International Securities Markets Diversification and Globalization
The World Equity Market <ul><li>World equity markets grew rapidly from 1992 to 2006  </li></ul><ul><li>Market capitalizati...
The World Equity Market <ul><li>Markets fluctuate with economic activity  </li></ul><ul><li>Over time markets recover with...
Emerging Markets Share 2002 and 2005 <ul><li>2002   2005 </li></ul><ul><li>Mideast and Africa  18%   > 31% </li></ul><ul><...
Diversification Benefits <ul><li>Invest in foreign markets for   diversification </li></ul><ul><li>Foreign markets do NOT ...
Diversification Benefits  cont. <ul><li>Correlation between the historical returns of different countries is less than 1.0...
Risk Reduction with International Securities
Degree of Diversification <ul><li>Measure correlation of stock movements </li></ul>Correlation Coefficient:   Measures mov...
Assets with correlation coefficient  of  less than 1 reduce amount of risk  No relationship 0 Two variables move opposite ...
Correlation Coefficients Between Foreign Markets    and U.S. Markets in $ rates of Return 0.78 0.55 Average 0.82 0.64 Unit...
Correlations of Total Return between U.S. Markets and  Emerging Markets in U.S. Dollars 2000-2005 0.39 South Africa 0.45 R...
Return Potential in International Markets International  diversification Less risk exposure Possible higher returns <ul><l...
Returns in Developed Markets In U.S. $ 4.1 32.2 41.3 -6.3 Italy  17.0 15.9 36.3 -10.9 Switzerland 6.7 30.1 59.9 -11.8 Spai...
5 Yr. Returns in Emerging Markets  in U.S. $ 2000-2005 7.68% Italy  6.00% Switzerland 13.20% Spain 8.40% Hong Kong 6.60% G...
Return Potential in International Markets <ul><li>Many countries are highly competitive in  </li></ul><ul><li>automobiles,...
Annualized rates of return of world indexes over 32-yr. period 1969-2001
Current Quotations on Foreign Market Performance <ul><li>Track performance of selected world markets </li></ul><ul><li>1st...
Other Market Differences <ul><li>Culture </li></ul><ul><li>Willingness to take risk </li></ul><ul><li>Desire for dividend ...
Other Market Differences cont. <ul><li>Accounting conventions  </li></ul><ul><li>Government regulation of markets </li></u...
Currency Fluctuations and Rates of Return <ul><li>Tracking foreign markets requires adjustments </li></ul><ul><li>Reported...
Currency Fluctuations and Rates of Return <ul><li>Foreign currency effect is about 10 to 20% as significant as the actual ...
Currency Fluctuations and Rates of Return  <ul><li>Investment in Switzerland: 10% return </li></ul><ul><li>CHF declines by...
Currency Fluctuations and  Rates of Return <ul><li>Examine currency effects in Sweden YTD </li></ul><ul><li>Return in loca...
Currency Fluctuations and  Rates of Return <ul><li>Computed returns: </li></ul><ul><li>104.58% (Investment with 4.58% prof...
 
Other Obstacles to International Investments   <ul><li>Political Risks </li></ul><ul><li>Tax Problems </li></ul><ul><li>La...
Political Risks <ul><li>Danger of nationalization of foreign firms  </li></ul><ul><li>Restriction of capital flows to inve...
Tax Problems <ul><li>Foreign countries may impose 15 to 30% withholding tax against dividends or interest paid to nonresid...
Lack of Market Efficiency <ul><li>U.S. capital markets the most liquid & efficient in the world </li></ul><ul><li>Investor...
Elkins/McSherry Global Universe of  Transaction Costs Developed Markets 4 factors: price, commission, fees, mkt impact 30....
Market Capitalization of Developed World Markets (Year end 2005) in billions of U.S. $ $798 Italy  $938 Switzerland $960 S...
Market Capitalization of The Largest Emerging Markets (year end 2005) in billions of U.S. $ $474 Brazil $485 Taiwan $548 R...
Market Capitalization of the Three Largest U.S. Companies in billions U.S. $ $1,087 $280 Microsoft $361 General Electric $...
Administrative Problems <ul><li>Adjusting to various local systems </li></ul><ul><li>For example,  </li></ul><ul><li>Hong ...
