FNCE 4070: FINANCIAL MARKETS
AND INSTITUTIONS
Lecture 9: Global Debt and Equity
Markets
With a Discussion of the
Globalization of Financial
Markets and the
Implications of Global
Markets for Borrowers
and Investors
Where is this Financial Center?
Arab Spring Risk. Cairo stock
market closed from January
27, 2011 to March 23, 2011
Long Term Risk: Investing in the
Japanese Stock Market
January 1990 – April 2012
-75%
January 1984 – January 1990
+270%
Fads in Equity Markets
January 2008 – December 2008
-61%
January 2006 – January 2008
+275%
January 2000 – January 2006
-17%
Importance of Capital Markets to
World Economy
World's Capital Market as a Percent of World GDP
500.00
450.00
439.62
418.27
401.50
400.00
350.00
330.60
358.87
369.24
370.29
397.50
361.80
300.00
250.00
200.00
150.00
100.00
2002
2003
2004
2005
2006
2007
World's Capital Market % of World GDP
2008
2009
2010
Institutional Arrangements in
Corporate Funding

The historical institutional patterns of corporate
borrowing in various countries have influenced
the development a country’s bond markets and
equity markets.


In Japan and Germany, companies have relied less on
equity markets for funds than their counterparts in the
U.S. In both of these counties, banking has been a
relatively more important source of funds.
In Europe, the close ties between banks and their
corporate clients hindered the development of a
European corporate bond market.

That changed, however, with the launch of the euro in 1999,
which promoted the development of Europe’s bond market.
Importance of Banking Markets for
the U.S., Japan and Germany
Banking Assets as a % of
Country’s GDP
250.0
Banking Assets as a % of
Country’s Capital Markets
60.0
50.0
200.0
40.0
150.0
30.0
100.0
20.0
50.0
10.0
0.0
0.0
2002 2003 2004 2005 2006 2007 2008 2009 2010
2002 2003 2004 2005 2006 2007 2008 2009 2010
U.S. Banking % GDP
U.S. Banking % Capital Market
Germany Banking % GDP
Germany Banking % Capital Market
Japan Banking % GDP
Japan Banking % Capital Market
Changing Corporate Capital
Structures
Japan, Germany & the U.K. Changing Debt/Equity
Ratios, 1977 - 1985
 During the early post war years,




Japanese corporation relied
heavily on banks and the bond
markets to finance their capital
structures.
In the 1970s, Japanese
corporate debt to equity ratios
were 4 times as high as that of
U.S. companies.
But, by the late 1980s, corporate
Japan and the U.S. had similar
leverage ratios.
Germany continued to rely
heavily on its banking market.
The U.K. paralleled the U.S.
during this time.
Germany
Japan
Changing Nature of the Global
Bond Market


Historically, the U.S. bond market dominated the global
bond market, with the U.S. market representing a key
source of financing for U.S. and foreign corporations.
However, since the expansion of the European Union and
the advent of the Euro-Zone, Europe’s importance in the
global bond market as grown.


In 2002, the U.S represented 43.7% of the world’s bond market;
the European Union represented 29.4%. By 2010, the U.S. share
of the global bond market had fallen to 34.3% and the European
Union’s share had grown to 32.9%.
In 2002, the U.S represented 53.8% of the world’s private bond
market; the European Union represented 29.2%. By 2010, the U.S.
share of the global private bond market had fallen to 40% and the
European Union’s share had grown to 38.9%.
Trends in Global Bond Markets
Percent of Total Bond
Market
45.0
Percent of Private Bond
Market
60.0
55.0
40.0
50.0
45.0
35.0
40.0
35.0
30.0
30.0
25.0
25.0
20.0
2002 2003 2004 2005 2006 2007 2008 2009 2010
20.0
2002 2003 2004 2005 2006 2007 2008 2009 2010
U.S. % Bond Markets
E.U. % Bond Markets
U.S. % Private Bond Markets
E.U. % Private Bond Markets
Individual Country Private Bond
Markets; % of Total, 2002 - 2010
50.0
53.8
U.S. % of Private
Bonds
40.0
40.0
Japan % of Private
Bonds
30.0
Germany % of Private
Bonds
20.0
France % of Private
Bonds
10.0
8.3
3.9
0.0
2002
2003
2004
2005
2006
2007
2008
2009
2010
Newly Industrialized
and Emerging % of
Private Bonds
Bond Market Growth in Europe:
Pre and Post the Euro
Bond Market Growth in Europe
Since the Introduction of the Euro
Classifying the World’s Bond Markets

