IBUS 302:
International Finance
Topic 14-International
Stock Markets
Lawrence Schrenk, Instructor
Note: Theses slides incorporate material from the slides accompanying Eun &
Resnick, International Financial Management, 4th ed.
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Learning Objectives
1.
2.
3.
Describe the general features of
international equity markets and
international investing.▪
List and explain the main mechanisms for
foreign equity investment.
Explain the characteristics and
benefits/costs of emerging market
investing.▪
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International
Investments
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International Stock Market

1980’s






International equity investment was limited to trade among
developed countries.
Emerging equity markets illiquidity, uncertainty and poor
reporting requirements.
Companies in developing countries were not cross listed.
Emerging market funds didn’t exist.
In the 1990’s investors began to take advantage of
benefits for international diversification.
By 2000 there where 170 emerging market equity
funds and 27 fixed income funds.
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Size of Global Equity Markets
Market Capitalization, in $ Billions
U .S .
Japan
U .K
T o ta l
D e ve lo p e d
T o ta l
E m e rg in g
W o rld
1980
1 ,4 4 8
380
205
2 ,5 5 2
186
2 ,7 3 8
1984
1 ,8 6 3
667
243
3 ,2 9 6
146
3 ,4 4 2
1988
2 ,7 9 4
3 ,9 0 7
771
9 ,2 4 0
489
9 ,7 2 8
1992
4 ,4 8 5
2 ,3 9 9
927
9 ,9 2 2
913
1 0 ,8 3 5
1996
8 ,4 8 4
3 ,0 8 9
1 ,7 4 0
1 7 ,9 3 3
2 ,2 2 6
2 0 ,1 5 9
2000
1 5 ,1 0 4
3 ,1 5 7
2 ,5 7 7
2 9 ,5 2 1
2 ,7 4 0
3 2 ,2 6 0
Source: SIA 2001 Securities Industry Fact Book
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Increasing Importance of Global
Sector versus Local Market
Note: Excludes emerging markets
.
Source: Reprinted by permission. Goldman, Sachs Global Investment Research.
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Gross Transactions in Foreign
Stocks by U.S. Investors
$ Billions
Europe
2,000
1,500
Asia
1,000
Latin Am. &
Caribbean
500
Canada
2000
1998
1996
1994
1992
1990
1988
1986
0
Source: SIA 2001 Securities Industry Fact Book
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Motives



Ignoring foreign markets can substantially
reduce the investment choices for U.S.
investors.
The rates of return on non-U.S. securities
often have substantially exceeded those for
U.S. securities.
The low correlation between U.S. stock
markets and many foreign markets can help
to substantially reduce portfolio risk.
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Challenges
of Foreign Investing

Investment issues







May need government permission to
buy securities
May be caps on foreign ownership


Exchange rate fluctuations
increase return volatility
Political Risk

Illiquidity of foreign markets
Difficulties in obtaining prices
Regulatory issues
Currency Risk

Trading costs


Conducting research on foreign
companies
Restrictions on shareholders’ role in
foreign companies

Government policies may change
toward foreign investors
Unexpected political problems
may increase market risk
Operational Risk


Some markets use physical stock
certificates
Some markets do not have
centralized / efficient settlement
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How International Investments Do
Risk Return 1990s
20%
U.S.
Return (Average Annual Return)
15%
Europe
10%
5%
0%
0%
5%
10%
15%
20%
25%
Japan
-5%
-10%
Source: Global Financial Data, w w w .globalfindata.com
Risk (Standard Deviation)
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Changes in International Investments
Risk Returns 1980s and 1990s
25%
Japan 1980's
Return (Annual Return on Index)
20%
U.S. 1990's
Europe 1980's
15%
U.S. 1980's
Europe 1990's
10%
5%
0%
0%
5%
10%
15%
-5%
20%
25%
30%
Japan 1990's
-10%
Risk (Standard Deviation)
Source: Global Financial Data, www.globalfindata.com
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Risk Return International Indexes
(1995-2000)
6.0%
Finland
5.0%
Return (Average Monthly Return)
4.0%
Brazil
3.0%
Italy
Netherlands
Mexico
Denmark
Sweden
2.0%
Germany
Canada
1.0%
Australia
Japan
New Zealand
0.0%
0.0%
-1.0%
2.0%
4.0%
S. Korea
Hong Kong
Spain
Austria
Singapore
Portugal
Taiwan
Peru
Norway
6.0%
8.0%
10.0%
Malaysia
Argentina
12.0%
14.0%
Philippines
16.0%
18.0%
Thailand
Chile
-2.0%
Risk (Standard Deviation)
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Mechanisms for
International Equity
Investment
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Overview


