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Module V: International Capital Markets. Week 13 – November 18 & 20, 2002. Objectives. Understand basics of global capital markets and recent developments for corporate financing decisions Understand how foreign firms raise capital in the United States and elsewhere

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Module V:International Capital Markets

Week 13 – November 18 & 20, 2002


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Objectives

  • Understand basics of global capital markets and recent developments for corporate financing decisions

  • Understand how foreign firms raise capital in the United States and elsewhere

  • Examine factors relevant to firms’ cost of financing in using international sources of financing


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International Cases: Context

  • The Hostile Bid for Red October

    • Russian equity market risks

      • Inflation

      • Liquidity problems

      • Reporting and transparency issues

      • Political risk: taxation, regulation, favoritism

  • Huaneng Power International

    • China in 1994


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Example Stock Markets 1999

Source: IMF Working Paper 00/216


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Emerging Market Performance

Source:IFC S&P/IFCI Index, 3/28/2002 (column 2) and WSJ, 11/15/2002 (column 3)


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Issues in Global Markets

  • Integration of capital markets

    • How much or how little do events in one market reflect events in other markets

    • Expected real returns across markets

  • Benefits of diversification

    • Risk reduction through correlations of returns

    • How to choose portfolio allocations

  • Risks of international investing


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Recent Findings

  • Importance of global effects has increased in the “new economy” of the 1990’s

  • Emerging country specific risk has increased dramatically since the crises of the 1990’s while developed-country specific risk has declined

  • Industry factors, especially technology, probably explain higher correlations


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Global Financial Management

  • Investment in assets

    • Find highest NPV or highest return projects on a risk-adjusted basis

    • Cash flows measured in purchasing power of owners (maximize shareholders’ wealth!)

  • Financing

    • Minimize cost of funds on a risk-adjusted basis

  • International finance: analysis of currency and political risks that are unique to foreign operations


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Currency and Political Risk

  • Currency risk is variability in cash returns due to variations in exchange rates

    • For important currencies can be hedged in financial markets

    • Often can be hedged on the balance sheet by operating and financing policies (recall American Airlines and Canada and G.E. turbine sales examples

  • Some currencies cannot be hedged: what kind of risk is currency risk (systematic, liquidity, etc.)?


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International Capital Flows

  • Where are highest real returns to be found in the world today?

    • Emerging market economies (educated, hard-working labor, low capital stocks)

    • The United States? (capital inflow, new economy, benign business environment)

    • Europe? (opening to East, Euro, restructuring)

    • Latin America?


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Determinants of Capital Flows

  • Take advantage of higher returns

    • Japanese investments in Asian neighbors

    • OPEC investments in diversified economies

  • Benefits from diversification

    • Pension funds and other institutional flows

  • Arbitrage risk-return differentials

    • Temporary differentials that are expected to go away, as from political threats that can be managed by diversification


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Issues in International Investing

  • Taxes and/or restrictions of payment of dividends or proceeds of sale

  • Currency related issues

    • Ability to hedge and/or convert cash flows

    • Costs of currency hedging and/or conversion

    • Currency risk due to economic fundamentals (devaluation/revaluation)

  • Liquidity and transaction costs


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Equity Trading Costs (One-Way Mean, in Basis Points)


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Emerging Market Equity Issues

  • Private equity versus public issues

    • Role played by private investors (like venture capital)

    • Importance of marketability for some investors

  • Second board markets

    • Examples: MOTHERS in Japan, U.S. NASDAQ Small Cap markets

    • Hong Kong GEMs, Korean Kosdaq, Sesdaq


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Markets and Venture Capital

  • Emerging market economies in Asia have been active in developing venture capital industries

    • Most successful (like U.S.) is Taiwan

    • Others differ from U.S. experience, partially for cultural reasons

    • Organizational forms and exit possibilities

  • Second board markets in Asia have not represented a reliable exit strategy


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Trends in Equity Trading

  • Global integration in equity trading

    • Natural economies of scale in markets: size promotes liquidity

    • Technology

    • History and legal system

  • Three models of future markets

    • Concentration, as in NYSE in U.S.

    • Alliances (e.g. Singapore and Australia)

    • Electronic markets (ECNs)


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Advantages of U.S. Listing

  • Liquidity provided by large markets

  • Established market with global reputation and known and enforced rules of conduct

  • Prestige of listing

  • Attractiveness to investors

    • Domestic U.S. retail investors

      • Reporting and currency issues

    • Institutional investors

      • Liquidity and liability concerns


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American Depository Receipts

  • American depository receipts (ADRs) are used for foreign companies to trade on U.S. markets

    • Shares deposited in custodial bank in firms’ home countries

    • ADRs have grown in popularity since 1980’s

      • Institutional investors wishing international diversification

      • Foreign firms wishing to raise funds in U.S.

  • Several levels of ADRs


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Levels of ADRs

  • Level I

    • Simplest but unlisted and traded over-the-counter (pink sheets)

    • Reporting requirements are minimal (Form F-6)

  • Level II

    • Required to list on exchanges (NYSE, AMEX, NASDAQ)

    • Disclosure but not meeting U.S. standards

  • Level III

    • Full compliance with U.S. reporting requirements (using GAAP standards)



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China

  • Shanghai and Szenzhen stock exchanges

    • A and B shares

  • Currency (remninbi) non-convertible but discussion of changing policies

  • Rapid growth in non-government sector

  • State-owned enterprises (SOEs) and town and village enterprises (TVEs)

  • Banks and trust-and-investment companies


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Who Owns Chinese Corporations?

  • SOEs partially privatized

    • Shares traded in China

    • Ownership by a variety of institutions

  • Stakes in firms also owned by

    • Regional governments

    • Government ministries

    • TVEs

    • Pension funds and TICs

  • Goal of management?


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Next Week – Nov. 25 & 27, 2002

  • Review topics covered in RWJ, Chapter 13

  • Read and think carefully about issues of corporate governance in xxx case for discussion on November 25 and remember that this is the last individual case write-up

  • Use week of December xxx to begin review for final exam by reviewing course syllabus and weekly objectives and slides


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