Information Problems <ul><li>U.S. securities markets are the best at providing investment information </li></ul><ul><li>S....
Information Problems <ul><li>Extensive economic data provided by governmental sources e.g. </li></ul><ul><ul><li>Departmen...
Methods of Participating in Foreign Investments <ul><li>International investment  </li></ul><ul><li>Investing in firms in ...
Methods of Participating in Foreign Investments <ul><li>Direct Investments </li></ul><ul><li>Indirect Investments </li></ul>
Direct Investments <ul><li>Directly purchase shares of firm in foreign market  </li></ul><ul><li>Use foreign broker/overse...
Direct Investments <ul><li>Purchase shares of foreign firms that trade in U.S. stock markets (NYSE) </li></ul><ul><li>Purc...
Direct Investments -  Hyperlinks to some companies that have ADRs www.alcan.com www.honda.com www.sony.com www.britishairw...
Indirect Investments <ul><li>Investments in international securities include:  </li></ul><ul><li>Purchasing shares of mult...
(a)- Purchasing Shares of Multinational Corporations <ul><li>Firms with operations in several countries </li></ul><ul><li>...
(b)- Mutual Funds and Closed-End Investment Companies <ul><li>Mutual funds offer </li></ul><ul><ul><li>Diversification  </...
(c)- Exchange Traded Funds  (ETFs) <ul><li>Use ETFs to invest in international markets </li></ul><ul><li>Biggest market th...
Exchange Traded Funds (ETFs) <ul><li>ETF mimics a major index, e.g. </li></ul><ul><ul><li>Financial Times 100 for United K...
(d)- Specialists in International Securities <ul><li>Large investors may engage services of firms with specialized experti...
Provides international news & information on foreign markets www.global-investor.com Provides news on global markets cbs.m...
Provides international economic information and links to related sites www.oecd.org Provides currency rates and conversion...
Summary <ul><li>Diversify by investing in international securities  </li></ul><ul><li>Different foreign markets influenced...
Summary <ul><li>Investments in selected foreign equity markets may provide  </li></ul><ul><li>Excellent return opportuniti...
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  • Step 1- On the left hand side column of the Home page click on the Equity Indeces (located one block above U.S. Equity Indeces) Step 2 – On the tool bar shown on the first line click on Country/Regional Perf For Bonds 1. Click on Fixed Income box shown on the tool bar (Fixed income = Bond) OR, 2. On the homepage, there is a box SEARCH WEBSITE – In the box type: Bond Indeces and click on Go
  • International Securities Markets Diversification and ...

    1. 1. International Securities Markets Diversification and Globalization
    2. 2. The World Equity Market <ul><li>World equity markets grew rapidly from 1992 to 2006 </li></ul><ul><li>Market capitalization (value) of developed countries stock markets was $33 trillion at year end 1999. By year end 2002 it was $20.9 trillion </li></ul><ul><li>By 2005 the developed markets had recovered and their market capitalization reached $36.5 trillion </li></ul>
    3. 3. The World Equity Market <ul><li>Markets fluctuate with economic activity </li></ul><ul><li>Over time markets recover with the economy </li></ul><ul><li>World markets had a strong recovery in 2003 and continued into 2007. </li></ul><ul><li>Developed world securities markets continue to expand </li></ul><ul><li>Major growth also in the “emerging” markets </li></ul><ul><ul><li>Argentina - Brazil - China – Taiwan -- Mexico </li></ul></ul>
