If 2

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
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 companys NET assets.
It plays a fundamental role in investment analysis and portfolio management.
A Statistical Perspective
A Statistical Perspective
Market Capitalization of Developed Countries Market Capitalization of Developing Countries Measures of Liquidity Measures of Market Concentration
Market Capitalization
Worlds 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
Market Capitalization of Equity Markets in Developed Countries (in Billions U.S. Dollars)
Market Capitalization of Equity Markets in Selected Developing Countries (in Billions U.S. Dollars)
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 $43 Tr. Increase was not evenly distributed: 177% for Europe, 137% for North America, and 95% for Far East
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Measures of Liquidity
Liquidity refers to how quickly an asset can be sold without a major price concession. The equity markets of the developed world tend to be much more liquid than emerging markets. So, while investments in emerging markets may be profitable, the focus should be on the long term.
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Turnover Ratio
Market transactions($)
Turnover ratio =
Market cap
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Turnover Ration of Equity Markets in Developed Countries (Transaction in U.S.$/Year-End Market Capitalization in U.S. $)
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Turnover Ration of Emerging Equity Markets in Selected Developing Countries

(Transaction in U.S. $/Year-End Market Capitalization in U/S/ $)
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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.
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Percentage of Market Capitalization Represented by the 10 Largest Stocks: Emerging Equity Markets in Selected Developing Countries
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Country and Regional Contributions to Global GDP and Equity Market Capitalization (2007)
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Equity Markets Ranked by Total Market Capitalization at the End of 2008 (Billions of U.S. Dollars)
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Real Returns on Global Equity Securities, Bonds, and Bills During 1900-2008
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Real Returns on Global Equity Securities, During 1990-1999, and 2000-2008
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International Comparisons of Stock Ownership in Selected Countries: 2000 - 2008
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Market Structure, Trading Practices, and Costs
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Market Structure
Primary market: New issues are first offered Secondary market: Subsequent trading takes place -They provide Marketability and Share valuation
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Secondary Market
Market order
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)
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Limit or Market order?

The choice is yours
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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 clients 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
Secondary Markets Characteristics

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

Characteristics of Major Equity Trading Systems
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Important Exchanges In The World- America

New York Stock Exchange (NYSE)
American Stock Exchange (AMEX)

National Association of Securities Dealers Automated Quotation System (NASDAQ)
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Important Exchanges In The World- Europe

London Stock Exchange (LSE)
Frankfurt Stock Exchange (FTSE)

Euronext
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Important Exchanges In The World- Europe

Tokyo Stock Exchange, (TSE)
Singapore Exchange, (SGX)

The Stock Exchange of Hong Kong, (SEHK)
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Standards of Major Stock Exchanges
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Trading in International Equities
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Trading in International Equities

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

1980sworld 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.
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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.
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)
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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
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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

Do cross-listings create value?
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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
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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.
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Depository Receipts
American Depository Receipt (ADR) Global Depository Receipt (GDR)
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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
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Sponsored vs. Unsponsored ADRs

Sponsored ADR Program
Direct involvement of foreign company Foreign company provide Investment information Investors have the same rights Foreign company pay depository fees
Unsponsored ADR Program

No direct involvement of foreign company Foreign company provide no investment information Depository bank has the rights Investors pay depository fees
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Sponsored ADRs
Summary of the Main Features of American Depository Receipts
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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
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Special Risks of ADRs

Exchange rate risk Inflationary risk Political risk
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ADR Pricing
ADR
= Conv X P X S
FS
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ADR Pricing
A share of the ADR of the French firm Pari represents one share of this firms 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.
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ADR Pricing
P
ADR
= Conv X P X S
FS
= 1 x 20 x $1.05 = $21
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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?
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Global Depository Receipt

Access to global markets outside home market Raise capital in the Europe and the US
Reg S and ADR

Benefits of Depository Receipts
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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
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International Equity Market Benchmarks
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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.
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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
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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
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Factors Affecting International Equity Returns
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Factors affecting equity returns

Macroeconomic factor
Exchange rate Industrial structure
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Macroeconomic Factors
Affect the overall economic environment
Interest rate Interest rate differentials Inflation rate Employment rate, etc
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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.
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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.
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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.
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Industrial Structure
Studies examining the influence of industrial structure on foreign equity returns are inconclusive.
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Extreme Losses in Global Equity Markets During 1900-2008
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Case Study: Huaneng Power International
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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
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HPIs Challenge
In 1994, HPI needed Rmb 34.3 billion for expansion, but domestic sources were insufficient to this huge requirement.
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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
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Political Background
Deng Xiaopings 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
Financial Market Background

Chinas 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 Market Background

Hong Kong market was a reliable source of capital, but it wasnt 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.
Final Decision
HPI decided to tap on the NYSE.
HPI entered the NYSE by issuing Level III ADRs HPI adapted the U.S. GAAP.
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Is this the right timing for HPI to raise capital overseas, and will foreign investors be interested in investing this company?
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Right Timing
Domestic Issue
Inefficient self financing Bank incapable to meet capital needs Oversaturation of Hong Kong Market Need for expansion to meet growth needs
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Right Timing
U.S. investors point of view:
State-run for-profit organization No tax withholding Prospective growth of stock value (driven by Chinas energy need) Latest equipment and technologies for efficient operation Guaranteed return
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Is there any alternatives to stocks HPI can use to finance its expansion?
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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
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What are advantages to investors of trading in ADRs rather than the underlying stock?
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As a foreign investor of HPI, what are the factors that can affect your equity return?
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Factors to Consider
Developing / emerging Chinese market Inflation problem Interest rate differentials Exchange rate risk Political uncertainties
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Questions?
Content
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International Equity Markets

Dora Chen, Zhen Zhang, Daisy Guo, Spencer Hu,

International Equity Markets

International Financial Management

International Financial Management

International Financial Management

International Financial Management

-Europe -Far East -Atlantic -North America

-Latin America -Asia -Eastern Europe -Mideast/Africa

International Financial Management

International Financial Management

International Financial Management

Growth of Global Equity Market

International Financial Management

International Financial Management

International Financial Management

International Financial Management

Turnover Ration of Emerging Equity Markets in Selected Developing Countries

International Financial Management

Measures of Market Concentration

International Financial Management

International Financial Management

International Financial Management

International Financial Management

International Financial Management

Real Returns on Global Equity Securities, During 1990-1999, and 2000-2008

International Financial Management

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

International Financial Management

Market Structure, Trading Practices, and Costs

International Financial Management

International Financial Management

International Financial Management

Limit or Market order?

International Financial Management

Agency Market/Auction Market

Secondary Markets Characteristics

International Financial Management

Secondary Markets Characteristics

International Financial Management

Important Exchanges In The World- America

American Stock Exchange (AMEX)

International Financial Management

Important Exchanges In The World- Europe

Frankfurt Stock Exchange (FTSE)

International Financial Management

Important Exchanges In The World- Europe

Singapore Exchange, (SGX)

International Financial Management

Standards of Major Stock Exchanges

International Financial Management

Standards of Major Stock Exchanges

International Financial Management

Standards of Major Stock Exchanges

International Financial Management

Standards of Major Stock Exchanges

International Financial Management

Trading in International Equities

International Financial Management

Trading in International Equities

International Financial Management

Magnitude of International Equities Trading

International Financial Management