Emerging Markets Finance
Spring 2002
Wei Li
Darden School of Business
Acknowledgement: Some of the materials are drawn from IMF reports and from Professor Walter Molano’s emerging
market course.
Emerging Markets Defined
 Income.
 Lower and middle income economies with
per capita income < $9,656 in 1997.
 Financial market depth.
 Investable market capitalization/GDP < 20%
(Note: Investable market capitalization is a market's
capitalization after removing holdings not truly "in the market"
for foreign portfolio investors. Non-investable holdings include,
but are not limited to, large block holdings and parts of
companies that are inaccessible due to foreign investment
limits.)
Global mix of natural resources
Global mix of capital
Opportunities for exchange
 The mismatch between resources and
population provides an excellent
opportunity for trade (exchange of goods
and services).
 The mismatch between capital and
population provides an excellent
opportunity for investment (exchange of
assets).
 Emerging Markets Finance is the
vehicles that facilitate the interchange
of resources and capital.
Financial vehicles
 Trade finance
 Usually short term facilities
 Foreign direct investment
 Usually cross-border project and corporate finance
performed by multinationals in setting up new
productive capacity. Usually long-term in nature – 510 years time horizon
 Recently FDI flows have included services, such as
electricity and telecommunications
 Portfolio investments—equity and debt investments in
corporate or sovereign entities
 Very volatile
 Highly dependent on short-term liquidity conditions,
such as interest rates and US monetary policy
Global exchange of factors
Net Private Capital Flows to and Gross Private Issuance in
Emerging Markets (Source: IMF)
Net private capital flow to emerging markets
Summary
 Comparative advantage is a power tool for
understanding capital flows.
 Emerging markets financial activity focuses mainly on
Asia, Latin America, and the Emerging Europe.
 The main areas of investment are in foreign direct
investment, trade finance, and portfolio investment.
 The areas of activity are largely dependent on the
region. For example, fixed income trading is largely
focused on Latin America. Equity investment
concentrates in Asia. Foreign direct investment
activity is strong in both regions and in emerging
Europe.
Emerging markets finance
 Focuses on direct investment
 Has two central themes
 Risk management
 Valuation
 Country risk approach
 Downside risk approach
 Real options
Gerber: What happened?
 Gerber purchased 60% of Alima on
February 13, 1992.
 Promised to keep all current employees
for at least 18 months and increased all
salaries by 40%
 In fiscal year 1993 (ended March 30),
Gerber reported profits in “the sevenfigure category”.
Gerber Summary
 Two strategic considerations:
 Alima as a “Euro facility”—access to both east and
west Europe. An expansion option (a call option).
 At the minimum, it will cost less to ship baby food to
France from Poland than from the US.
 A good deal: $25 million is far less than that a
greenfield plant ($75-100 million)
 Mitigating political risk: Leave a large portion of its
$11 million investment in an escrow account in
London. Gerber agreed to release the monies as the
Poles met the negotiated terms—mainly the tax
credit.
 Gerber bears most of the macroeconomic and project
risks. Should the cost of capital be higher than 15%?
EMDB Coverage
S&P/IFCG (Global)
•
•
Broadest constituent base
•
•
•
No adjustments for foreign investment restrictions
Covers 60% of total exchange market
capitalization
Daily calculation
Industry indices calculated monthly
S&P/IFCI (Investable)
•
Foreign investment restrictions incorporated
at constituent level
•
•
Size and liquidity screens
•
•
Daily calculation
Corporate cross-holding & government
ownership adjusted
Industry indices calculated monthly
S&P/IFCG Frontier
•
•
•
•
Introduced in 1996
20 markets
Included if trading occurs regularly; activity typically thin
Graduate to S&P/IFCG daily series when liquidity increases