INTERNATIONAL FINANCIAL MANAGEMENT Fifth Edition EUN / RESNICK McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. International Equity Markets 13 Chapter Thirteen Chapter Objective: This chapter continues discussion of international capital markets with a discussion of both the Fifth Edition primary and secondary equity markets throughout EUN / RESNICK the world. 13-1 Market Capitalization of Developed Countries 13-2 At year-end 2006, total market capitalization of the world’s equity markets stood at $54,195 billion. Of this amount, 81 percent is accounted for by the market capitalization of the major equity markets from 29 developed countries. Market Capitalization of Developing Countries The other 19% is accounted for by the market capitalization of developing countries in “emerging markets”. 13-3 Latin America Asia Eastern Europe Mideast/Africa Emerging Markets Standard & Poor’s Emerging Markets Data Base classifies a stock market as “emerging” if it meets at least one of two general criteria: 13-4 (1) it is located in a low- or middle-income economy as defined by the World Bank, and/or (2) its investable market capitalization is low relative to its most recent GNI figures. Measures of Liquidity The equity markets of the developed world tend to be much more liquid than emerging markets. 13-5 Liquidity refers to how quickly an asset can be sold without a major price concession. So, while investments in emerging markets may be profitable, the investor’s focus should be on the long term. Measures of Market Concentration Emerging Markets tend to be much more concentrated than our markets. 13-6 Concentrated in relatively few companies. That is, a few issues account for a much larger percentage of the overall market capitalization in emerging markets than in the equity markets of the developed world. The number of equity investment opportunities in emerging stock markets in developing countries has not been improving in recent years. Market Structure, Trading Practices, and Costs Primary Markets Secondary Markets 13-7 Shares offered for sale directly from the issuing company. Provide market participants with marketability and share valuation. Market Consolidations And Mergers There are approximately 80 major national stock markets. 13-8 Western and Eastern Europe once had more than 20 national stock exchanges where at least 15 different languages were spoken. It appears that over time a European stock exchange will eventually develop. However, a lack of common securities regulations, even among the countries of the European Union, is hindering this development. Today, stock markets around the world are under pressure from clients to combine or buy stakes in one other to trade shares of companies anywhere, at a faster pace. Magnitude of International Equity Trading 13-9 During the 1980s world capital markets began a trend toward greater global integration. Diversification, reduced regulation, improvements in computer and communications technology, increased demand from MNCs for global issuance. Cross-Listing of Shares 13-10 Cross-Listing refers to a firm having its equity shares listed on one or more foreign exchanges. The number of firms doing this has exploded in recent years. Advantages of Cross-Listing It expands the investor base for a firm. 13-11 Very important reason for firms from emerging market countries with limited capital markets. Establishes name recognition for the firm in new capital markets, paving the way for new issues. May offer marketing advantages. May mitigate possibility of hostile takeovers. Yankee Stock Offerings The direct sale of new equity capital to U.S. public investors by foreign firms. 13-12 Privatization in South America and Eastern Europe Equity sales by Mexican firms trying to “cash in” following implementation of NAFTA American Depository Receipts 13-13 Foreign stocks often trade on U.S. exchanges as ADRs. It is a receipt that represents the number of foreign shares that are deposited at a U.S. bank. The bank serves as a transfer agent for the ADRs American Depository Receipts There are many advantages to trading ADRs as opposed to direct investment in the company’s shares: 13-14 ADRs are denominated in U.S. dollars, trade on U.S. exchanges and can be bought through any broker. Dividends are paid in U.S. dollars. Most underlying stocks are bearer securities, the ADRs are registered. Volvo ADR A good example of a familiar firm that trades in a U.S. as an ADR is Volvo AB, the Swedish car maker. Volvo trades in the U.S. on the NASDAQ under the ticker VOLVY. 13-15 The depository institution is JPMorgan ADR Group. The custodian is a Swedish firm, S E Banken Custody. Of course, Volvo also trades on the Stockholm Stock Exchange under the ticker VOLVB. Mechanics of Issuance and Cancellation of ADRs NYSE OTC NASDAQ U.S. Broker Broker orders shares for new ADR Foreign Broker Foreign broker buys shares Foreign Exchange 13-16 Depository issues new ADR Foreign broker deposits shares Depository Depository receives confirmation of share deposit Broker buys existing ADR Delivery Place order ADR Investor Custodian International Equity Market Benchmarks 13-17 North America Europe Asia/Pacific Rim North American Equity Market Benchmarks NAME SYMBOL DJIA Dow Jones Industrial Average NASDAQ Combined Composite S&P 500 CCMP TSE 300 TS300 Mexico BOLSA Index 13-18 SPX MEXBOL European Equity Market Benchmarks 13-19 NAME SYMBOL FT-SE 100 UKX CAC 40 CAC Frankfurt DAX Index DAX IBEX Index IBEX Milan MIB30 MIB30 BEL20 Index BEL20 Asia/ Pacific Rim Equity Market Benchmarks NAME 13-20 SYMBOL NIKKEI 225 Index NKY Hang Seng Index HSI Sing Straits Times Index STI ASX All Ordinaries Index AS300 i Shares MSCI Country-specific baskets of stocks designed to replicate the country indexes of 22 countries. i Shares are exchange traded funds that trade on the American Stock Exchange and are subject to U.S. SEC and IRS diversification requirements. 13-21 Low cost, convenient way for investors to hold diversified investments in several different countries. Factors Affecting International Equity Returns 13-22 Macroeconomic Factors Exchange Rates Industrial Structure Macroeconomic Factors Affecting International Equity Returns 13-23 The data do not support the notion that equity returns are strongly influenced by macro factors. That is correspondent with findings for U.S. equity markets. Exchange Rates 13-24 Exchange rate movements in a given country appear to reinforce the stock market movements within that country. One should be careful not to confuse correlation with causality. Industrial Structure 13-25 Studies examining the influence of industrial structure on foreign equity returns are inconclusive.