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11
Chapter Nineteen
International Securities Markets
McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
22
The World Equity MarketThe World Equity Market
World equity markets grew rapidly from 1992 World equity markets grew rapidly from 1992 to 1999 to 1999
Peaked end of 1999Peaked end of 1999 Market capitalization (value) of developed Market capitalization (value) of developed
countries stock markets was $33 trillioncountries stock markets was $33 trillion 3 years later decreased to about $20.9 trillion 3 years later decreased to about $20.9 trillion Lot of money evaporated in 3 years timeLot of money evaporated in 3 years time
33
The World Equity MarketThe World Equity Market Markets fluctuate with economic activity Markets fluctuate with economic activity Over time markets recover with the economyOver time markets recover with the economy World markets had a strong recovery in 2003World markets had a strong recovery in 2003 Developed world securities markets continue to Developed world securities markets continue to
expandexpand Major growth also in the “emerging” marketsMajor growth also in the “emerging” markets
• ArgentinaArgentina• BrazilBrazil• ChinaChina• TaiwanTaiwan• MexicoMexico
44
55
Diversification BenefitsDiversification Benefits
Invest in foreign markets forInvest in foreign markets for diversificationdiversification Foreign markets do NOT move in harmony Foreign markets do NOT move in harmony
with each other with each other Diversified Diversified portfolio from many countries is portfolio from many countries is
less volatile than domestic portfolio - could less volatile than domestic portfolio - could even have a higher rate of returneven have a higher rate of return
WARNING – It does not always workWARNING – It does not always work In1987 market crashIn1987 market crash
19 of 23 markets declined more than 20%19 of 23 markets declined more than 20%
66
Diversification Benefits Diversification Benefits cont.cont.
Low degree of correlation between the Low degree of correlation between the historical returns of different countrieshistorical returns of different countries
Richard Roll: Most significant factor relating Richard Roll: Most significant factor relating to the size of the market decline in each to the size of the market decline in each
country was the beta, country was the beta, ββ,, of that market to of that market to the world market indexthe world market index
No country continually outperforms the No country continually outperforms the others on an annual basisothers on an annual basis
77
Degree of DiversificationDegree of Diversification
Measure correlation of stock movementsMeasure correlation of stock movements
Correlation Coefficient:Correlation Coefficient: Measures movement of one series of dataMeasures movement of one series of data
over time to another series of data -over time to another series of data -in this case stock market returnsin this case stock market returns
88
1 nCorrelatiot Coefficien1 CoefficientCoefficient RelationshipRelationship ImplicationImplication
11Perfect Perfect positivepositive
Two variables move Two variables move together up and downtogether up and down
-1-1Perfect Perfect
negativenegativeTwo variables move Two variables move opposite of each otheropposite of each other
00No No
relationshiprelationship
Assets with correlation coefficient of less than 1 reduce amount of risk
99
Return Potential in International MarketsReturn Potential in International Markets
International International diversificationdiversification
Less risk exposureLess risk exposure Possible higher returnsPossible higher returns
1.1. Several countries had long-term growth Several countries had long-term growth rates superior to U.S. in terms of real GDP:rates superior to U.S. in terms of real GDP:
• SingaporeSingapore • ChinaChina• NorwayNorway
++
1010
Return Potential in International MarketsReturn Potential in International Markets
2.2. Many countries are highly competitive in Many countries are highly competitive in automobiles, steel, & consumer electronicsautomobiles, steel, & consumer electronics
Capital formation and Capital formation and potential investment opportunitypotential investment opportunity
Germany Germany JapanJapan FranceFrance CanadaCanada
3.3.Enjoy higher Enjoy higher
individual individual savings rates savings rates
than U.S.than U.S.
1111
Annualized rates of return of Annualized rates of return of selected indexes over 32-year periodselected indexes over 32-year period
1212
Current Quotations on Foreign Current Quotations on Foreign Market PerformanceMarket Performance
Track performance of selected world marketsTrack performance of selected world markets
1st index EAFE =Europe, Australia, FarEast1st index EAFE =Europe, Australia, FarEast Quotes are in local currencies & in U.S. $Quotes are in local currencies & in U.S. $ U.S. investors compare returns in U.S. U.S. investors compare returns in U.S.
against an investment in U.S. stock marketagainst an investment in U.S. stock market
Instructions to navigate msci website: on Power Point Instructions to navigate msci website: on Power Point tool bar click tool bar click ViewView, choose , choose Notes PageNotes Page
www.msci.com
1313
Other Market DifferencesOther Market Differences
CultureCulture Willingness to take riskWillingness to take risk Desire for dividend income versus growth in Desire for dividend income versus growth in
share valueshare value Number & type of companies available to Number & type of companies available to
stockholdersstockholders Bureaucratic differences Bureaucratic differences
1414
Other Market Differences cont.Other Market Differences cont.