The world’s bond market can be divided into two
broad groups:



(1) The domestic bond market is comprised of all
securities issued in each country by “domestic”
government entities and corporates.


(1) the domestic bond market and
(2) the international bond market.
In this case, issuers are domiciled (i.e., headquartered) in
the country where those bonds are traded.
(2) The international bond market is comprised of
non-residents borrowing in another country’s bond
markets



Furthermore, the international bond market consists of two
groups:
(1) Foreign Bonds and
(2) Eurobonds.
Domestic Versus International Bond
Market by Country; % of GDP, 2009
Foreign Bonds: Characteristics

Foreign Bonds are bonds issued by a non-resident
and denominated in the currency of the country in
which it is being placed (i.e., issued).


Foreign bonds are subject to the regulations of the
country in which the bond is being offered.


The SEC regulates foreign bond offerings in the U.S.
Historically, the most important foreign bond markets
have been in Zurich, New York, and Tokyo.


Example: Ford Motor Corporation issuing a yen denominated
bond in Japan
Zurich and Tokyo because of low market interest rates; the
U.S. because of its large market.
Foreign bonds are often swapped out for another
currency.
The Use of the Foreign Bond Market


In contrast to IPO equity financing, where the majority of
U.S. firms exhibit a strong home bias, in bond financing a
growing number of U.S. issuers are relying more on foreign
bond markets for funding.
For example: The percent of all U.S. firms issuing bond’s
domestically fell from 92% in 1995 to 82% in 2006.
Additionally, the share of non-financial U.S. firms issuing
bonds domestically declined from 95% to 83% over the
same period.


Thus, U.S. corporates are increasing their funding presence in
the foreign bond markets.
At the same time, the share of European issuers borrowing
in the U.S. bond market dropped from around 20% in 2000
to approximately 9% in 2006.

Thus, European firms are increasing turning to their own markets
In addition to issuing more equity in their home markets for debt
financing
Unique Names for Foreign Bonds

The financial markets
have come up with
unusual nicknames for
foreign bonds. These
include:

Yankee bonds






Issued in Japan.
Issued in Canada.
Panda bonds


Issued in Australia.
Maple bonds


Issued in New Zealand.
Kangaroo bonds


Issued in the United
Kingdom.
Kiwi bonds

Issued in the Netherlands.
Samurai bonds


Issued in Spain.
Rembrandt bonds
Bulldog bonds

Issued in the United States.
Matador bonds


Issued in China.
Kangaroo or Matilda
bonds

Issued in Australia.
Eurobonds

Eurobonds are bonds issued by a non-resident
and denominated in other than the currency of
the country in which it is being placed.





The bond’s currency of denomination is referred to as an
offshore currency.
Example: Coca Cola issuing a U.S. dollar denominated
bond in Europe.
They are generally issued and sold simultaneously
in more than one market and thus the advantage of
the Eurobond market is that issuers can raise large
sums of capital from investors all around the world.
Issuers include national governments,
supranational organizations (such as the World
Bank),“AAA” corporations and global banks.
The U.S. dollar is the dominant currency of
denomination for Eurobonds.
History of the Eurobond Market

The first Eurobond (which was also a U.S. dollar
denominated bond) was the July 1963 issue by the Italian
Autostrade (Italian National Highway Authority), led by SG
Warburg & Co and issued in London.




$15 million; 5.5% coupon; 15 year bonds; listed on the London
and Luxembourg stock exchanges.
By 1972, the market had grown to $5 billion; $42 billion by
1982 and $371 billion by 1995.
In the early 1960s, the Eurobond market was mainly a
Eurodollar bond market.
Today, the Eurobond market comprises bonds
denominated in all the major currencies and several minor
currencies.

