Financial integration
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FINANCIAL INTEGRATION. Paula Garrido Mirat. Background. H igh levels of financial integration a hundred years ago. British investment in Argentina, Australia, Canada and US between 1865 and 1890 went mostly into railroads and government bonds. Obstacles for investing abroad then.

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FINANCIAL INTEGRATION

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Financial integration

FINANCIAL INTEGRATION

Paula GarridoMirat


Background

Background

  • High levels of financial integrationa hundred years ago.

  • British investment in Argentina, Australia, Canada and US between 1865 and 1890 went mostly into railroads and government bonds.


Obstacles for investing abroad then

Obstacles for investing abroad then

  • INFORMATION PROBLEMS

    • Communications technology of the day

    • Asymmetric information

  • CONTRACTING PROBLEMS

    • US laws VS. Britain laws

  • MACROECONOMIC RISKS

    • Exchange rate risk

    • Unstable and uncertain monetary and fiscal policies

  • ACCOUNTING PROBLEMS


Information problems

Information problems

  • Communications technology of the day:

    • Transatlantic cable (1860)

    • Time for cable transmission less than a minute by 1914

    • Equalization in prices in different places of the world


Information problems1

Information problems

  • Information asymmetry:

    • Adverse selection

    • Disproportionate share of railway bonds in foreign investment portfolios

    • Family groups and merchant and investment banks

    • Freestanding companies for FDI


Contracting problems

Contracting problems

  • Uncertainty of legal security of the claims of foreign investors in the US was an issue for British investors

  • The US prohibited foreigners from serving as directors of the corporations chartered there

  • Freestanding companies were very trusted then because they were subject to British law.


Macroeconomic risks

Macroeconomic Risks

  • British investors viewed securities issued by countries not on the gold standard riskier than those of the countries that were.

  • Loans to countries with a fluctuating standard value commanded significantly higher interest rates


Absence of adequate accounting standards

Absence of adequate accounting standards

  • Suggestion to create generally accepted accounting principles

  • British investors insisted on the transfer to the US of accounting practices accepted in Britain

  • Need for regulatory intervention: Interstate Commerce Commission for the railroads until the Securities Exchange Commission

  • British accountants set up practice in the US from the mid-19th century


F inancial integration now

Financial integration now

  • Deeper and broader economic integration

  • More complexity of financial markets

  • More regulation

  • More financial innovations

  • Improvements in communication

  • Bankruptcies, scandals and fraud still there


Problems the enron scandal

Problems. The Enron scandal

  • INFORMATION PROBLEMS

    • Still asymmetry information

    • Hidden information

  • DEREGULATED MARKETS

    • California deregulated the energy market

  • RISKS

    • Credit rating agencies

    • Enron´s sophisticated financial risk management tools

  • ACCOUNTING AND AUDITING

    • Arthur Andersen downfall with the scandal


Information problems2

Information problems

  • Failed investments

  • ENRON formed partnerships to hide $500 Million in company losses

  • People continued buying ENRON stocks and the price didn’t go down

  • NO INFORMATION OF THE REAL STATUS OF THE COMPANY


Deregulated markets

Deregulated markets

  • 1996: California deregulated the energy market in order to increase competition

  • Market manipulations and illegal shutdowns

  • State of emergency in January 2001

  • ENRON saw opportunity to make money to cover their huge losses: TAKE ADVANTAGE OF THE DEREGULATED MARKET IN CRISIS

  • Government regulated the market: no more opportunity to make money for ENRON

  • ENRON announced its first losses in more than four years


Macroeconomic risks1

Macroeconomic risks

  • Credit agencies:

    • They were giving Enron the highest qualifications, when Enron was facing huge losses, which prevented their stock price from falling.

    • They downgraded Enron´s credit rate too late, when it was already bankrupt.

  • ENRON´s sophisticated financial risk management tools

    • Enron's bankruptcy downfall was attributed to its reckless use of derivatives and special purpose entities


Accounting and auditing

Accounting and auditing

  • ENRON succeeded in hiding some important facts, such as off-book liabilities, from banks and shareholders

  • ENRON's auditor´s firm, Arthur Andersen, was accused of applying reckless standards in its audits because of a conflict of interest over the significant consulting fees generated by ENRON

  • Arthur Andersen fell with the Enron´s fall

  • ENRON was attributed as the biggest audit failure in history


Comparissons

COMPARISSONS

After more than a century, similar problems to those that faced British investors still exist but in a more complex and integrated financial system:

  • Asymmetry information: the investors (now and then) didn’t have all the real information of the economic status of the company, despite the improvements in communication technologies

  • British investors and ENRON company also took into account the laws in different places in order to choose the best apparent investment opportunity

  • Even though there have been many improvements in risk management, sometimes it is very hard to measure it

  • Distinction between the auditor´s inspective function and the accountant´sanalytical function emerged in the 20th centurybut it doesn´t prevent conflict of interests


Conclusion

Conclusion

  • INFORMATION IS THE KEY ELEMENT IN AN INVESTMENT

  • THERE WILL ALWAYS BE COMPANIES AND PEOPLE THAT WILL HAVE OTHER INTERESTS

  • MORE REGULATION CAN HELP BUT WON´T SOLVE THE PROBLEM COMPLETELY


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