International Equity Markets. Dora Chen, Zhen Zhang, Daisy Guo, Spencer Hu,

International Equity Markets Dora Chen, Zhen Zhang, Daisy Guo, Spencer Hu,

International Equity Markets Chapter Objective: This chapter continues discussion of international capital markets with a discussion of both the primary and secondary equity markets throughout the world. International Financial Management 2

Agenda A Statistical Perspective Market Structure, Trading Practices, and Costs Trading in International Equities International Equity Market Benchmarks Factors Affecting International Equity Returns ishares MSCI Case study: Huaneng International Power International Financial Management 3

Definition Equity securities represent the ownership claims on a company s NET assets. It plays a fundamental role in investment analysis and portfolio management. International Financial Management 4

A Statistical Perspective International Financial Management 5

A Statistical Perspective Market Capitalization of Developed Countries Market Capitalization of Developing Countries Measures of Liquidity Measures of Market Concentration International Financial Management 6

Market Capitalization World s equity Market Capitalization at year-end 2006: $52 trillion Developed Country Almost 83% of the market capitalization is accounted for by the developed world. Developing Country The other 17% is accounted for by developing countries in emerging markets. -Europe -Far East -Atlantic -North America -Latin America -Asia -Eastern Europe -Mideast/Africa International Financial Management 7

Market Capitalization of Equity Markets in Developed Countries (in Billions U.S. Dollars) International Financial Management 8

Market Capitalization of Equity Markets in Selected Developing Countries (in Billions U.S. Dollars) International Financial Management 9

Growth of Global Equity Market Recently the growth rates in these emerging markets have been strong, but with more volatility than we have here at home. From 1996 to 2006 market cap. In developed countries increased 140% from $18 Tr. to $43 Tr. Increase was not evenly distributed: 177% for Europe, 137% for North America, and 95% for Far East International Financial Management 10

Measures of Liquidity Liquidity refers to how quickly an asset can be sold without a major price concession. The equity markets of the developed world tend to be much more liquid than emerging markets. So, while investments in emerging markets may be profitable, the focus should be on the long term. International Financial Management 11

Turnover Ratio Turnover ratio = Market transactions($) Market cap International Financial Management 12

Turnover Ration of Equity Markets in Developed Countries (Transaction in U.S.$/Year-End Market Capitalization in U.S. $) International Financial Management 13

Turnover Ration of Emerging Equity Markets in Selected Developing Countries (Transaction in U.S. $/Year-End Market Capitalization in U/S/ $) International Financial Management 14

Measures of Market Concentration Emerging Markets tend to be much more concentrated than our markets. 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. International Financial Management 15

Percentage of Market Capitalization Represented by the 10 Largest Stocks: Emerging Equity Markets in Selected Developing Countries International Financial Management 16

Country and Regional Contributions to Global GDP and Equity Market Capitalization (2007) International Financial Management 17

Equity Markets Ranked by Total Market Capitalization at the End of 2008 (Billions of U.S. Dollars) International Financial Management 18

Real Returns on Global Equity Securities, Bonds, and Bills During 1900-2008 International Financial Management 19

Real Returns on Global Equity Securities, During 1990-1999, and 2000-2008 International Financial Management 20

International Comparisons of Stock Ownership in Selected Countries: 2000-2008 International Financial Management 21

Market Structure, Trading Practices, and Costs International Financial Management 22

Market Structure Primary market: New issues are first offered Secondary market: Subsequent trading takes place -They provide Marketability and Share valuation International Financial Management 23

Market order Secondary Market an order for the broker to buy or sell share immediately at the market price Limit order an order to transact at a specified price (the limit price) International Financial Management 24

Limit or Market order? The choice is yours International Financial Management 25

Market Structure Dealer Market The stock is sold by dealers, who stand ready to buy and sell the security for their own account. In the U.S., the OTC market is a dealer market, NASDAQ. Agency Market/Auction Market broker take client s order through the agent, who matches it with another public order. in the U.S., each stock traded on the exchange is represented by a specialist. Automated Exchanges International Financial Management 26

Secondary Markets Characteristics Market structure, types of flow. Continuous (i.e. OTC, NYSE, and AMEX) Non-continuous Call market Crowed trading International Financial Management 27

Secondary Markets Characteristics Characteristics of Major Equity Trading Systems International Financial Management 28

Important Exchanges In The World- America New York Stock Exchange (NYSE) American Stock Exchange (AMEX) National Association of Securities Dealers Automated Quotation System (NASDAQ) International Financial Management 29