Cross-Listing refers to a firm having its equity
shares listed on one or more foreign
exchanges.
Mechanisms:



ADRs
Funds
Direct Investment
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American Depository Receipts
(ADRs)





Foreign shares are put in deposit with a bank.
The bank issues ADRs.
ADRs are listed on U.S. exchanges.
ADR is priced in U.S. dollars and can be
traded just like any other stock.
Dividends are paid in U.S. dollars.
Close to $900 Billion in ADRs are traded.
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ADRs Types

Level I



Level II



Traded over-the-counter
Companies don't have to follow GAAP
Follow SEC rules
Traded on any U.S. stock exchange.
Level III

Able to do public offerings in U.S. financial
markets.
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International Equity Funds
10% of all mutual fund assets.
 Fund takes care of buying, selling, and
foreign requirements.
 Higher fees than other funds.
 Types




Developed versus Developing
Regional
Country
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Country Specific Investing
 Speculate
in a single foreign market
with minimum cost.
 Construct their own personal
international portfolios.
 Diversify into emerging markets that
are otherwise practically
inaccessible.
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Country Specific Investing
(cont’d)

World Equity Benchmark Shares (WEBS)



Country-specific baskets of stocks designed to
replicate the country indexes of 14 countries.
WEBS are subject to U.S. SEC and IRS
diversification requirements.
Low cost, convenient way for investors to hold
diversified investments in several different
countries.
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Direct Investment

Direct investment in foreign equity marketsdifficult and complicated





Administrative,
Information,
Taxation,
Market Efficiency Problems,
Etc.
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Emerging Markets
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Emerging Markets


The term “emerging markets’ was coined by the
World Bank's International Finance Corporation
in the early 1980s.
Typically, emerging markets are in countries that:




Are in the process of industrialization, and
Have lower per capita gross national product (GNP)
than the more developed countries.
Higher growth rates and higher average returns in
many countries
Of the 130 countries that the international
financial community generally considers to be
emerging or developing countries, approximately
40 currently have stock markets.
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Emerging Markets Returns




From 1988 to 2006, emerging country stock
markets have recorded an annualized return of
14.8% in US dollar terms.
For the four years ended December 31, 2006
emerging markets had an annualized return of
36.4% a year.
In 2006 alone, the MSCI Emerging Markets Index
rose 30%, led by an extraordinary 77% average
gain in its four biggest countries — Brazil,
Russia, India and China!
In 2006, the Shanghai Composite Index posted a
128% gain, making it the “star performer” among
equity markets.
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Average Annual Returns for
1994-2006
24.10%
Mexico
22.50%
Brazil
17.80%
India
11.60%
Argentina
10.40%
China
10.20%
Chile
9.80%
US
8.80%
Hong Kong
3.40%
Singapore
2.50%
Malaysia
T aiwan
-5.0%
-0.80%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
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Emerging Markets Volatility
Emerging Markets
Annual return
Standard deviation
S&P 500
Annual return
Standard deviation
Last 3 years Last 5 years
24.45%
21.46%
17.71%
18.11%
10.06%
6.27%
6.95%
12.29%
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Annual Return Emerging Markets Indexes
(1968-1999)
150%
U.S.
100%
Latin America
Emerging Asia
50%
19
68
19
69
19
70
19
71
19
72
19
73
19
74
19
75
19
76
19
77
19
78
19
79
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
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89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
0%
-50%
-100%
Source: Global Financial Data, www.globalfindata.com
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Emerging Markets Crises
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Emerging Markets Concerns


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
Size and Scope of Markets
Correlation Variable and Increasing
Sophistication of The Local Professionals
Liquidity and Transaction Costs
Quality and Quantity of Financial Information
Financial Regulations, Business Laws,
Ethics, Investor Protection
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