For example, in 1996, the Eurobond market included issues
denominated in the Egyptian pound, Polish zloty and Croatian
kuna.
The Main Features of a Eurobond



Eurobonds are not regulated by the country of the currency in
which they are denominated.
Eurobonds are “bearer bonds”, i.e., they are not registered
anywhere centrally, so whomever holds (or bears) the bond is
considered the owner. Bearer status also enables Eurobonds
to be held anonymously.
The Eurobond market is largely a wholesale (i.e., institutional
market) with bonds held by large institutions.



Pension funds, insurance companies, mutual funds
Since they are denominated in an offshore currency, investors
in euro-bonds assume both credit and foreign exchange risks
(if the currency if denomination is other than their home
currency).
Some publically offered eurobonds trade on stock exchanges,
normally in London or Luxembourg. Others are placed
directly with institutional investors without a listing (private
placement).
Rise of the Euro-Bond Market

The Eurobond market offers several
advantages for borrowers that may account
for its rising popularity.



(1) It gives U.S. borrowers access to a wider
range of lenders, enabling them to diversify their
sources of long-term funding.
(2) The market provides a good environment for
internationally active companies to hedge foreign
currency exposures (through offsetting liabilities)
(3) finally, through this market companies can
enhance their global profile.
Nicknames for Eurobonds



Dragons: U.S. dollar denominated bonds
issued in Asia.
Shogun: Foreign currency bonds (including
U.S. dollar bonds) issued in Japan
Dim-Sum: Chinese yuan denominated bond
issued in Hong Kong.
Equity Markets


For most of the post WW II years, U.S. equity
markets had routinely attracted the lion’s
share of global equity activity, especially from
markets that were themselves considered
relatively important (size, liquidity, regulation).
However, following the dramatic evolution in
globalization since the early 1990s, an
increasing number of alternative financial
centers have developed and achieve the
level of sophistication needed to attract global
equity business.
Early History of Equity Markets

In 1899, London was the world’s leading
financial center, with an estimated 30% of the
global stock market.


The U.S. ranked second with just under 20% but
was gaining momentum. Other European
countries held significant market caps, namely
France and Germany with 14% and 7%,
respectively. (Note only 18 countries had “major”
stock markets in 1899).
By 1970, the U.S. equity markets accounted
for 2/3rds of the world’s total equity market.
Rise of Foreign Stock Markets

In 1985, the market value of foreign stock
markets combined exceeded the market
value of the U.S. stock market. By 2005, the
U.S. share had fallen to 40%, and currently it
is approximately 31%

Over this time we have seen an unparalleled rise
in stock markets around the world. Today, almost
every country possess a stock market, and some
with multiple markets.

For example: Today India has 23 stock exchanges,
trading over 12,000 companies (Sept, 2011).
Trends in Global Equity Markets,
2002- 2010
50.0
45.0
U.S. % World Equity Market
% of Total
40.0
35.0
Japan % World Equity Market
30.0
U.K. % World Equity Market
25.0
Canada % World Equity Market
20.0
Germany % World Equity Market
15.0
France % World Equity Market
10.0
Rest of the World % World Equity
Market
5.0
0.0
2002
2003
2004
2005
2006
2007
2008
2009
2010
But the U.S. Equity Market Still
Dominates: Stock Market
Capitalization, By Country, 2011
But at the Same Time U.S. Share of
Equity Financing Has Declined
Which is Represented by a
Declining U.S. Share of Narrowly
Defined (Public Offerings)IPOs
IPOs by U.S. Companies Done
Entirely Outside of the U.S.
Cross Listing Equity Shares


Cross listing refers to the listing of a company's
common shares on a different exchange other
than its primary and original stock exchange. In
global finance, the term applies to the listing of
foreign-based companies on national exchanges
other than (and in addition to) its home
exchange.
Example of cross listings:


Citigroup currently lists its stock on both the NYSE
and the Tokyo Stock Exchange .
Sony Corporation currently lists its shares on the
Tokyo Stock Exchange, the NYSE and the
London Stock Exchange.
Why do Firms Cross List?