Important Exchanges In The World- Europe London Stock Exchange (LSE) Frankfurt Stock Exchange (FTSE) Euronext International Financial Management 30

Important Exchanges In The World- Europe Tokyo Stock Exchange, (TSE) Singapore Exchange, (SGX) The Stock Exchange of Hong Kong, (SEHK) International Financial Management 31

Standards of Major Stock Exchanges International Financial Management 32

Trading in International Equities International Financial Management 36

Trading in International Equities Magnitude of International Equity Trading Cross-listing of Shares Yankee Stock Offerings American Depository Receipts Global Registered Shares International Financial Management 37

Magnitude of International Equities Trading 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. International Financial Management 38

Designing a Strategy to Source Equity Globally Most firms raise their initial capital in their own domestic market. But not well known enough to attract foreign investors. an international bond offering and/or cross-listing equity shares on more highly liquid foreign stock exchanges. International Financial Management 39

Cross-Listing of Shares A firm having its equity shares listed on one or more foreign exchanges. American Depository Receipt (ADR) Global Depository Receipt (GDR) European Depository Receipt (EDR) International Depository Receipts (IDR) Global Registered Shares (GRS) International Financial Management 40

Benefits of Cross-Listing Improve the liquidity Lower cost of capital Expands the investor base for a firm. May mitigate possibility of hostile takeovers. Increase its share price Increase the firms visibility International Financial Management 41

Costs to Cross-Listing and Selling Equity Abroad Full and Transparent disclosure Worldwide trend fuller, more transparent, and more standardized financial disclosure may have the desirable effect of lowering the cost of equity capital. Securities laws in both countries International Financial Management 42

Do cross-listings create value? International Financial Management 43

Yankee Stock Offerings Direct sale of new equity capital to U.S. public investors by foreign firms. Privatization in South America and Eastern Europe Rapid growth in the economies of the developing countries Equity sales by Mexican firms trying to cash in on NAFTA International Financial Management 44

Depository Receipts Negotiable certificates issued by a bank to represent the underlying shares of stock, which are held in trust at a foreign custodian bank. International Financial Management 45

Depository Receipts American Depository Receipt (ADR) Global Depository Receipt (GDR) International Financial Management 46

American Depository Receipts A receipt that represents the number of foreign shares that are deposited at a U.S. bank.(bank of New York) Foreign stocks trade on U.S. exchanges as ADRs. NYSE NASDAQ (OTC) Involved financial entities: depository bank investing financial intermediary International Financial Management 47

International Financial Management 48

Sponsored vs. Unsponsored ADRs Sponsored ADR Program Unsponsored ADR Program Direct involvement of foreign company Foreign company provide Investment information Investors have the same rights Foreign company pay depository fees No direct involvement of foreign company Foreign company provide no investment information Depository bank has the rights Investors pay depository fees International Financial Management 49

Sponsored ADRs Summary of the Main Features of American Depository Receipts International Financial Management 50

Advantages of ADRs denominated in U.S. dollars, trade on U.S. exchanges and can be bought through any broker. Prices & Dividends in U.S. dollars. Most underlying stocks are bearer securities, the ADRs are registered. Represents fraction of a shares, single share or multiple shares of foreign stock International Financial Management 51

Special Risks of ADRs Exchange rate risk Inflationary risk Political risk International Financial Management 52

ADR Pricing PADR = Conv X PFS X S International Financial Management 53

ADR Pricing A share of the ADR of the French firm Pari represents one share of this firm s stock that is traded on a French stock exchange. The share price of Pari was 20 euros when the French market closed. As the U.S. stock market opens, the euro is worth $1.05. What is the no-arbitrage US dollar price of an ADR? Assume that transactions costs are negligible. International Financial Management 54

ADR Pricing PADR = Conv X PFS X S = 1 x 20 x $1.05 = $21 International Financial Management 55

ADR Arbitrage What if Pari ADRs were trading at $20 when the underlying shared were trading in France at 20 euros, what would you do to earn a trading profit? International Financial Management 56

Global Depository Receipt Access to global markets outside home market Raise capital in the Europe and the US Reg S and ADR International Financial Management 57

Benefits of Depository Receipts International Financial Management 58

Global Registered Shares SHAREs traded globally with same price in different currencies Trade in both dollars and euros. Advantage: All shareholders have equal status and voting rights. Disadvantage: More expensive to establish a global registrar and clearing facility Limited success International Financial Management 59