    4. 4. Emerging Markets Share 2002 and 2005 <ul><li>2002 2005 </li></ul><ul><li>Mideast and Africa 18% > 31% </li></ul><ul><li>South Asia 12% > 14% </li></ul><ul><li>East Asia 48% < 29% </li></ul><ul><li>Eastern/Central Europe 7% > 11% </li></ul><ul><li>Latin America 15% = 15% </li></ul>
    5. 5. Diversification Benefits <ul><li>Invest in foreign markets for diversification </li></ul><ul><li>Foreign markets do NOT move in harmony with each other </li></ul><ul><li>Diversified portfolio from many countries is less volatile than domestic portfolio - could even have a higher rate of return </li></ul><ul><li>As the world markets become more global , returns between countries may become more harmonized. </li></ul>
    6. 6. Diversification Benefits cont. <ul><li>Correlation between the historical returns of different countries is less than 1.0 </li></ul><ul><li>Richard Roll: Most significant factor relating to the size of the market decline in each country was the beta, β , of that market to the world market index </li></ul><ul><li>No country continually outperforms the others on an annual basis </li></ul>
    7. 7. Risk Reduction with International Securities
    8. 8. Degree of Diversification <ul><li>Measure correlation of stock movements </li></ul>Correlation Coefficient: Measures movement of one series of data over time to another series of data - in this case stock market returns
    9. 9. Assets with correlation coefficient of less than 1 reduce amount of risk No relationship 0 Two variables move opposite of each other Perfect negative -1 Two variables move together up and down Perfect positive 1 Implication Relationship Coefficient
    10. 10. Correlation Coefficients Between Foreign Markets and U.S. Markets in $ rates of Return 0.78 0.55 Average 0.82 0.64 United Kingdom 0.72 0.53 Switzerland 0.82 0.55 Spain 0.86 0.66 Netherlands 0.36 0.31 Japan 0.77 0.37 Italy 0.89 0.54 Germany 0.87 0.58 France 0.80 0.77 Canada 0.72 0.48 Australia Correlation Correlation Country 2000-2005 1985-2003
    11. 11. Correlations of Total Return between U.S. Markets and Emerging Markets in U.S. Dollars 2000-2005 0.39 South Africa 0.45 Russia 0.44 Taiwan 0.49 India 0.40 China 0.73 Mexico 0.72 Brazil 0.34 Argentina Correlation Coefficients
    12. 12. Return Potential in International Markets International diversification Less risk exposure Possible higher returns <ul><li>Several countries had long-term growth </li></ul><ul><li>rates superior to U.S. in terms of real GDP: </li></ul><ul><li>Singapore </li></ul><ul><li>China </li></ul><ul><ul><li>Norway </li></ul></ul>+
    13. 13. Returns in Developed Markets In U.S. $ 4.1 32.2 41.3 -6.3 Italy 17.0 15.9 36.3 -10.9 Switzerland 6.7 30.1 59.9 -11.8 Spain 11.6 23.2 45.3 -16.3 Hong Kong 11.4 16.9 65.2 -29.9 Germany 28.6 24.7 56.7 -10.8 Canada 11.9 20.8 42.8 -18.6 France 9.1 21.3 34.2 -14.2 United Kingdom 28.0 16.9 38.6 -8.7 Japan 6.6% 12.5% 31.9% -21.4% United States 2005 2004 2003 2002
    14. 14. 5 Yr. Returns in Emerging Markets in U.S. $ 2000-2005 7.68% Italy 6.00% Switzerland 13.20% Spain 8.40% Hong Kong 6.60% Germany 14.60% Canada 6.00% France 6.36% United Kingdom 7.68% Japan 3.12% United States
    15. 15. Return Potential in International Markets <ul><li>Many countries are highly competitive in </li></ul><ul><li>automobiles, steel, & consumer electronics </li></ul>Capital formation and potential investment opportunity <ul><ul><li>Germany </li></ul></ul><ul><ul><li>Japan </li></ul></ul><ul><ul><li>France </li></ul></ul><ul><ul><li>Canada </li></ul></ul>3. Enjoy higher individual savings rates than U.S.