•
•
•
(1) Improved liquidity: A listing on a more-liquid stock market can potentially
increase a stock's liquidity and produce larger price earnings multiples. Thus, firms
with shares trading in small, less liquid markets may see price benefits from cross
listing in larger secondary markets overseas; thus positive impact on value of the
firm.
(2) Raising capital: Having shares trade in multiple countries increases the ability of
firms to raise capital. Cross listing as part of an IPO or secondary offering in the
foreign market.
(3) Increasing the firms visibility to potential customers, suppliers and
creditors (e.g., banks and bond markets): Thus, increase sales and expand
funding opportunities.
(4) Information quality: A firm's willingness to cross-list its stock on a market with
stringent disclosure requirements and strong investor-protection laws can provide
outside investors with information they may need to determine the quality of the firm's
accounting information and financial statements.
(5) Investor protection: This motivation, described in academic research as
"bonding," is based on the idea that registration on a US exchange acts as a
mechanism that voluntarily commits the firm to a higher standard of corporate
governance and investor protection. Bonding therefore might make firms attractive to
risk-averse investors who might otherwise be reluctant to invest.
(6) Cost of capital benefits: Cross listing may lower a company’s cost of capital
through improving liquidity, better corporate governance, and providing direct access
to foreign capital markets. See next slide.
Impact of Cross Listing on Cost of
Capital (Data: 1970 -1996)
Australia
Canada
UK
Europe
Asia
Before Cross Listing
13.74%
8.17%
15.56%
8.80%
16.15%
After Cross Listing
12.15%
7.49%
12.91%
8.47%
14.08%
Difference in Basis
Points
-159
-68
-265
-33
-207
Cost of Capital:
Source: Andrew Karolyi, Financial Markets and Institutions,
1998.
Cross Listings for Selected Exchanges
Domestic and Foreign Firm Listings; Percent of Total
Firms (#), March 2011
100
90
80
70
60
50
40
30
20
10
0
99
90
89
87
80
77
59
41
Domestic
23
Foreign
20
13
11
10
1
Singapore NYSE
London
NYSE
NASDAQ Deutsche
(782) Euronext (2938) Euronext (2760)
Börse
US (2312)
Europe
(756)
(1132)
Tokyo
(2293)
History of Cross Listing

Number of Companies
Cross Listing:

1950s:
114
1960s:
135
1970:
255
1980:
741
1990:
1,350
2000s:
2,784
Total:
5,379*
*Number represents gross
listings (thus, not excluding any
delistings which occurred)
Source: (1950s through 1990s)
Schill and Sarkisian, CrossListing Waves, 2011. World
Federation of Stock Markets,
Annual Reports, (2000 – 2009)









Dominant host country
listing site (firm listings)

1950s: U.K.: (South Africa
firms)
1960s: France: (U.S. firms)
1970s: U.K.: (U.S. and Irish
firms)
1980s: Japan (U.S. and U.K.
firms)
1990s: U.S. (Canadian and
emerging market firms)
2000s: U.S. (emerging
market firms)





