International Equity Markets
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Chapter Eight
Chapter Objective: This chapter discusses both the primary and secondary equity markets throughout the world. Chapter Outline A Statistical Perspective International Equity Market Benchmarks World Equity Market Benchmark Shares Trading in International Equities Factors Affecting International Equity Returns 1
Statistical Perspective World’s Equity Market Capitalization at year-end 2006: $52 trillion Almost 83% of the market cap. is accounted for by the market cap. of the developed world. The other 17% is accounted for by the market capitalization of developing countries in “emerging markets”. Latin America Asia Eastern Europe Mideast/Africa Recently the growth rates in these emerging markets have been strong, but with more volatility than we have here at home. 2
Capitalization of Equity Markets in Developed Countries (US$bn)
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Market Capitalization in Selected Emerging Markets (US$ bn)
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Statistical Perspective From 1996 to 2006 market cap. In developed countries increased 140% from $18 Tr. to $43 Tr. Increase was not evenly distributed: 177% for Europe, 137% for North America, and 95% for Far East The equity markets of the developed world tend to be much more liquid than emerging markets. Turnover ratio = market transactions($) / market cap.
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Turnover Ratio of Equity Markets in Industrial Nations (annual value transactions/year-end capitalization)
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Market Structure Primary Markets
Shares offered for sale directly from the issuing company.
Secondary Markets
Provide market participants with marketability and share valuation.
Shares traded in the secondary market do not supply fresh funds to the issuing firm. Then how are primary and secondary markets related? 7
Secondary Markets 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.
Auction Market
Organized exchanges have specialists who match buy and sell orders. Buy and sell orders may get matched without the specialist buying and selling as a dealer.
Automated Exchanges
Computers match buy and sell orders. 8
International Equity Market Benchmarks Equity Market Benchmarks An index of stocks from a particular country (or region) is used to measure or gauge the activity and performance of that country’s (or region’s) equity market(s). Low cost, convenient way for investors to hold diversified investments in several different countries. Morgan Stanley Capital International (MSCI) World Index
Market –value weighted index of 2,600 share issues of major corporations worldwide. Also many regional indices, emerging market indices.
Dow Jones provides national indices. Barclay’s Global Investors introduced iShares MSCI, exchange-traded index funds designed to replicate the returns to 21 countries and four regions (see www.ishares.com ) 9
Dow Jones Country Stock Market Indices
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Trading in International Equities ď ˇ During the 1980s world capital markets began a trend toward greater global integration. ď ˇ Diversification, reduced regulation, improvements in computer and communications technology, increased demand from MNCs for global issuance. 11
Cross-Listing of Shares 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:
It expands the investor base for a firm. 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. May improve corporate governance 12
Canadian Cross-listed Shares About 233 Large Canadian Corporations
NYSE (88) NASDAQ (90) AMEX or others (32) LSE (23)
Enhanced visibility and access to larger market for new issues Reduced cost of capital Lower information asymmetry for investors. Research found:
Cross-listed firms show strong performance at home beforehand Once listed, they underperform their at-home Canadian peers on average for three years. 13
The European Stock Market Euronext N.V. is pan-European stock market based in Amsterdam, Netherlands with subsidiaries in Belgium, France, Portugal and the United Kingdom.
It operates in equities and derivative markets and provides clearing and information services; By January 2007 it was the fifth largest exchange with over US$3.2 trillion in market capitalization. Euronext was acquired by NYSE in April 2007
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American Depository Receipts It is a receipt that represents the number of foreign shares that are deposited at a U.S. bank. Bank of New York is the main depository bank The bank serves as a transfer agent for the ADRs There are many advantages to trading ADRs as opposed to direct investment in the company’s shares:
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. 15
American Depository Receipts Level 1 ADRs -
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OTC Easiest, least expensive and least regulated way for foreign companies to market ADRs in USA Requires minimal SEC registration Cannot be used to raise new capital
Level 2 ADRs -
Sold on Nasdaq, NYSE and AMEX Stricter SEC requirements More liquid than Level 1 ADRs
Level 3 ADRs -
Are used to raise new equity capital in US markets. Stricter requirements than Level 1 and Level 2 ADRs. 16
Global Registered Shares DaimlerChrysler AG is a German firm, whose stock trades as a GRS. GRS are one share traded globally, unlike ADRs, which are receipts for banks deposits of homemarket shares and traded on foreign markets. They trade in both dollars and euros. All shareholders have equal status and voting rights. 17
Factors Affecting International Equity Returns Macroeconomic Factors
International monetary variables (such as Interest rate differentials, change in domestic inflation expectations) have only weak influence on equity returns in comparison to domestic variables. (Solnik 1984)
Exchange Rates
Changes in exchange rates generally explain a larger portion of the variability of foreign bond indexes than foreign equity indexes, but that some foreign equity markets are more exposed to exchange rate changes than are the respective foreign bond markets. (Adler and Simon, 1986) Cross-correlations studies among major stock markets and exchange markets are relatively low but positive. The exchange rate changes in a given country reinforce the stock market movements in that country as well as in the other countries examined. (Eun and Resnick, 1988)
Industrial Structure
Studies examining the influence of industrial structure on foreign equity returns are inconclusive. 18