2. Forces Expanding the International Capital Market

Around 40 years ago, national capital markets functioned largely as independent markets^. But since that time, the amount of debt, equity, and currencies traded internationally has increased dramatically. This rapid growth can be traced to three main factors:

1) Information Technology. Information is the lifeblood of every nation's capital market because investors need information about investment opportunities and their corresponding risk levels. Large investments in information technology over the past two decades have drastically reduced the costs, in both time and money, of communicating around the globe. Investors and borrowers can now respond in record time to breaking news in the international capital market. The introduction of electronic trading after the daily close of formal exchange also facilitates faster response times.

2) Deregulation. Deregulation of national capital market has been instrumental in the expansion of the international capital market. The need for deregulation became apparent in the early 1970x, when heavily regulated markets in the largest countries were facing fierce competition from less regulated markets in smaller nations. Deregulation increased competition, lowered the cost of financial transactions, and opened many national markets to global investing and borrowing. Continued growth in the international capital market depends on further deregulation. For instance, although Japan opened its banking industry somewhat to outsiders in the late 1990s, more needs to be done to spur greater competition there.

3) Financial Instruments. Greater competition in the financial industry is creating the need to develop innovative financial instruments. One result of the need for new types of financial instruments is securitization-the unbundling and repackaging of hard-to-trade financial assets into more liquid, negotiable, and marketable financial instruments (or securities). For instance, a mortgage loan from a bank is not liquid or negotiable because it is a customized contract between the bank and the borrower: Banks cannot sell loans and thus raise capital for further investment because each loan differs from every other loan. But agencies of the U.S. government, such as the Federal National Mortgage Association (www fanniemae.com), guarantee mortgages against default and thus accumulate them as pools of assets. They then sell securities in capital markets that are backed by these mortgage pools. When mortgage bankers participate in this process, they are able to raise capital for further investment.

World Financial Centers

The world's three most important financial centers are London, New York, and Tokyo. But officials at traditional exchanges worry that information technology may make formal stock exchanges obsolete. Indeed, unless they continue to modernize, cut costs, and provide new customer services, they might be rendered obsolete by trading on the Internet and other new electronic systems.

An offshore financial center is a country or territory whose financial sector features very few regulations and few, if any, taxes. These centers tend to be characterized by economic and political stability and usually provide access to international capital market through an excellent telecommunications infrastructure. Most governments protect their own currencies by restricting the amount of activity that domestic companies can conduct in foreign currencies. That is why companies often find it hard to borrow funds in foreign currencies and so turn to offshore centers, which offer large amounts of funding in currencies other than their own. In short, offshore centers are sources of (usually cheaper) funding for companies with multinational operations.

Offshore financial centers fall into two categories:

1) Operational centers see a great deal of financial activity. Prominent operational centers include London (which does a good deal of currency trading) and Switzerland (which supplies a great deal of investment capital to other nations).

2) Booking centers are usually located on small island nations or territories with favorable tax and/or secrecy laws. Little financial activity takes place here. Rather, funds simply pass through on their way to large operational centers. In fact, booking centers are typically home to offshore branches of domestic banks that use them merely as bookkeeping facilities to record tax and currency-exchange information. Some important booking centers are the Cayman Islands and the Bahamas in the Caribbean; Gibraltar, Monaco, and the Channel Islands in Europe; Bahrain in the Middle East; and Singapore in Southeast Asia.

Increasingly, offshore centers are attracting attention in the rapidly expanding ,world of electronic commerce. Anguilla, a small Caribbean island that belongs to the United Kingdom, is attempting to become a center for Internet-based companies. How? In Anguilla, such firms are allowed to do all the electronic commerce they want via the Internet and pay no taxes on their profits. To meet one "Webpreneur" who is working to attract business to Anguilla, see his Web site at (wwvw.offshore.com.ai).

Now that we have covered the basic features of the international capital market, let's take a closer look at its main components: the international bond, international equity, and Eurocurrency markets.