    16. 16. Annualized rates of return of world indexes over 32-yr. period 1969-2001
    17. 17. Current Quotations on Foreign Market Performance <ul><li>Track performance of selected world markets </li></ul><ul><li>1st index EAFE =Europe, Australia, FarEast </li></ul><ul><li>Quotes are in local currencies & in U.S. $ </li></ul><ul><li>U.S. investors compare returns in U.S. against an investment in U.S. stock market </li></ul>Instructions to navigate msci website: on Power Point tool bar click View , choose Notes Page www.msci.com
    18. 18. Other Market Differences <ul><li>Culture </li></ul><ul><li>Willingness to take risk </li></ul><ul><li>Desire for dividend income versus growth in share value </li></ul><ul><li>Number & type of companies available to stockholders </li></ul><ul><li>Bureaucratic differences </li></ul>
    19. 19. Other Market Differences cont. <ul><li>Accounting conventions </li></ul><ul><li>Government regulation of markets </li></ul><ul><li>Problem with comparing P/E ratios: </li></ul><ul><li>Earnings calculated differently according to local or regional accounting </li></ul>
    20. 20. Currency Fluctuations and Rates of Return <ul><li>Tracking foreign markets requires adjustments </li></ul><ul><li>Reported returns adjusted for </li></ul><ul><li>foreign currency effects </li></ul><ul><li>How important is the foreign currency effect in relation to overall return performance in foreign currency? </li></ul><ul><li>Do foreign exchanges overpower actual return on investments in foreign countries? </li></ul>
    21. 21. Currency Fluctuations and Rates of Return <ul><li>Foreign currency effect is about 10 to 20% as significant as the actual return performance in the foreign currency </li></ul><ul><li>If dollar is rising/falling rapidly over a short period the impact can be much greater </li></ul>
    22. 22. Currency Fluctuations and Rates of Return <ul><li>Investment in Switzerland: 10% return </li></ul><ul><li>CHF declines by 5% against U.S. $ </li></ul><ul><li>CHF profits are worth less in $ </li></ul><ul><li>Gain on investment: </li></ul><ul><li>110% (Investment with 10% profit) </li></ul><ul><li>Adjusted value of CHF relative to U.S. $ </li></ul><ul><li>= 0.95 =1.00 - 0.05 decline in currency </li></ul><ul><li>104.5% (= 110 x 0.95) of original investment </li></ul><ul><li>Actual return in U.S. $ 4.5% instead of 10% </li></ul>Swiss franc = CHF
    23. 23. Currency Fluctuations and Rates of Return <ul><li>Examine currency effects in Sweden YTD </li></ul><ul><li>Return in local currency 4.58% (3 rd column) </li></ul><ul><li>Return in U.S. $............. 6.31% (7 th column) </li></ul><ul><li>Change in $/SEK made a positive return in kronor become a negative return in U.S. $ </li></ul>Swedish currency Krona (pl. Kronor) symbol SEK See Table 19-8 next 2 slide
    24. 24. Currency Fluctuations and Rates of Return <ul><li>Computed returns: </li></ul><ul><li>104.58% (Investment with 4.58% profit) </li></ul><ul><li>(Adjusted value of the SEK to U.S. $) </li></ul><ul><li>0.896 (1.000 - 0.104 decline in currency) </li></ul><ul><li>93.7% (= 104.58 x 0.896) of original investment </li></ul>See Table 19-8 next slide
    25. 26. Other Obstacles to International Investments <ul><li>Political Risks </li></ul><ul><li>Tax Problems </li></ul><ul><li>Lack of Market Efficiency </li></ul><ul><li>Administrative Problems </li></ul><ul><li>Information Problems </li></ul><ul><li>Corruption </li></ul>
    26. 27. Political Risks <ul><li>Danger of nationalization of foreign firms </li></ul><ul><li>Restriction of capital flows to investors </li></ul><ul><li>Violent overthrow of political party in power </li></ul><ul><li>Not meeting their foreign debt obligations </li></ul><ul><li>Check the political/economic climate </li></ul>
    27. 28. Tax Problems <ul><li>Foreign countries may impose 15 to 30% withholding tax against dividends or interest paid to nonresidents </li></ul><ul><li>Tax-exempt U.S. investors can secure exemption or rebate </li></ul><ul><li>Taxable U.S. investors can claim a U.S. tax credit for taxes paid in foreign countries </li></ul><ul><li>Inconvenience rather than loss of funds </li></ul>