Distribution of Cross Listings by
Country of Listing: 1950 – April 2006
Country
1950s
1960s 1970s
1980s
1990s
2000s
Total
% of
Total
U.S.
5
26
42
263
703
367
1,403
39.1%
U.K.
22
26
63
105
184
71
471
13.1%
Luxembourg 3
5
18
8
133
118
285
7.9%
France
28
24
64
38
18
194
5.4%
10
41
129
13
193
5.4%
28
55
37
14
166
4.6%
12
110
13
3
138
3.8%
22
Germany
Switzerland
13
19
Japan
Belgium
24
19
24
18
26
11
122
3.4%
Canada
1
1
5
10
23
58
98
2.7%
Total
Source: Schill and Sarkisian, Cross-Listing Waves, 2011.
3,592
Distribution of Cross Listings by Home
Country of Listing Firm: 1950 – April 2006
Country
1950s 1960s 1970s
1980s
1990s
2000s
Total
% of
Total
Canada
16
19
16
177
258
144
630
17.5%
U.S.
49
50
80
181
101
63
524
14.6%
U.K.
2
11
22
65
130
53
283
8.2%
7
55
83
71
18
234
6.5%
3
2
33
102
31
172
4.8%
2
1
67
94
164
4.6%
1
20
90
37
149
4.2%
9
10
29
7
81
2.3%
16
21
37
1.0%
Japan
Australia
1
India
Israel
1
S. Africa
18
China
8
Total
Source: Schill and Sarkisian, Cross-Listing Waves, 2011.
3,592
Distribution of Cross Listings by
Industry: 1950 – April 2006
Industry
1950s 1960s 1970s
1980s
1990s
2000s
Total
% of
Total
Electronics
6
12
40
74
178
177
427
11.9%
Financials
3
9
38
95
190
89
424
11.8%
Mining
23
13
16
101
124
89
366
10.2%
Telecom &
Media
5
8
7
56
157
82
315
8.8%
Consumer
Goods
9
20
20
64
126
43
282
7.9%
Oil & Gas
10
12
21
65
100
50
258
7.2%
Total
Source: Schill and Sarkisian, Cross-Listing Waves, 2011.
3,592
Cross Listing on The Tokyo Stock
Exchange

Last foreign company listing
was Citigroup on Nov 5, 2007.
60
40
20
Number of Foreign Companies
Number of U.S. Companies
2008
2006
2004
2001
1999
1997
1995
1993
1991
1989
0
1987
http://www.tse.or.jp/english/listin
g/foreign/transition.html
80
1985

100
1983

Foreign company listings
peaked in December 1991 at
127 (with U.S. companies at
78)
By November 2011, the
number of foreign companies
listed had fallen to 11 (with
U.S. companies at 8).
120
1981

6 companies (5 U.S.
companies) listed that year.
1979

140
1977
The Tokyo Stock Exchange
first permitted foreign
companies to list in 1973.
1975

End of the Year Data
1973
History of Foreign Listings
NYSE Foreign Company Listings:
1956 – 2008: Impact of SOX?
Non-U.S. Companies
% of Total
Peak of 473 in 2002; 410 in
2008
Peak of 18% in 2003; 12% in
2008
50
2
0
0
Non U.S. Number of Companies
2007
4
2004
100
2001
6
1998
150
1995
8
1992
200
1989
10
1986
250
1983
12
1980
300
1977
14
1974
350
1971
16
1968
400
1965
18
1962
450
1959
20
1956
500
Foreign companies as a % of total
Demutualization of Stock Exchange

Since the turn of this century an increasing number of
stock exchanges have become public traded, for
profit, organizations





Visit the following sites:




Historically stock markets were private organizations.
However, in February 2001, Germany’s stock exchange, the Deutsche
Stock Exchange went public;
In July 2001, both the London Stock Exchange and Euronext went
public;
On March 8, 2006, the NYSE went public.
http://finance.yahoo.com/q?s=NYX&ql=0
http://finance.yahoo.com/q?s=LSE.L&ql=0
http://finance.yahoo.com/q?s=DB1.DE
Implications of publically traded exchanges:


Inclusion of exchanges in investor portfolios.
Facilitates mergers and take-overs (hostile or friendly) of exchanges.
Consolidations Among Exchanges

On September 22, 2000, the Euronext Stock Exchange was
formed through the merger of the national stock exchanges of
France, Belgium, and the Netherlands.



On April 4, 2007, the New York Stock Exchange and Euronext
merged to form NYSE Euronext.
On July 7, 2011, the stockholders of NYSE Euronext agreed to a
merger with the Deutsche Exchange


In December 2001, Euronext acquired the shares of the London International
Financial Futures and Options Exchange (LIFFE), in 2002 it acquired the
Portuguese Stock Exchange.
Currently, Brussels is examining possible anti-trust issues and has yet to
approve the merger.
On November 11, 2011, the Tokyo Stock Exchange announced
that they had agreed to purchase the Osaka Securities Exchange
for $1.68 billion. Merger will be completed by January 2013 and
combined company will be called the Japan Exchange Group.
Stock Exchange Consolidations

In 2006 and 2007, NASDAQ attempted hostile
takeovers of the London Stock Exchange.


