such as banks, mutual funds and insurance company act as a go betweens by holding a portfolio of assets and issuing claims based on that portfolio to savers which is made possible by the activities of financial intermediaries and financial markets. Regarding the mode of financial flows, funds flow from savers to borrowers either directly or via the operations of a financial intermediary. In the first case, borrowers receive funds directly from savers. In return, savers acquire debt, equity or mixed-type claims in the form of primary securities. Financial intermediaries facilitate this process, assisting in the design, marketing and completion of the transa ction. These financial instruments are marketable in secondary markets. The ultimate objective and benchmark of international finance is the undisturbed flow of funds from savers to borrowers regardless of national borders. FOREIGN EXCHANGE MARKET. The Foreign Exchange Market is vast in size and scope and exists to fulfill a number of purposes ranging from the finance of cross-border investment, loans, trade in goods and services and of course, currency speculation. The Foreign Exchange Market encompasses of conversion of purchasing power from one currency to another; bank deposits of foreign currency; credit denominated in foreign currency, foreign trade financing, trading in foreign currency options futures, and currency swaps. The trade of different currencies takes place on the foreign exchange markets, at prices called exchange rates. Trading occurs 24 hours a day and London is the largest Foreign Exchange center. Trading may be for spot or forward delivery. A spot contract is a binding obligation to buy or sell a certain amount of foreign currency at the current market rate. A forward contract is a binding obligation to buy or sell a certain amount of foreign currency at a pre agreed rate of exchange, on or befor e a certain date. Forward contracts are available for any period up to two years longer periods are available in certain currencies. The main players on the foreign exchange market are commercial banks, firms, nonbank financial institutions, and central banks. DERIVATIVES. Derivatives are financial instrument whose value is based on an underlying asset. Derivatives can be used to acquire risk, rather than to insure or hedge against risk, it allows investors to hedge when buying a certain asset. Hedging is a way to protect against a loss in value of an investment. For example, if the holder of a certain stock is concerned that the stock price will fall, he or she might purchase a type of option whose value will increase if the stock falls in price. The option thus provides a kind of insurance against loss for the stockholder. Derivatives have a great amount of leverage, such that a small movement in the underlying value can cause a large difference in the value of the derivative. Speculate and make a profit if the value of the underlying asset moves the way they expect. One of the types of derivatives is over the counter which is the largest market for derivatives and is largely unregulated with respect to disclosure of information between the part ies. They are contract that are traded and privately negotiated directly between the two parties without going through other intermediary. The second type of derivatives is Exchange traded derivatives which acts as an intermediary to all related transactions, and takes Initial margin from both sides of the trade to act as a guarantee The three major classes of derivatives include: Futures/Forwards which are contracts to buy or sell an asset on or before a future date at a price specified today. Options are contracts that give the owner the right, but not the obligation, to buy in the case of a call option or sell in the case of a put option an asset. Swaps are contracts to exchange cash (flows) on or before a specified future date based on the underlying value of currencies/exchange rates. While the major classes of derivatives of underlying asset are interest rate derivatives, foreign exchange derivatives, credit derivatives, equity derivatives and commodity derivati ves. COMMODITY MARKET AND ECONOMIC PERFORMACE Commodity markets are markets where raw or primary products are exchanged and where organized traders exchange in which standardized, graded products are bought and also the right to sell goods that plays a major role in the global economic scenario. These goods may be mineral based such as oil and natural gas, metals such as gold or copper, agricultural, cotton or wool, livestock, or foodstuffs like rice, wheat, soy and corn. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold. A commodity exchange is a market in which multiple buyers and sellers trade commodity-linked contracts on the basis of rules and procedures laid down by the exchange .Worldwide, there are 48 major commodity exchanges that trade over 96 commodities, ranging from wheat and cotton to silver and oil. Before World War II London was the centre of international trade in primary goods, but New York City has become at least as important. It is in these two cities that the international prices of many primary products are determined. Although New York often has the bigger market, many producers prefer the London market because of the large fluctuations in local demand in the United States that influence New York market prices. In some cases international commodity agreements have reduced the significance of certain commodity markets. The focus on commodity exchanges in the traditional sense that is, exchanges trading agricultural commodities, metals or energy products, as opposed to financial products (annex I). These exchanges are, however, described in the context of global futures trade, including financial contracts (annex II). 2.1 TYPES OF COMMODITY MARKET 1. SPOT MARKETS. Spot markets are markets in which a commodity is bought or sold for cash and delivery is immediate, money is exchanged and a product is obtained. Spot contracts, a less widely used form of trading, call for immediate delivery of a specified commodity and are often used to obtain the goods necessary to fulfill a futures contract. 2. FORWARD MARKETS. Forwards are advance payment for future supply, like reserving your share of next years yield. Forward contract are for future delivery of a commodity. 3. FUTURE MARKETS. Futures are a contract on future supply that wont actually be delivered. The purpose of trading in futures is either to insure against the risk of price changes (hedging) or to make a profit by speculating on the price trend. The great bulk of commodity trading is in contracts for future delivery. The operation of futures markets requires commodities of uniform quality grades in order that transactions may take place without the buyer hav ing to inspect the commodities themselves. A futures contract is an agreement to deliver or receive a certain quantity of a commodity at an agreed price at some stated time in the future. 2.2 THE ROLE OF COMMODITY MARKETSÂÂ  IN ECONOMIC. They play a very important role in the global economy in three major ways. First, reducing the price volatility and risk, the market mechanism helps to reduce price volatility by letting human nature work freely. Thereby reducing excess supply of some product in the market by producing less and if there is a shortage of some product in the market, the producers raise their prices and produce more. This brings things in balance as the market constantly adjusts to the current market situation. The system of hedging reduces risk and helps to promote economic growth as farmers, consumers, producers, distributors, etc. can lock in prices of their crops, raw material costs or other input costs. This allows market participants to better plan for their production output, consumption and capital spending budgets. Commodity markets provide the perfect system and place for buyers and sellers to use all of the available information in the market in determination of price at that moment for investment. And finally, the market helps to keep a balance between consumption and production as price adjustments are constantly being made in the market based on supply and demand. Producers and consumers alike decide how much to produce or consume based on market prices and their decisions on production and consumption levels based on daily pricing through commodity futures exchanges around the world helps to keep levels in balance. 