    28. 29. Lack of Market Efficiency <ul><li>U.S. capital markets the most liquid & efficient in the world </li></ul><ul><li>Investors accustomed to trading on NYSE will find it difficult to adjust to foreign markets </li></ul><ul><li>Larger spread between bid (sell) & ask (buy) price </li></ul><ul><li>Difficulty executing large transaction </li></ul><ul><li>Higher commission rates </li></ul>
    29. 30. Elkins/McSherry Global Universe of Transaction Costs Developed Markets 4 factors: price, commission, fees, mkt impact 30.65 BP Italy 30.38 BP Switzerland 28.37 BP Spain 41.71 BP Hong Kong 23.20 BP Germany 32.51 BP Canada 25.77 BP France 73.77 BP United Kingdom (buys) 25.78 BP United Kingdom (sells) 21.39 BP Japan 20.14 BP United States, NYSE Total Cost
    30. 31. Market Capitalization of Developed World Markets (Year end 2005) in billions of U.S. $ $798 Italy $938 Switzerland $960 Spain $1,006 Hong Kong $1,221 Germany $1,480 Canada $1,710 France $3,058 London $4,736 Japan $16,997 United States
    31. 32. Market Capitalization of The Largest Emerging Markets (year end 2005) in billions of U.S. $ $474 Brazil $485 Taiwan $548 Russia $553 India $565 South Africa $646 Saudi Arabia $718 S. Korea $780 China
    32. 33. Market Capitalization of the Three Largest U.S. Companies in billions U.S. $ $1,087 $280 Microsoft $361 General Electric $446 Exxon
    33. 34. Administrative Problems <ul><li>Adjusting to various local systems </li></ul><ul><li>For example, </li></ul><ul><li>Hong Kong, Swiss, & Mexican stock markets settle accounts one day after the transaction </li></ul><ul><li>London: two-week settlement </li></ul><ul><li>Different administrative procedures add extra difficulty in executing trades </li></ul><ul><li>Avoid these difficulties by going through mutual funds and other investment outlets </li></ul>
    34. 35. Information Problems <ul><li>U.S. securities markets are the best at providing investment information </li></ul><ul><li>S.E.C. has rigorous requirements for full disclosure information </li></ul><ul><li>FASB continually providing pronouncements on GAAP for financial reporting </li></ul><ul><li>Publicly traded companies required to provide stockholders with fully audited annual reports </li></ul><ul><li>Evaluative reports/ratings by Moody’s, Standard & Poor’s, Value Line, & other firms </li></ul>
    35. 36. Information Problems <ul><li>Extensive economic data provided by governmental sources e.g. </li></ul><ul><ul><li>Department of Commerce </li></ul></ul><ul><ul><li>Federal Reserve System </li></ul></ul><ul><li>International firms in less sophisticated foreign markets do not provide sufficient data </li></ul><ul><li>Language problems for the analyst </li></ul>
    36. 37. Methods of Participating in Foreign Investments <ul><li>International investment </li></ul><ul><li>Investing in firms in foreign markets </li></ul><ul><li>Purchasing foreign shares trading in U.S. </li></ul><ul><li>Mutual funds investing overseas </li></ul><ul><li>Closed-end funds with global orientation </li></ul><ul><li>Buying shares of multinational corporations </li></ul>
    37. 38. Methods of Participating in Foreign Investments <ul><li>Direct Investments </li></ul><ul><li>Indirect Investments </li></ul>
    38. 39. Direct Investments <ul><li>Directly purchase shares of firm in foreign market </li></ul><ul><li>Use foreign broker/overseas branch of U.S. broker </li></ul><ul><li>Difficulties and administrative problems: </li></ul><ul><li>Information-gathering problems </li></ul><ul><li>Tax problems </li></ul><ul><li>Stock-delivery problems </li></ul><ul><li>Capital-transfer problems </li></ul><ul><li>Communication difficulties in executing orders </li></ul><ul><li>Sophisticated money manager follow this approach </li></ul>
    39. 40. Direct Investments <ul><li>Purchase shares of foreign firms that trade in U.S. stock markets (NYSE) </li></ul><ul><li>Purchase ADRs </li></ul>ADRs represent ownership interest in a foreign company’s common stock Go to: 1. International 2. Non-U.S. Listed Company Directory www.nyse.com
    40. 41. Direct Investments - Hyperlinks to some companies that have ADRs www.alcan.com www.honda.com www.sony.com www.britishairways.com www.nortelnetworks.com