Accounting conventions Accounting conventions Government regulation of marketsGovernment regulation of markets Problem with comparing P/E ratios: Problem with comparing P/E ratios:
Earnings calculated differently according Earnings calculated differently according to local or regional accountingto local or regional accounting
1515
Currency Fluctuations and Currency Fluctuations and Rates of ReturnRates of Return
Tracking foreign markets requires Tracking foreign markets requires adjustmentsadjustments
Reported returns adjusted for Reported returns adjusted for foreign currency effectsforeign currency effects How important is the foreign currency effect How important is the foreign currency effect
in relation to overall return performance in in relation to overall return performance in foreign currency? foreign currency?
Do foreign exchanges overpower actual Do foreign exchanges overpower actual return on investments in foreign countries?return on investments in foreign countries?
1616
Currency Fluctuations and Currency Fluctuations and Rates of ReturnRates of Return
Foreign currency effect is about 10 to 20% Foreign currency effect is about 10 to 20% as significant as the actual return as significant as the actual return performance in the foreign currencyperformance in the foreign currency
If dollar is rising/falling rapidly over a short If dollar is rising/falling rapidly over a short period the impact can be much greaterperiod the impact can be much greater
1717
Currency Fluctuations and Currency Fluctuations and Rates of Return Rates of Return
Investment in Switzerland: 10% return CHF declines by 5% against U.S. $ CHF profits are worth less in $Gain on investment: 110% (Investment with 10% profit) Adjusted value of CHF relative to U.S. $ = 0.95 =1.00 - 0.05 decline in currency 104.5% (= 110 x 0.95) of original investment Actual return in U.S. $ 4.5% instead of 10%
Swiss franc = CHF
1818
Currency Fluctuations and Currency Fluctuations and Rates of ReturnRates of Return
Examine currency effects in Sweden YTDExamine currency effects in Sweden YTD Return in local currency 4.58% (3Return in local currency 4.58% (3rdrd column) column) Return in U.S. $............. 6.31% (7Return in U.S. $............. 6.31% (7thth column) column) Change in $/SEK made a positive return in Change in $/SEK made a positive return in
kronor become a negative return in U.S. $kronor become a negative return in U.S. $
Swedish currency Krona (pl. Kronor) symbol SEK
See Table 19-8 next 2 slide
1919
Currency Fluctuations and Currency Fluctuations and Rates of ReturnRates of Return
Computed returns:Computed returns: 104.58% (Investment with 4.58% profit)104.58% (Investment with 4.58% profit) (Adjusted value of the SEK to U.S. $)(Adjusted value of the SEK to U.S. $)
0.896 (1.000 - 0.104 decline in currency)0.896 (1.000 - 0.104 decline in currency) 93.7% (= 104.58 x 0.896) 93.7% (= 104.58 x 0.896) of original of original
investmentinvestment
See Table 19-8 next slide
2020
2121
Other Obstacles to International Other Obstacles to International InvestmentsInvestments
Political RisksPolitical Risks Tax ProblemsTax Problems Lack of Market EfficiencyLack of Market Efficiency Administrative ProblemsAdministrative Problems Information ProblemsInformation Problems Corruption (not having an Eliot Spitzer!)Corruption (not having an Eliot Spitzer!)
