Role of International Financial Markets
This article focuses on the different aspects of the international financial market. There are many influences on the international financial markets, and the article will provide an exploration of the role of international banking, the euro, hedge funds and moral hazards within international financial markets. Financial markets could be defined in two ways, and there are different categories of financial markets.
Keywords Euro; Financial Markets; Hedge Funds; International Banking; International Banking Federation; Letters of Credit (LOCs); Moral Hazard; Multinational Bank; Wire Transfers
Money is power. A former Treasury Department official has stated that the most significant conflicts countering terrorism following 9/11 took place in the buildings and boardrooms of economic corporations (Taylor, 2007). Taylor, in an interview with USINFO, stated that he believes that "financial issues should be treated jointly with the two other pillars of international relations, military and political" (Anders, n.d.). According to Taylor (2007), finances are a crucial factor in foreign policy. Let's step back and look at the foundation of financial markets, then tie the concept to its role in a global economy.
Financial markets could be defined in two ways. The term could refer to organizations that facilitate the trade of financial products or it can refer to the interaction between buyers and sellers to trade financial products. Many who study the economic field will utilize both definitions, but finance scholars tend to apply the second meaning most often. Economic markets have the potential to be both domestic and foreign.
Financial markets can be explore on an economic basis terms because it focuses on how individuals purchase and sell financial security, assets and other forms of capital with cheap transaction fees and prices that symbolize the efficiency of the markets. The overall objective of a financial market is to gather all of the sellers and put them in one place that they can meet and interact with potential buyers. The goal is to create a process that will make it easy for the two groups to conduct business.
When looking at the concept of "financial markets" from a finance perspective, one could view financial markets as a way to facilitate the process of raising capital, transferring risk and conducting international trade. The overall objective is to provide an opportunity for those who want capital to interact with those who have capital. In most cases, a borrower will issue a copy of the purchase to the borrower agreeing to pay back the finances in full. These receipts are known as securities and are able to be purchased or sold. Lenders expect to be compensated for lending the money. Their compensation tends to be in the form of interest or dividends.
There are different categories of financial markets, and some of them are:
- Capital markets. Capital markets are comprised of primary and secondary markets, and are considered a critical factor in American capitalism. Recently established securities are purchased and sold in the primary market and investors sell their securities in the secondary markets. Companies rely on these markets to raise the funds needed to purchase the equipment required to run a business; conduct research and development; and assist in securing other items needed for the operations of the company.
- Stock markets — In order to raise a large amount of cash at one time, public corporations will sell shares of ownership to investors. Investors gain profits when the corporations increase their earnings. Many view the Dow Jones Industrial Average as the stock market, but it is one of many components. Two other components are the Dow Jones Transportation Average and the Dow Jones Utilities Average. Stocks are traded on world exchanges such as the New York Stock Exchange and NASDAQ.
- Bond markets — Bonds are the opposite of stocks. Usually, when stocks go up, bonds go down. The forms of bonds include Treasury Bonds, corporate bonds, and municipal bonds. Each bond has a crucial influence on mortgage interest rates.
- Commodity markets. Facilitate the trading of raw or primary commodities. The commodities are traded on regulated commodities exchanges. According to Amadeo (n.d.), “the most important commodity to the American economy is oil, and its price is determined in the commodities futures market. Futures are a way to pay for something today that is delivered tomorrow, which helps to remove some of the volatility in the American economy. However, futures also increase the trader's leverage by allowing him to borrow the money to purchase the commodity. This can have a huge impact on the stock market, and the American economy, if the trader guesses wrong” (Amadeo, n.d., “What are commodities”).
- Money markets. Provides short term debt financing and investment. The money market is the international financial market for temporary borrowing and lending. The allow for short-term liquid financing for the international economic system. In most financial markets, borrowers tend to repay their debts after about a year of lending, in most cases. Money markets use “paper” as their instruments in short-term financing.
- Derivatives markets. Provides tools for the administration of economic risk.
- Futures markets Offer standardized contracts for exchanging products in the future.
- Insurance markets. Facilitates the redistribution of different risks.
- Foreign exchange markets. Facilitates the trading of international exchange.
- Hedge fund markets. “Recently, hedge funds have increased in popularity due to their supposed higher returns for high-end investors. Since hedge funds invest heavily in futures, some have argued that they have decreased the volatility of the stock market and therefore the U.S. economy. However, in 1997, the world's largest hedge fund at the time, Long Term Capital Management, practically brought down the U.S. economy” (Amadeo, n.d. “What are hedge funds”).
Influences on the International Financial Markets
There are many influences on the international financial markets. This section will discuss three of them: The euro, moral hazard, and hedge funds.
1. The Euro.
"Economic and monetary union (EMU) prompted some speculation as to the future international role of the new European currency" (Detken & Hartmann, 2002). Many had speculated that the euro would challenge the dollar's dominance as the number one currency in the world while others were skeptical that the euro would last. “The emergence of one currency as a medium of exchange in currency trading is an important dimension of a currency's role in international financial markets, and is related to a currency's trading volume and trading costs” (Detken & Hartmann, 1998, p. 564). Detken and Hartmann (2002) found that the euro's role is similar to the deutschemark before EMU and features a prominent position in spot trading in the Nordic and other Central European nations. The euro was severly tested during the euro-zone crisis, as first Greece and then Italy sank under economic pressures and required financial assistance from stronger EU members. Fields & Vernengo (2013) contended that despite predictions of euro supremacy, the dollar would remain the hegemonic international currency for the foreseeable future.
2. Moral Hazard.
Moral hazard in international financial markets has received considerable attention in the past years. Moral hazard refers to "the possibility that the provision of insurance, by diminishing the incentives to prevent a particular...
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