Both takeover attempts were rejected by LSE
shareholders.
Why are exchanges merging?
 (1) cost reductions (to the exchanges
themselves through economies of scale).
 (2) to expand global capital raising benefits
(IPOs) to corporations and
 (3) to provide liquidity (turnover) and global
outreach benefits to investors.
Appendix 1
The Process of Cross Listing Shares
Methods of Cross Listing



Cross listing can take the form of either a direct
share listing or a depository receipt program.
A Depositary Receipt represents ownership of
equity shares in a foreign company. These
receipts are issued against ordinary shares held
in custody in the issuer's home market.
Depository Receipt Programs


American Depository Receipt (ADR): arrangement by which
foreign companies cross list on U.S. exchanges.
Global Depository Receipt (GDR): arrangement by which foreign
companies (including U.S. companies) cross list on foreign
exchanges, other than U.S. exchanges.
Depository Receipts

A depositary receipt is a claim against specified
number of underlying common stock shares.


The DR ratio to the underlying share will vary based
upon the local market share price and, in the case of
an ADR, the US share price of other companies in
similar industries.
DRs can be listed (and traded) on a major
exchanges:


For example: NYSE, AMEX, NASDAQ in the U.S. and
London, Luxembourg, or Singapore outside of the
U.S..
DRs may also trade in the over-the-counter (OTC)
markets, or be privately-placed.
American Depository Receipts

The first ADRs issued and traded in the U.S.
occurred in 1927 when JPMorgan listed the
retail U.K. company, Selfridge's.



ADRs were initially seen as a means of reducing the risk
associated with holding shares overseas and reducing
the trading (clearing) times for American investors.
Today companies from around 80 countries have
ADR programs in the United States.
Currently, ADR Depositary receipt volume
accounts for about 15% of the U.S. equity market.
American Depository Receipts

American Depository Receipts (ADRs):
Certificates that represent ownership of shares
of foreign companies.



ADRs can be listed on any U.S. exchange, such as
the NYSE, the American Stock Exchange, or
NASDAQ. They can also be privately placed as Rule
144A securities.
ADRs trade in the United States just like shares of
domestic companies, with each ADR representing
some multiple of the underlying foreign shares.
ADR programs are managed by commercial
banks on behalf of foreign companies.

In the U.S. the major depository banks (April 2009
data) are Bank of New York (1,732 programs)
Citibank (322 programs) and JP Morgan (250
programs)
The Price of an ADR



The price of an ADR trading on a U.S. stock
market corresponds to the local currency price of
the foreign stock in its home market, adjusted to
the ratio of the ADRs to foreign company shares.
Thus, the ADR price also reflects the exchange
rate between the two markets.
Example:



ADR ratio of 1:2 for a Japanese company (i.e., each
ADR represents 2 shares of the underlying stock)
This stock trades in Japanese market at 1,000 yen per
share and the exchange rate is 95 yen to the dollar.
Given this information, this ADR would trade in the
U.S. at $21.05 or (1,000 x 2)/95 = $21.05
What Causes the Price of an ADR
to Change?

(1) Changes in the home currency price of the
foreign company.


(2) Changes in the overall stock market of the ADR
country.


Price risk resulting from changes in the outlook for the
company.
Systematic risk.
(3) Changes in the exchange rate between the U.S.
dollar and the currency associated with the
underlying asset. Everything else equal:


A strong foreign currency will increase the price of the
ADR.
A weak foreign currency will decrease the price of the ADR.
Depository Receipt Web-Site

The 3 major U.S. banks offering DR
programs with their web sites are as follows:

(1) JP Morgan:


(2) Bank of New York


http://www.adr.com/
http://www.adrbnymellon.com/
(3) Citibank

http://www.citiadr.idmanagedsolutions.com/www/front_p
age.idms