2222
Political RisksPolitical Risks
Danger of nationalization of foreign firms Danger of nationalization of foreign firms Restriction of capital flows to investorsRestriction of capital flows to investors Violent overthrow of political party in power Violent overthrow of political party in power Not meeting their foreign debt obligations Not meeting their foreign debt obligations Check the political/economic climateCheck the political/economic climate
2323
Tax ProblemsTax Problems Foreign countries may impose 15 to 30% Foreign countries may impose 15 to 30%
withholding tax against dividends or interest withholding tax against dividends or interest paid to nonresidentspaid to nonresidents
Tax-exempt Tax-exempt U.S. investors can secure U.S. investors can secure exemption or rebate exemption or rebate
Taxable U.S. investors can claim a U.S. tax Taxable U.S. investors can claim a U.S. tax credit for taxes paid in foreign countriescredit for taxes paid in foreign countries
Inconvenience rather than loss of fundsInconvenience rather than loss of funds
2424
Lack of Market EfficiencyLack of Market Efficiency
U.S. capital markets the most liquid & U.S. capital markets the most liquid & efficient in the worldefficient in the world
Investors accustomed to trading on NYSE will Investors accustomed to trading on NYSE will find it difficult to adjust to foreign marketsfind it difficult to adjust to foreign markets
Larger spread between bid (sell) & ask (buy) Larger spread between bid (sell) & ask (buy) priceprice
Difficulty executing large transaction Difficulty executing large transaction Higher commission rates Higher commission rates
2525
Administrative ProblemsAdministrative Problems Adjusting to various local systemsAdjusting to various local systems
For example, For example, Hong Kong, Swiss, & Mexican stock markets Hong Kong, Swiss, & Mexican stock markets
settle account one day after the transaction settle account one day after the transaction London: two-week settlement London: two-week settlement Different administrative procedures add extra Different administrative procedures add extra
difficulty in executing tradesdifficulty in executing trades Avoid these difficulties by going through Avoid these difficulties by going through
mutual funds and other investment outletsmutual funds and other investment outlets
2626
Information ProblemsInformation Problems U.S. securities markets are the best at U.S. securities markets are the best at
providing investment informationproviding investment information S.E.C. has rigorous requirements for full S.E.C. has rigorous requirements for full
disclosure informationdisclosure information FASB continually providing pronouncements FASB continually providing pronouncements
on GAAP for financial reportingon GAAP for financial reporting Publicly traded companies required to Publicly traded companies required to
provide stockholders with fully audited provide stockholders with fully audited annual reportsannual reports
Evaluative reports/ratings by Moody’s, Evaluative reports/ratings by Moody’s, Standard & Poor’s, Value Line, & other firmsStandard & Poor’s, Value Line, & other firms
2727
Information ProblemsInformation Problems
Extensive economic data provided by Extensive economic data provided by governmental sources e.g.governmental sources e.g.• Department of CommerceDepartment of Commerce
• Federal Reserve SystemFederal Reserve System International firms in less sophisticated International firms in less sophisticated
foreign markets do not provide sufficient dataforeign markets do not provide sufficient data Language problems for the analystLanguage problems for the analyst
2828
Methods of Participating in Methods of Participating in Foreign InvestmentsForeign Investments
International investment International investment Investing in firms in foreign marketsInvesting in firms in foreign markets Purchasing foreign shares trading in U.S.Purchasing foreign shares trading in U.S. Mutual funds investing overseasMutual funds investing overseas Closed-end funds with global orientationClosed-end funds with global orientation Buying shares of multinational corporationsBuying shares of multinational corporations
2929
Methods of Participating in Methods of Participating in Foreign InvestmentsForeign Investments
Direct InvestmentsDirect Investments Indirect InvestmentsIndirect Investments
3030
Direct InvestmentsDirect Investments
Directly purchase shares of firm in foreign market Directly purchase shares of firm in foreign market Use foreign broker/overseas branch of U.S. brokerUse foreign broker/overseas branch of U.S. broker
Difficulties and administrative problems: Difficulties and administrative problems: Information-gathering problemsInformation-gathering problems Tax problemsTax problems Stock-delivery problemsStock-delivery problems Capital-transfer problemsCapital-transfer problems Communication difficulties in executing ordersCommunication difficulties in executing orders Sophisticated money manager follow this approachSophisticated money manager follow this approach
3131
Direct InvestmentsDirect Investments
Purchase shares of foreign firms that trade in Purchase shares of foreign firms that trade in U.S. stock markets (NYSE)U.S. stock markets (NYSE)
Purchase Purchase ADRsADRs
ADRs represent ownership interest ADRs represent ownership interest in a foreign company’s common stockin a foreign company’s common stock
Go to: Go to: 1. International1. International 2. Non-U.S. Listed Company Directory2. Non-U.S. Listed Company Directory
www.nyse.com
3232
