INTERNATIONAL FINANCIAL MARKETS

International Financial Markets

International Financial Markets

Introduction

The purpose of this study is to expand the boundaries of our knowledge by exploring some relevant information relating to the analysis of International Financial Markets.

“International financial markets comprise of those agents who come from different countries to make their investment, financing or sale of financial assets” (Kuznetsova, 2012, pp. 193-200).

Following are the main objectives of international financial markets:

Allocate resources

Clear and settle payments

Divide capital into shares

Manage risk (hedging)

Provide information on share volatility

Provide better incentives

Classification of financial markets

The financial markets can be classified into three broad groups:

The foreign exchange market: “It is the market where the buyers and sellers can exchange, buy and sell currencies of different countries of the world” (Ferguson, 2008, pp. 1-5).

International financial capital market: “It is the market where money is exchanged internationally through financial assets like stocks (equities) and bonds (fixed income) or by the international credit market” (Steil, 1994, pp. 2-8).

International financial market derivatives: It is the market where financial derivatives are exchanged based among underlying financial products such as options, futures and swaps.

In this paper, we will examine International financial markets with particular reference to:

(a) Options and

(b) collateralised debt obligations.

We will also define the term financial derivatives and explain whether derivatives improve the working of international financial markets.

Discussion & Analysis

Options

In finance, the term option means a particular type of contract that gives holder the right but not the obligation to buy or sell the stock at a specified exercise price of the option (the strike price). The options may exist in the form of shares, commodities, interest rates, etc. The fundamental difference of the options compared to other derivatives consists in the definition of the rights of the owner i.e. he or she is not obligated to purchase / sell the underlying asset, but may exercise the option if he or she foresees a real economic advantage. “For this reason, they are also called asymmetric derivative securities” (Thompson, 2012, pp. 603-634). The options can be either “call” or “put”. “Call” is used to purchase the options while “put” is used to sell the option. Using options, four different strategies can be adapted by the investor (Thompson, 2012, pp. 603-634):

Purchase of call option (long call).

Sale of option (short call).

Purchase option (long put).

Sale of put option (short put).

The options are widely used for speculative purposes or to hedge financial investment. For example, an importer may cover / guard the exchange rate risk in the long term by signing an option on the price of the goods to be imported in future. This allows the importer to avoid the exchange rate risk and exercise the option only if he or she foresees an economic advantage. In case of purchase of call options, the maximum possible loss is the premium paid plus trading commissions payable to the intermediary, while the gain is theoretically unlimited, whereas, “in the case of sale of call options, the maximum gain is the premium paid by the ...