The opening case describes how China Mobile overcame the financing constraints imposed by a relatively small and

illiquid Hong Kong capital market and raised $8.24 billion by simultaneously selling equity and bonds through several different exchanges, including Hong Kong and New York, to a broad range of international investors. As we saw, China Mobile also lists its shares on the New York Stock Exchange in addition to the Hong Kong Stock Exchange. By successfully tapping into the large and liquid global capital market, the Hong Kongbased company was able to raise more funds than initially planned and lower its cost of capital. (The cost of capital refers to the price of money, such as the interest rate that must be paid to bondholders or the dividends and capital appreciation that stockholders expect to receive.) For example, as noted in the opening case, the convertible bonds carried an interest rate a full half point lower than originally expected, implying a lower cost of capital for China Mobile. Although China Mobiles international equity and debt offering was among the largest to date, the tactic of selling equity and debt internationally is becoming increasingly common. This represents a sharp break from common practice during much of the 20th century. In the past, substantial regulatory barriers separated national capital markets from each other. These made it difficult for a company based in one country to list its stock on a foreign exchange. These regulatory barriers tumbled during the 1980s and 1990s. By the middle of the last decade, a truly global capital market was emerging. This capital market enabled firms to list their stock on multiple exchanges and to raise funds by issuing equity or debt around the world. For example, in 1994, Daimler-Benz, Germanys largest industrial company, raised $300 million by issuing new shares not in Germany, but in Singapore.1 In 1996, the German telecommunications provider Deutsche Telekom raised some $13.3 billion by simultaneously listing its shares for sale on stock exchanges in Frankfurt, London, New York, and Tokyo. And in late 2002, China Telecom, Chinas largest fixed-line phone company, raised $1.4 billion by selling a 10 percent stake in the company to investors in New York and Hong Kong.2 Like China Mobile, these three companies elected to raise equity through foreign markets because they reasoned that their domestic capital market was too small to supply the requisite funds at a reasonable cost. To lower their cost of capital,

they tapped into the large and highly liquid global capital market. We begin this chapter by looking at the benefits associated with the globalization of capital markets. This is followed by a more detailed look at the growth of the international capital market and the macroeconomic risks associated with such growth. Next, there is a detailed review of three important segments of the global capital market: the eurocurrency market, the international bond market, and the international equity market. As usual, we close the chapter by pointing out some of the implications for the practice of international business. Benefits of the Global Capital Market Although this section is about the global capital market, we open it by discussing the functions of a generic capital market. Then we will look at the limitations of domestic capital markets and discuss the benefits of using global capital markets. |Functions of a Generic Capital Market A capital market brings together those who want to invest money and those who want to borrow money (see Figure 11.1). Those who want to invest money include corporations with surplus cash, individuals, and nonbank financial institutions (e.g., pension funds, insurance companies). 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 (e.g., Citicorp, U.S. Bancorp) and investment banks (e.g., Merrill Lynch, Goldman Sachs). Commercial banks perform an indirect connection function. They take cash deposits from corporations and individuals and pay them interest in return. They then lend that money to borrowers at a higher rate of interest, making a profit from the difference in interest rates (commonly referred to as the interest rate spread). Investment banks perform a direct connection function. They bring investors and borrowers together and charge commissions for doing so. For example, Merrill Lynch may act as a stockbroker for an individual who wants to invest some money. Its personnel will advise her as to the most attractive purchases and buy stock on her behalf, charging a fee for the service. 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 share of stock gives its holder a claim to a firms profit stream. The corporation honors this claim by paying dividends to the stockholders. The amount of the dividends is not fixed in advance. Rather, it is determined by management based on how much profit the corporation is making. Investors purchase stock both for their dividend yield and in anticipation of gains in the price of the stock, which in theory reflects future dividend yields. Thus, investors may (and often do) purchase equity in companies that do not currently issue dividends to stockholders because they anticipate that the company will do so in the future.Stock prices increase when a corporation is projected to have greater earnings in the future, which increases the probability that it will raise (or initiate) future dividend payments. A debt loan requires the corporation to repay a predetermined portion of the loan amount (the sum of the principal plus the specified interest) at regular intervals regardless of how much profit the company 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. When an investor purchases a corporate bond, he purchases the right to receive a specified fixed stream of income from the corporation for a specified number of years (i.e., until the bond maturity date). |Attractions of the Global Capital Market A global capital market benefits both borrowers and investors. It benefits borrowers by increasing the supply of funds available for borrowing and by lowering the cost of capital. It benefits investors by providing a wider range of investment opportunities, thereby allowing them to build portfolios of international investments that diversify their risks. The Borrowers Perspective: A Lower Cost of Capital 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. (China Mobile faced this problem in the opening case.) A global capital market, with its much larger pool of investors, Perhaps the most 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. The cost of capital is the price of borrowing money, which is the rate of return that borrowers must pay investors. This is the interest rate on debt loans and the dividend yield and expected capital gains on equity loans. 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. The argument is illustrated in Figure 11.2, using the China Mobile example. The vertical axis in the figure is the cost of capital (the price of borrowing money), and the horizontal axis is the amount of money available at varying interest rates. DD is the China Mobile demand curve for borrowings. Note that the China Mobile demand for funds varies with the cost of capital; the lower the cost of capital, the more money China Mobile will borrow. (Money is just like anything else; the lower its price, the more of it people can afford.) SSHK is the supply curve of funds available in the Hong Kong capital market, and SSI represents the funds available in the global capital market. Note that China Mobile can borrow more funds more cheaply on the global capital market. As Figure 11.2 illustrates, the greater pool of resources in the global capital marketthe greater liquidityboth lowers the cost of capital and increases the amount China Mobile can borrow. Thus, the advantage of a global capital market to borrowers is that it lowers the cost of capital. Problems of limited liquidity are not restricted to less developed nations, which naturally tend to have smaller domestic capital markets. As discussed in the introduction, even very large enterprises based in some of the worlds most advanced industrialized nations in recent years have tapped the international capital markets in their search for greater liquidity and a lower cost of capital, such as Germanys Deutsche Telekom.3 The Deutsche Telekom case is discussed in more detail in the Management Focus. The Investors Perspective: Portfolio Diversification By using the global capital market, investors have a much wider range of investment opportunities than in a purely domestic capital market. The most significant consequence of this choice is that investors can diversify their portfolios internationally, thereby reducing their risk to below what could be achieved in a purely domestic capital market. We will consider how this works in the case of stock holdings, although

the same argument could be made for bond holdings. provides a larger supply of funds for borrowers to draw on. Chapter 11 The Global Capital Market 381 Figure 11.1