Direct Investments - Direct Investments - Hyperlinks to some companies that Hyperlinks to some companies that
have ADRshave ADRs
www.alcan.com
www.honda.com
www.sony.com
www.britishairways.com
www.nortelnetworks.com
3333
Indirect InvestmentsIndirect Investments
Investments in international securities include: Investments in international securities include:
a)a) Purchasing shares of multinational corporationsPurchasing shares of multinational corporations
b)b) Mutual funds or closed-end investment funds Mutual funds or closed-end investment funds specializing in worldwide investmentsspecializing in worldwide investments
c)c) Investing in exchange traded funds (ETF) Investing in exchange traded funds (ETF)
d)d) Use a private firm specializing in foreign Use a private firm specializing in foreign investment portfolio managementinvestment portfolio management
3434
(a)- Purchasing Shares of (a)- Purchasing Shares of Multinational CorporationsMultinational Corporations
Firms with operations in several countriesFirms with operations in several countries Opportunity for international diversificationOpportunity for international diversification
• Major oil companiesMajor oil companies
• Large banking firms Large banking firms
• Large mainframe computer manufacturersLarge mainframe computer manufacturers
E.g. ExxonMobil 69.4% overseas salesE.g. ExxonMobil 69.4% overseas sales
3535
(b)- Mutual Funds and Closed-(b)- Mutual Funds and Closed-End Investment CompaniesEnd Investment Companies
Mutual funds offerMutual funds offer• Diversification Diversification
• Professional management Professional management Invest in closed-end investment Invest in closed-end investment
companies specializing in international companies specializing in international equity investmentsequity investments
May trade at premium/discount from NAV May trade at premium/discount from NAV Example - Japan FundExample - Japan Fund
3636
(c)- Exchange Traded Funds (ETFs)
Use ETFs to invest in international marketsUse ETFs to invest in international markets Biggest market the American Stock Exchange Biggest market the American Stock Exchange
Lists over 40 international funds Lists over 40 international funds ETF: basket of securities that track an indexETF: basket of securities that track an index Trades like an individual stock with all dayTrades like an individual stock with all day
• Trading Trading • Price trackingPrice tracking
www.amex.com
3737
Exchange Traded Funds (ETFs)
ETF mimics a major index, e.g.ETF mimics a major index, e.g.• Financial Times 100 for United KingdomFinancial Times 100 for United Kingdom• DAX for GermanyDAX for Germany
ETF can track ETF can track • A broad stock indexA broad stock index• Bond indexBond index• Industry indexIndustry index• Sector indexSector index
Lower costs Lower costs Better tax efficiency than mutual fundsBetter tax efficiency than mutual funds Ability to diversify using these fundsAbility to diversify using these funds
www.amex.com
3838
(d)- Specialists in International Securities
Large investors may engage services of firms with Large investors may engage services of firms with specialized expertise in foreign equities specialized expertise in foreign equities
BanksBanks Investment counselorsInvestment counselors
• Morgan Guaranty Trust Company Morgan Guaranty Trust Company • State Street Bank and Trust CompanyState Street Bank and Trust Company• Batterymarch Financial ManagementBatterymarch Financial Management• Fidelity Trust Company of New YorkFidelity Trust Company of New York
Minimum investment well in excess of $100,000 Minimum investment well in excess of $100,000 Cater to large institutional investorsCater to large institutional investors
3939
WebsiteWebsite CommentsComments
www.adr.comwww.adr.com
Provides screening &research Provides screening &research services for American services for American depository receiptsdepository receipts
www.amex.comwww.amex.com Exchange Traded FundsExchange Traded Funds
www.global-investor.comwww.global-investor.comProvides international news & Provides international news & information on foreign information on foreign marketsmarkets
cbs.marketwatch.comcbs.marketwatch.com Provides news on global Provides news on global marketsmarkets
4040
WebsiteWebsite CommentsComments
www.economist.comwww.economist.comGlobal magazine Global magazine providing news on providing news on markets and economicsmarkets and economics
www.wsj.comwww.wsj.comProvides information on Provides information on global markets and global markets and economicseconomics
www.oecd.orgwww.oecd.orgProvides international Provides international economic information and economic information and links to related siteslinks to related sites
www.www.rubiconrubicon.com.comProvides currency rates Provides currency rates and conversionsand conversions
4141
SummarySummary Diversify by investing in international
securities Different foreign markets influenced by
varying & contradictory factors Effective risk reduction
Example:Sharp & unexpected increase in energy pricesnegative impact on oil importers may beoffset by positive impact on oil exporters
4242
SummarySummary
Investments in selected foreign equity markets Investments in selected foreign equity markets may provide may provide
Excellent return opportunitiesExcellent return opportunities Many countries GDP growth rate is like U.S.Many countries GDP growth rate is like U.S. Greater savings rates Greater savings rates Higher capital formationHigher capital formation Consider currency fluctuationsConsider currency fluctuations RiskRisk