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Module V: International Capital Markets

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Title: Module V: International Capital Markets


1
Module VInternational Capital Markets
  • Week 13 November 18 20, 2002

2
Objectives
  • Understand basics of global capital markets and
    recent developments for corporate financing
    decisions
  • Understand how foreign firms raise capital in the
    United States and elsewhere
  • Examine factors relevant to firms cost of
    financing in using international sources of
    financing

3
International Cases Context
  • The Hostile Bid for Red October
  • Russian equity market risks
  • Inflation
  • Liquidity problems
  • Reporting and transparency issues
  • Political risk taxation, regulation, favoritism
  • Huaneng Power International
  • China in 1994

4
Example Stock Markets 1999
Source IMF Working Paper 00/216
5
Emerging Market Performance
Country Price Index (1988100) Year-to-Date Total Return ()
China 44.89 -4.51
South Korea 51.09 -7.29
Taiwan 117.96 -15.95
Asia 106.96 N/a
East Europe 71.32 N/a
Latin America 531.87 N/a
Composite 198.21 -21.3
SourceIFC SP/IFCI Index, 3/28/2002 (column 2)
and WSJ, 11/15/2002 (column 3)
6
Issues in Global Markets
  • Integration of capital markets
  • How much or how little do events in one market
    reflect events in other markets
  • Expected real returns across markets
  • Benefits of diversification
  • Risk reduction through correlations of returns
  • How to choose portfolio allocations
  • Risks of international investing

7
Recent Findings
  • Importance of global effects has increased in the
    new economy of the 1990s
  • Emerging country specific risk has increased
    dramatically since the crises of the 1990s while
    developed-country specific risk has declined
  • Industry factors, especially technology, probably
    explain higher correlations

8
Global Financial Management
  • Investment in assets
  • Find highest NPV or highest return projects on a
    risk-adjusted basis
  • Cash flows measured in purchasing power of owners
    (maximize shareholders wealth!)
  • Financing
  • Minimize cost of funds on a risk-adjusted basis
  • International finance analysis of currency and
    political risks that are unique to foreign
    operations

9
Currency and Political Risk
  • Currency risk is variability in cash returns due
    to variations in exchange rates
  • For important currencies can be hedged in
    financial markets
  • Often can be hedged on the balance sheet by
    operating and financing policies (recall American
    Airlines and Canada and G.E. turbine sales
    examples
  • Some currencies cannot be hedged what kind of
    risk is currency risk (systematic, liquidity,
    etc.)?

10
International Capital Flows
  • Where are highest real returns to be found in the
    world today?
  • Emerging market economies (educated, hard-working
    labor, low capital stocks)
  • The United States? (capital inflow, new economy,
    benign business environment)
  • Europe? (opening to East, Euro, restructuring)
  • Latin America?

11
Determinants of Capital Flows
  • Take advantage of higher returns
  • Japanese investments in Asian neighbors
  • OPEC investments in diversified economies
  • Benefits from diversification
  • Pension funds and other institutional flows
  • Arbitrage risk-return differentials
  • Temporary differentials that are expected to go
    away, as from political threats that can be
    managed by diversification

12
Issues in International Investing
  • Taxes and/or restrictions of payment of dividends
    or proceeds of sale
  • Currency related issues
  • Ability to hedge and/or convert cash flows
  • Costs of currency hedging and/or conversion
  • Currency risk due to economic fundamentals
    (devaluation/revaluation)
  • Liquidity and transaction costs

13
Equity Trading Costs (One-Way Mean, in Basis
Points)
14
Emerging Market Equity Issues
  • Private equity versus public issues
  • Role played by private investors (like venture
    capital)
  • Importance of marketability for some investors
  • Second board markets
  • Examples MOTHERS in Japan, U.S. NASDAQ Small Cap
    markets
  • Hong Kong GEMs, Korean Kosdaq, Sesdaq

15
Markets and Venture Capital
  • Emerging market economies in Asia have been
    active in developing venture capital industries
  • Most successful (like U.S.) is Taiwan
  • Others differ from U.S. experience, partially for
    cultural reasons
  • Organizational forms and exit possibilities
  • Second board markets in Asia have not represented
    a reliable exit strategy

16
Trends in Equity Trading
  • Global integration in equity trading
  • Natural economies of scale in markets size
    promotes liquidity
  • Technology
  • History and legal system
  • Three models of future markets
  • Concentration, as in NYSE in U.S.
  • Alliances (e.g. Singapore and Australia)
  • Electronic markets (ECNs)

17
Advantages of U.S. Listing
  • Liquidity provided by large markets
  • Established market with global reputation and
    known and enforced rules of conduct
  • Prestige of listing
  • Attractiveness to investors
  • Domestic U.S. retail investors
  • Reporting and currency issues
  • Institutional investors
  • Liquidity and liability concerns

18
American Depository Receipts
  • American depository receipts (ADRs) are used for
    foreign companies to trade on U.S. markets
  • Shares deposited in custodial bank in firms home
    countries
  • ADRs have grown in popularity since 1980s
  • Institutional investors wishing international
    diversification
  • Foreign firms wishing to raise funds in U.S.
  • Several levels of ADRs

19
Levels of ADRs
  • Level I
  • Simplest but unlisted and traded over-the-counter
    (pink sheets)
  • Reporting requirements are minimal (Form F-6)
  • Level II
  • Required to list on exchanges (NYSE, AMEX,
    NASDAQ)
  • Disclosure but not meeting U.S. standards
  • Level III
  • Full compliance with U.S. reporting requirements
    (using GAAP standards)

20
ADRs on NYSE 2000
Country/ Region ADR Issues Shares (mill) Volume ( mill) Market Cap ()
China 13 166.5 5,631.0 2,480.3
Japan 13 242.8 22,588.0 10,594.5
S. Korea 5 351.0 15,469.9 6,649.5
Taiwan 4 229.1 14,299.0 2,858.8
Asia 64 2,346.1 920,617.6 45,331.2
Europe 174 9,763.3 514,235.1 399,607.2
L. America 103 3,563.4 141,416.9 79,795.9
21
China
  • Shanghai and Szenzhen stock exchanges
  • A and B shares
  • Currency (remninbi) non-convertible but
    discussion of changing policies
  • Rapid growth in non-government sector
  • State-owned enterprises (SOEs) and town and
    village enterprises (TVEs)
  • Banks and trust-and-investment companies

22
Who Owns Chinese Corporations?
  • SOEs partially privatized
  • Shares traded in China
  • Ownership by a variety of institutions
  • Stakes in firms also owned by
  • Regional governments
  • Government ministries
  • TVEs
  • Pension funds and TICs
  • Goal of management?

23
Next Week Nov. 25 27, 2002
  • Review topics covered in RWJ, Chapter 13
  • Read and think carefully about issues of
    corporate governance in xxx case for discussion
    on November 25 and remember that this is the last
    individual case write-up
  • Use week of December xxx to begin review for
    final exam by reviewing course syllabus and
    weekly objectives and slides
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