International Equity Market Benchmarks International Financial Management 60

International Equity Market Benchmarks Equity Market Benchmarks Morgan Stanley Capital International (MSCI) Dow Jones World Equity Benchmark Shares (WEBS) -Country-specific baskets of stocks designed to replicate the country indexes of 20 countries and 3 regions. International Financial Management 61

North American Equity Market Benchmarks NAME Dow Jones Industrial Average NASDAQ Combined Composite S&P 300 TSE 300 (CA) Mexico BOLSA Index SYMBOL DJIA CCMP SPX TS300 MEXBOL International Financial Management 62

I Shares MSCI Country- specific baskets of stocks designed to replicate the country indexes of 21 countries and 4 regions. I Shares are exchange traded funds that trade on the American Stock Exchange and are subject to U.S. SEC and IRS diversification requirements International Financial Management 63

Factors Affecting International Equity Returns International Financial Management 64

Factors affecting equity returns Macroeconomic factor Exchange rate Industrial structure International Financial Management 65

Macroeconomic Factors Affect the overall economic environment Interest rate Interest rate differentials Inflation rate Employment rate, etc International Financial Management 66

Macroeconomic Factors The data do not support the notion that equity returns are super strongly influenced by macro factors. It is not to say that macro factors are not important, but we cannot ignore these factors. International Financial Management 67

Exchange Rate Exchange rate movements in a given country reinforce the stock market movements in that country. Weak relationship, so one should be careful not to confuse correlation with causality. International Financial Management 68

Exchange Rate Changes in exchange rates explained a larger portion of the variability of foreign bond markets than foreign equity markets. Hedging is considered to be beneficial. International Financial Management 69

Industrial Structure Studies examining the influence of industrial structure on foreign equity returns are inconclusive. International Financial Management 70

Extreme Losses in Global Equity Markets During 1900-2008 International Financial Management 71

Case Study: Huaneng Power International International Financial Management 72

Huaneng Power International (HPI) Started in 1991 A for-profit and state-run organization A monopoly in power industry of China Mandate for growth Reliable and efficient International Financial Management 73

HPI s Challenge In 1994, HPI needed Rmb 34.3 billion for expansion, but domestic sources were insufficient to this huge requirement. International Financial Management 74

Economic Background Rapid economic growth since 1970s Serious inflation problem followed Electricity became a scare commodity Interest rate differential between China and U.S. Unstable exchange rate International Financial Management 75

Political Background Deng Xiaoping s passing was near. Courts of the PRC was not likely to enforce against the company judgements obtained in foreign courts. No withhold tax on dividends and capital gains earned by foreigners International Financial Management 81

Financial Market Background China s capital market was just emerging International market perception on PRC firms new issue was not expected to be well. HPI offers guaranteed return to attract foreign investors International Financial Management 82

International Market Background Hong Kong market was a reliable source of capital, but it wasn t clear that whether it was saturated. NYSE, NASDAQ, and other international market offer much potential in terms of size, higher valuation, and thirst for emerging market investment. International Financial Management 83

Final Decision HPI decided to tap on the NYSE. HPI entered the NYSE by issuing Level III ADRs HPI adapted the U.S. GAAP. International Financial Management 84

Is this the right timing for HPI to raise capital overseas, and will foreign investors be interested in investing this company? International Financial Management 85

Domestic Issue Right Timing Inefficient self financing Bank incapable to meet capital needs Oversaturation of Hong Kong Market Need for expansion to meet growth needs International Financial Management 86

Right Timing U.S. investors point of view: State-run for-profit organization No tax withholding Prospective growth of stock value (driven by China s energy need) Latest equipment and technologies for efficient operation Guaranteed return International Financial Management 87

Is there any alternatives to stocks HPI can use to finance its expansion? International Financial Management 88

No alternatives Debt financing ( Corporate bond, bank loan, term loan) Increase leverage Change in debt structure and risk level Local banks do not have sufficient capital International banks might not take the risk International Financial Management 89

What are advantages to investors of trading in ADRs rather than the underlying stock? International Financial Management 90

As a foreign investor of HPI, what are the factors that can affect your equity return? International Financial Management 91

Factors to Consider Developing / emerging Chinese market Inflation problem Interest rate differentials Exchange rate risk Political uncertainties International Financial Management 92

Questions?

Content International Financial Management 94