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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. Describe the general features of international equity markets and international investing.▪
2. List and explain the main mechanisms for foreign equity investment.
3. Explain the characteristics and benefits/costs of emerging market investing.▪
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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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Market Capitalization, in $ Billions
U.S. Japan U.K Total
Developed Total
Emerging World
1980 1,448 380 205 2,552 186 2,738
1984 1,863 667 243 3,296 146 3,442
1988 2,794 3,907 771 9,240 489 9,728
1992 4,485 2,399 927 9,922 913 10,835
1996 8,484 3,089 1,740 17,933 2,226 20,159
2000 15,104 3,157 2,577 29,521 2,740 32,260
Source: SIA 2001 Securities Industry Fact Book
Size of Global Equity Markets
6 (of 32)Source: Reprinted by permission. Goldman, Sachs Global Investment Research.
Note: Excludes emerging markets.
Increasing Importance of Global Sector versus Local Market
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Gross Transactions in Foreign Stocks by U.S. Investors
$ Billions
Source: SIA 2001 Securities Industry Fact Book
0
500
1,000
1,500
2,000
1986
1988
1990
1992
1994
1996
1998
2000
Europe
Asia
Latin Am. &Caribbean
Canada
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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
Conducting research on foreign companies
Restrictions on shareholders’ role in foreign companies
Trading costs Illiquidity of foreign markets Difficulties in obtaining prices
Regulatory issues May need government permission to
buy securities May be caps on foreign ownership
Currency Risk Exchange rate fluctuations
increase return volatility
Political Risk 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
-10%
-5%
0%
5%
10%
15%
20%
0% 5% 10% 15% 20% 25%
Risk (Standard Deviation)
Re
turn
(A
ve
rag
e A
nn
ua
l Re
turn
)
Japan
Europe
U.S.
Source: Global Financial Data, www.globalfindata.com
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Changes in International Investments Risk Returns 1980s and 1990s
-10%
-5%
0%
5%
10%
15%
20%
25%
0% 5% 10% 15% 20% 25% 30%
Risk (Standard Deviation)
Re
turn
(A
nn
ua
l Re
turn
on
Ind
ex
)
Europe 1990's
U.S. 1990's
Japan 1990's
Europe 1980's
Japan 1980's
U.S. 1980's
Source: Global Financial Data, www.globalfindata.com
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Risk Return International Indexes(1995-2000)
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0%
Risk (Standard Deviation)
Re
turn
(A
vera
ge
Mo
nth
ly R
etu
rn)
Finland
Brazil
Spain
ThailandPhilippines
Chile
MalaysiaJapan
Peru
Singapore
Hong Kong
TaiwanPortugal
MexicoItaly
S. Korea
Sweden
Norway
Netherlands
Germany
Canada
Denmark
Australia
New Zealand
AustriaArgentina
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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 Traded over-the-counter Companies don't have to follow GAAP
Level II 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 markets- difficult and complicated Administrative, Information, Taxation, Market Efficiency Problems, Etc.
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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
-0.80%
2.50%
3.40%
8.80%
9.80%
10.20%
10.40%
11.60%
17.80%
22.50%
24.10%
-5.0% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0%
Taiwan
Malaysia
Singapore
Hong Kong
US
Chile
China
Argentina
India
Brazil
Mexico
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Emerging Markets Volatility
Emerging Markets Last 3 years Last 5 years
Annual return 24.45% 21.46%
Standard deviation 17.71% 18.11%
S&P 500
Annual return 10.06% 6.95%
Standard deviation 6.27% 12.29%
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Annual Return Emerging Markets Indexes (1968-1999)
-100%
-50%
0%
50%
100%
150%
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
U.S.
Latin America
Emerging Asia
Source: Global Financial Data, www.globalfindata.com
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Emerging Markets Concerns
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