    41. 42. Indirect Investments <ul><li>Investments in international securities include: </li></ul><ul><li>Purchasing shares of multinational corporations </li></ul><ul><li>Mutual funds or closed-end investment funds specializing in worldwide investments </li></ul><ul><li>Investing in exchange traded funds (ETF) </li></ul><ul><li>Use a private firm specializing in foreign investment portfolio management </li></ul>
    42. 43. (a)- Purchasing Shares of Multinational Corporations <ul><li>Firms with operations in several countries </li></ul><ul><li>Opportunity for international diversification </li></ul><ul><ul><li>Major oil companies e.g. Exxon, BP, Shell </li></ul></ul><ul><ul><li>Large banking firms e.g. Barclays, HSBC </li></ul></ul><ul><ul><li>Pharmaceuticals e.g. Glaxo, Novartis </li></ul></ul><ul><ul><li>Consumer Products e.g. Sony, Coca Cola </li></ul></ul>
    43. 44. (b)- Mutual Funds and Closed-End Investment Companies <ul><li>Mutual funds offer </li></ul><ul><ul><li>Diversification </li></ul></ul><ul><ul><li>Professional management </li></ul></ul><ul><li>Invest in closed-end investment companies specializing in international equity investments </li></ul><ul><li>May trade at premium/discount from NAV </li></ul>
    44. 45. (c)- Exchange Traded Funds (ETFs) <ul><li>Use ETFs to invest in international markets </li></ul><ul><li>Biggest market the American Stock Exchange </li></ul><ul><li>Lists over 40 international funds </li></ul><ul><li>ETF: basket of securities that track an index </li></ul><ul><li>Trades like an individual stock with all day </li></ul><ul><ul><li>Trading </li></ul></ul><ul><ul><li>Price tracking </li></ul></ul>www.amex.com
    45. 46. Exchange Traded Funds (ETFs) <ul><li>ETF mimics a major index, e.g. </li></ul><ul><ul><li>Financial Times 100 for United Kingdom </li></ul></ul><ul><ul><li>DAX for Germany </li></ul></ul><ul><li>ETF can track </li></ul><ul><ul><li>A broad stock index </li></ul></ul><ul><ul><li>Bond index </li></ul></ul><ul><ul><li>Industry index </li></ul></ul><ul><ul><li>Sector index </li></ul></ul><ul><li>Lower costs </li></ul><ul><li>Better tax efficiency than mutual funds </li></ul><ul><li>Ability to diversify using these funds </li></ul>www.amex.com
    46. 47. (d)- Specialists in International Securities <ul><li>Large investors may engage services of firms with specialized expertise in foreign equities </li></ul><ul><li>Banks </li></ul><ul><li>Investment counselors </li></ul><ul><ul><li>Morgan Guaranty Trust Company </li></ul></ul><ul><ul><li>State Street Bank and Trust Company </li></ul></ul><ul><ul><li>Batterymarch Financial Management </li></ul></ul><ul><ul><li>Fidelity Trust Company of New York </li></ul></ul><ul><li>Minimum investment well in excess of $100,000 </li></ul><ul><li>Cater to large institutional investors </li></ul>
    47. 48. Provides international news & information on foreign markets www.global-investor.com Provides news on global markets cbs.marketwatch.com Exchange Traded Funds www.amex.com Provides screening &research services for American depository receipts www.adr.com Comments Website
    48. 49. Provides international economic information and links to related sites www.oecd.org Provides currency rates and conversions www.rubicon.com Provides information on global markets and economics www.wsj.com Global magazine providing news on markets and economics www.economist.com Comments Website
    49. 50. Summary <ul><li>Diversify by investing in international securities </li></ul><ul><li>Different foreign markets influenced by varying & contradictory factors </li></ul><ul><li>Effective risk reduction </li></ul>Example: Sharp & unexpected increase in energy prices negative impact on oil importers may be offset by positive impact on oil exporters
    50. 51. Summary <ul><li>Investments in selected foreign equity markets may provide </li></ul><ul><li>Excellent return opportunities </li></ul><ul><li>Many countries GDP growth rate is like U.S. </li></ul><ul><li>Greater savings rates </li></ul><ul><li>Higher capital formation </li></ul><ul><li>Consider currency fluctuations </li></ul><ul><li>Risk </li></ul>

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