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- 1. International Equity Markets ChapterThirteen Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 2. Chapter Outline • TheWorld’s Equity Markets: A Statistical Perspective • Market Structure, Trading Practices, and Costs • Trading in International Equities • International Equity Market Benchmarks • iShares MSCI • Factors Affecting International Equity Returns 13-2 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 3. Market Capitalization • Atyear-end 2018, total market capitalization of the 80 organized stock exchanges tracked by the World Federation of Exchanges (WFE) stood at $74,667b – Five largest stock exchanges at end of 2018: • New York Stock Exchange (NYSE) • NASDAQ • Japan Exchange Group • Shanghai Stock Exchange • Hong Kong Exchanges and Clearing 13-3 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 4. Market Liquidity • Aliquid stock market is one in which investors can buy and sell stocks quickly at close to the current quoted prices – A measure of liquidity for a stock market is the turnover ratio, calculated as the ratio of stock market transactions over a period of time divided by the size, or market capitalization, of the stock market – Generally, the higher the turnover ratio, the more liquid the secondary stock market, indicating ease in trading – In 2018, many national stock exchanges had relatively high turnover ratios, with close to 40% of the exchanges in excess of 30% turnover on average 13-4 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 5. Market Concentration • Investorswould have difficulty diversifying their investments in concentrated markets, those dominated by a few large firms – Concentrated financial markets also represent poor access of firms to the stock market – A common measure of stock market concentration is the ratio of the market capitalization of the largest ten companies divided by the total market capitalization • In 2018, the largest ten companies on the Budapest Stock Exchange accounted for a whopping 95.46% of the total market capitalization of the stock exchange • Alternatively, also in 2018, the London Stock Exchange had a much lower concentration ratio of 29.38% 13-5 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 6. Market Structure, TradingPractices, and Costs • Secondary equity markets of the world serve two major purposes: 1. Provide marketability 2. Provide share valuation • Investors who buy shares from the issuing firm in the primary market may not want to hold them indefinitely • The secondary market allows those share owners to reduce holdings of unwanted shares and purchasers to acquire the stock 13-6 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 7. Market Structure, TradingPractices, and Costs (Continued) • When conducting a trade in the secondary market, public buyers and sellers are represented by an agent, known as a broker – Order submitted to broker may be a market or limit order • Market order is executed at the best price available in the market when the order is received, that is, the market price • Limit order is an order away from the market price that is held in a limit order book until it can be executed at the desired price 13-7 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 8. Market Structure, TradingPractices, and Costs (Concluded) • Secondary markets may have different designs that allow for the efficient trading of shares – Generally, a secondary market is structured as a dealer or agency market • In a dealer market, the broker takes the trade through the dealer, who participates in trades as a principal by buying and selling the security for his own account • In an agency market, the broker takes the client’s order through the agent, who matches it with another public order – Both dealer and agency structures exist in the U.S. 13-8 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 9. EXHIBIT 13.3 Characteristics ofMajor Equity Trading Systems 13-9 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 10. Market Consolidations AndMergers • Approximately 80 major national stock markets – Western and Eastern Europe once had more than 20 national stock exchanges where at least 15 different languages were spoken – Possibly, over time a European stock exchange will eventually develop; however, a lack of common securities regulations, even among the countries of the European Union, hinders this development • Today, stock markets around the world are under pressure from clients to combine or buy stakes in one another to trade shares of companies anywhere, at a faster pace 13-10 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 11. Trading in InternationalEquities • During the 1980s, world capital markets began a trend toward greater global integration due the following factors: 1. Investors began to realize the benefits of international portfolio diversification 2. Major capital markets became more liberalized 3. New computer and communications technology facilitated efficient and fair securities trading 4. MNCs realized the benefits of sourcing new capital internationally 13-11 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 12. Cross-Listing of Shares •Cross-listing refers to a firm having its equity shares listed on one or more foreign exchanges, in addition to the home country stock exchange – Not a new concept, but amount of cross-listing has exploded in recent years due to increased globalization – MNCs often cross-list their shares, but non-MNCs may choose to cross-list, as well 13-12 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 13. Cross-Listing of Shares(Continued) • A firm may cross-list shares for many reasons: 1. Provides a means for expanding the investor base for a firm’s stock, thus potentially increasing its demand 2. Establishes name recognition of the company in a new capital market 3. Brings the firm’s name before more investor and consumer groups 4. May be a signal to investors that improved corporate governance is forthcoming (if cross-listing into developed capital markets with strict securities regulations and information disclosure requirements) 5. May mitigate the possibility of a hostile takeover of the firm 13-13 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 14. Yankee Stock Offerings •Yankee stock offerings are sold directly to U.S. investors by foreign companies – Since the beginning of the 1990s, many foreign companies, Latin America in particular, have listed their stocks on U.S. exchanges to prime the U.S. equity market for future Yankee stock offerings – Three factors appear to be fueling the sale of Yankee stocks 1. Push for privatization by many Latin American and Eastern European government-owned companies 2. Rapid growth in economies of developing countries 3. Large demand for new capital by Mexican companies following approval of NAFTA 13-14 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 15. American Depository Receipts •Foreign stocks can be traded directly on a national stock market, but frequently they are traded in the form of a depository receipt – Depository receipts (DR) market has grown significantly over the years – In 2018 alone, $15b was raised through 49 DR offerings • An American Depository Receipt (ADR) is a receipt representing a number of foreign shares that remain on deposit with the U.S. depository’s custodian in the issuer’s home market – First ADRs began trading in 1927 13-15 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 16. Advantages of ADRs •Investment advantages of ADRs include the following: – ADRs are denominated in dollars, trade on a U.S. exchange, and can be purchased through the investor’s regular broker – Dividends received on the underlying shares are collected and converted to dollars by the custodian – ADR trades clear in 3 business days, as do U.S. equities – ADR price quotes are in U.S. dollars – ADRs (except Rule 144A issues) are registered securities that provide for the protection of ownership rights, whereas most underlying stocks are bearer securities 13-16 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 17. Advantages of ADRs(Continued) • Investment advantages of ADRs include the following: – An ADR investment can be sold by trading the depository receipt to another investor in the U.S. stock market, or the underlying shares can be sold in the local stock market – ADRs frequently represent a multiple of the underlying shares, rather than a one-for-one correspondence, to allow the ADR to trade in a price range customary for U.S. investors – ADR holders give instructions to the depository bank as to how to vote the rights associated with the underlying shares 13-17 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 18. American Depository Receipts (Continued) •There are two types of ADRs: – Sponsored ADRs are created by a bank at the request of the foreign company that issued the underlying security • Only type that can be listed on the U.S. stock markets – Unsponsored ADRs were usually created at the request of a U.S. investment banking firm without direct involvement by the foreign issuing firm • Consequently, the foreign company may not provide investment information or financial reports to the depository on a regular basis or in a timely manner 13-18 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 19. 13-19 Copyright © 2021by the McGraw-Hill Companies, Inc. All rights reserved. EXHIBIT 13.6 Types of ADRs
- 20. Global Registered Shares •Merger of Daimler Benz AG and Chrysler Corporation in November 1998 created DaimlerChrysler AG, a German firm • Merger simultaneously created a new type of equity share, called Global Registered Shares (GRSs) – GRSs are traded globally, unlike ADRs – GRSs are fully fungible – a GRS purchased on one exchange can be sold on another – Main advantages of GRSs over ADRs appear to be that all shareholders have equal status and direct voting rights, while main disadvantage of GRSs appears to be the greater expense in establishing the global registrar and clearing facility 13-20 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 21. Empirical Findings onCross-Listings and ADRs • Several empirical studies document important findings on cross-listing in general and on ADRs in particular • Listed below are a few examples: – Ammer et al. (2012) found that the single most important determinant of the amount of U.S. investment a foreign firm receives is whether the firm cross-lists on a U.S. exchange – Sarkissian and Schill (2016) established that cross- listing occurs in waves at the host market, home market, and industry levels 13-21 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 22. Empirical Findings onCross-Listings and ADRs (Continued) • Jayaraman, Shastri, and Tandon (1993) interpreted their results as evidence that an ADR listing provides the issuing firm with another market from which to source new equity capital • Results of Berkman and Nguyen (2010) indicate that cross-listed firms from countries with poor corporate governance and/or weak accounting standards gain from improvements in domestic liquidity in the first two years after cross-listing but tend to diminish later 13-22 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 23. International Equity Market Benchmarks •As a benchmark of activity or performance of a given national equity market, an index of the stocks traded on the secondary exchange (or exchanges) of a country is used – Indexes constructed and published by MSCI are an excellent source of national stock market performance – MSCI presents return and price level data for 23 national stock market indexes from developed countries, 27 emerging market countries, and 34 frontier markets that cover investment opportunities beyond traditional developed and emerging markets 13-23 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 24. International Equity Market Benchmarks(Continued) • MSCI also publishes a market-value-weighted World Index representing large and mid-cap stocks across 23 developed markets – Includes approximately 2,600 stock issues of major corporations in the world • MSCI publishes several regional indexes – The European, Australasia, Far East (EAFE) Index, the North American Index, the Far East Index, several Europe Indexes, the Nordic Countries Index, the Pacific Index, and the Emerging Markets Index 13-24 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 25. iShares MSCI • BlackRockInc., an international investment management firm, operates iShares MSCI as vehicles to facilitate investment in country, regional, and world funds – iShares MSCI are baskets of stocks designed to replicate various MSCI stock indexes – Currently dozens of iShares MSCI – Exchange-traded funds, with most trading on NYSE AMEX – Low-cost, convenient way for investors to hold diversified investments in several different countries 13-25 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 26. Factors Affecting InternationalEquity Returns • Which factors influence equity returns? – Macroeconomic factors – Exchange rates – Industrial structure 13-26 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 27. Macroeconomic Factors • Twostudies have tested the influence of various macroeconomic variables on stock returns 1. Solnik (1984) found that international monetary variables had only weak influence on equity returns in comparison to domestic variables 2. Asprem (1989) found that changes in industrial production, employment, and imports, the level of interest rates, and an inflation measure explained only a small portion of the variability of equity returns for ten European countries, but that substantially more of the variation was explained by an international market index 13-27 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 28. Exchange Rates • Adlerand Simon (1986) – Found changes in exchange rates generally explained a larger portion of the variability of foreign bond indexes than foreign equity indexes • Eun and Resnick (1988) – Found that the cross-correlations among major stock markets and exchange markets are relatively low, but positive • Gupta and Finnerty (1992) – Concluded that exchange risk is generally not priced 13-28 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
- 29. Industrial Structure • Studiesexamining the influence of industrial structure on foreign equity returns are inconclusive 13-29 Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.