CH 13: International Equity Markets

Emerging Markets

A stock market is classified as “emerging” if it meets at least one of two general criteria:

• Located in a low or middle-income economy as defined by the World Bank.

• Investable market capitalization is low relative to its most recent GNI figures.

Measures of Liquidity

Equity markets of the developed world tend to be much more liquid than emerging markets.

Liquidity refers to how quickly an asset can be sold without a major price concession.

A measure of liquidity for a stock market is the turnover ratio.

Turnover ratio = Stock market transactions / Market capitalization

The higher the ratio, the more liquid the market.

Market Structure, Trading Practices, and Costs

Primary markets - The market in which new security issues are sold to investors. In selling the new securities, investment bankers can play the role of either broker or dealer.

Secondary markets - A market in which investors buy and sell securities to other investors; the original issuer is not involves in these trades. This market provides marketability and valuation of the securities.

Market order - An order to your broker to buy or sell shares immediately at the market price.

Limit order - An order to your broker to buy or sell at a price you want, when and if he can.

**If immediate execution is more important than the price, use a market order.

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.

Agency Market - A market in which the broker takes the clients order through the agent, who matches it with another public order.

Auction market - Organized exchanges have specialists who match buy and sell orders.

Automated exchanges - Computers match buy and sell orders.

Call Market - A market in which market and limit orders are accumulated and executed at specific intervals during the day.

Trading in International Equities

Magnitude of international equity trading

The trend of global integration during the 80s was caused by diversification, reduced regulation, improvements in computer and communications technology, and an increased demand from MNCs for global issuance.

Several factors account for the trend toward greater global integration in the 1980s:

• Investors began to realize the benefits of international portfolio diversification

• Major capital markets became more liberalized through the elimination of fixed trading commissions.

• New computer and communications technology facilitated efficient and fair securities trading.

• MNCs realized the benefits of sourcing new capital internationally.

Cross-Listing of Shares

Refers to a firm having its equity shares listed on one or more foreign exchanges.

Advantages:

• Expand investor base for a firm

• Establish name recognition for the firm in new capital markets, paving the way for new issues

• Cross-listing into developed markets may signal investors that improved corporate governance is forthcoming.

• May mitigate possibility of hostile takeovers

According to the bonding theory, a U.S cross-listing both restricts the ability of corporate insiders of the cross-listed firm from consuming private benefits and also publicly benefits the firm by allowing it to finance new growth opportunities.

Yankee Stock Offerings

The direct sale of new equity capital to U.S public investors by foreign firms.

• Privatization in South America and Eastern Europe.

• Equity sales by Mexican firms trying to “cash in” following implementation of NAFTA.

American Depository Receipts (ADR)

An ADR is a certificate representing a number of foreign shares that remain on deposit with the U.S depository custodian in the issuers home market. Foreign stocks often trade on U.S exchanges as ADRs.

It is a receipt that represents the number of foreign shares that are deposited at a U.S. Bank.

The bank serves as a transfer agent for the ADRs.

There are two types of ADRs: Sponsored and unsponsored.

Sponsored ADRs are created by a bank at the request of the foreign company that issued the underlying security. Depository fees of sponsored ADRs are paid by the foreign company.

Unsponsored ADRs are created at the request of a U.S investment banking firm without direct involvement by the foreign issuing firm.

Advantages: There are many advantages to trading ADRs as opposed to direct investment in the company’s shares:

• 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 and the ADRs are registered.

• ADR trades clear in 3 business days whereas settlement practices for the underlying stock vary in foreign countries.

Global Registered Shares (GRSs)

The merger of Daimler Benz AG and Chrysler Corporation created a new type of equity share, called Global Registered Shares.

GRS are traded globally, unlike ADRs, which are receipts for bank deposits of home-market shares and traded on foreign markets.

The shares are fully fungible - A GRS purchased on one exchange can be sold on another. They trade in both U.S dollars and Euro.

Main Advantage of GRSs over ADRs: Shareholders have equal status and direct voting rights.

Main disadvantage of GRSs: Appears to be the greater expense in establishing the global registrar and clearing facility.

iShares MSCI

Country-specific baskets of stocks designed to replicate the country indexes of 22 countries.

iShares are exchange-traded funds that trade on the American Stock Exchange and are subject to U.S SEC and IRS diversification requirements.

**Low cost, convenient way for investors to hold diversified investments in several different countries.

Factors Affecting International Equity Returns

Macroeconomic factors

The data do not support the notion that equity returns are strongly influenced by macro factors.

Exchange rates

In a given country appear to reinforce the stock market movements within that country.

**Careful to not confuse correlation with causality.

Industrial structure

Studies examining the influence of industrial structure on foreign equity returns are inconclusive.

Summary

Yankee shares can trade on U.S markets as American Depository Receipts (ADRs), which are certificates representing a multiple of foreign shares deposited in a foreign bank.

Ask Price - Offer price

Bid Price - The price at which dealers will buy a financial asset.