2.3 THE ROLES OF THE FINANCIAL SECTOR IN ECONOMIC PERFORMANCES. The most three basic decisions which influence economic performance are; How much to save and how to allocate the flow of savings in investment. How much to consume. How to allocate the existing stock of wealth which would depend on each independent households opportunities, present and expected future income, health, family composition, the costs of goods and services. To examine how a financial sector affects the economy we introduce the direct financial claims. Financial claims are reflected in the flow of funds accounts as liabilities of firms, but as assets of households. Financial market infrastructure which have involved in most developed countries reduces costs e.g. accounting standards, disclosure laws and ratings agencies which would otherwise be borne by individual savers. These markets, conventions and institutions may make it possible for small savers to hold direct claims on firms and achieve a greater return for any given level of risk in allocating th eir wealth. The development of secondary markets in which direct claims are traded helps in increasing the willingness of savers to exchange real assets for direct financial claims and encourages savers to accept longer maturity claims. Brokers, which match savers and investors, as well as organized markets, which publish prices at which direct claims have recently been traded, reduce search and information costs for issues of new direct financial claims and increase the efficiency of direct financial transactions. They provide valuable price to help price new issues of direct claims and to coordinate decentralized economic activity. As indirect financial claims is by means of financial intermediaries. Financial Intermediaries purchase direct financial claims and issue their own liabilities; in essence they transform direct claims into indirect claims. Financial intermediaries monitor changes in the borrowers creditworthiness, collect and evaluate information regarding creditw orthiness at lower cost and with greater expertise than the household sector. Financial intermediary transform a direct financial claim with attributes which the borrower prefers into an indirect claim with attributes which savers prefer, this occurs when the borrower needs large amounts for relatively long periods of time, while savers prefer to hold smaller-denomination claims for shorter periods of time. By pooling the resources, the financial intermediary may be able to accommodate the preferences of both the borrower and savers. Financial intermediary transform the risky, long-term, illiquid direct claims on borrowers into safer, shorter-term, liquid claims on itself that savers prefer by diversifying reducing the financial intermediarys net exposure to a variety of risks and thus reduces the cost of hedging which makes an important contribution to raising standards of living. In addition, governments foster an elastic financial infrastructure which can withstand the u nstable in financial market prices without increasing the shocks to the real economy. 2.4. OPPORTUNITIES ARISING FROM INTERNATIONAL CONTEXT. The opportunities arising from international context is that first, we need to better understand capital markets and the products available and also todays globally reliant economies. The accessibility to foreign markets information products increases everyday and this represent a huge opportunity. Cross-border financial transaction of all kinds has become a common place for investors to make choices in different products. Diversifying in both international and domestic companies will lower their overall risk of their investment portfolio. Opening a country to trade in financial assets offers advantages similar to those that we observed introducing financial instruments in the primitive economy. International specialization on the basis of comparative advantage in financial services, like international specialization in production is likely to enhance efficiency. Confidence in the financial system encourages investors to allocate their savings through financial markets and institutions rather than to invest in non-productive assets in order to hedge against inflation or the risk of financial collapse. 2.5 RISK RISING FROM INTERNATIONAL CONTEXT. Risk is the possibility that something unpleasant, undesirable which might happen in international finance. Consequently, risk cannot be eliminated, it can only be managed and controlled and this process required proper identification and monitoring. The most risk associated with international finance is credit risk, which can be defined as the possibility of the failure of the debtor to perform its legally binding agreement in accordance with the relevant credit agreement. Market risk is associated with the trading activities of investors in securities and other financial instruments and refers to the possibility of losses arising from unfavorable movements in market prices. Traditional financial risk focuses on risks within the financial system, and then efficiency should plainly be the central goal. Foreign exchange or currency risk, which refers to the possibilities of losses attributed to fluctuations and volatility of foreign exchange rates and these can have impa ct on the return on the investment invested. International politics risk where by the government destabilization and consequent impacts on the foreign corporations. Interest rate risks refer to the exposure of the institutions financial condition to contrary the movements in interest rates. Liquidity risk is the lack of ability of a lender or borrower to accommodate decreases in liabilities or to fund increases in assets. Finally, operational risk refers to the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events. Such failures can lead to financial distress through error, fraud, or failure to perform in a timely manner or cause the interests of the financial institution to be compromised in some other way. 2.6. CONCLUSIONS The financial sector mobilizes savings and allows the allocation of credit across space and time. As seen, this not only provides payment services but more importantly products which enables firms and households to cope with the economics uncertainties. An efficient financial sector helps reduce cost and risk for production and trading of goods and services thereby play an important role in raising the standard of living. As seen, are some advantages to international equity issues. It increases as well as diversifies shareholders base. This also improves a firms image and also offering less cumbersome listing the procedures. For most investors, international equities offer the benefits of portfolio diversification and make it possible and also favorable tax treatment. Commodity market plays a vital role in international market, hedging reduces the risk for producers, consumers etc there by helping to promote economic growth. Market infrastructure helps to reduce cost which would have been borne by the individual. Its sustained the economic strength and progress in an increasingly competitive global economy and with access to advance technol ogy. Indeed, we can see how the financial system and the commodity play a vital role in international and their economics performances.