International Financial Management: INBU 4200 Fall Semester 2004

1. International Financial Management: INBU 4200Fall Semester 2004 Lecture 8 The (International) Equity Markets (Chapter 8)

2. Equity Markets: Data • By year end 2000, the market capitalization of the world’s equity markets totaled about $32 trillion. • 91% (or $29.5 trillion) of this is accounted for by 30 developed countries of the world. • North America: 50% • Europe: 29% • Asia: 13% • 47% accounted for by U.S. markets • 10% accounted for by Japanese markets • 8% accounted for by U.K. markets

3. Equity Markets Data • Developing Countries Markets • 31 identified developing (emerging) countries stock markets had a combined capitalization of about $2 trillion in 2000, representing about 9% of the world market. • China ($581 billion; about 30% of the emerging market) • Taiwan ($248 billion) • Brazil ($226 billion) • South Africa ($205 billion) • Korea ($172 billion) • India ($148 billion)

4. Global Asset Management Issues • While approximately 90% of global equity market capitalization is in the developed world. • Remaining 10% of global equity market capitalization is in emerging markets. • The emerging markets are: • Generally growing faster, • often times their annual nominal returns exceed developed markets, • but have greater volatility. • Opportunities (and risks) for asset managers.

5. Market Concentration Issues for Asset Managers • Concentration ratio = ratio of 10 largest stocks traded as a fraction of total market capitalization of all equities traded. • Emerging markets tend to be much more concentrated than developed markets. • Relatively few companies dominate their industry sectors. • When this ratio is high, it is probably more difficult for asset managers to diversify a portfolio within that country • Why: there are fewer investment opportunities.

6. Market Liquidity Issues for Asset Managers • The equity markets of in emerging markets tend to be much less liquid than developed markets. • Liquidity refers to how quickly an asset can be sold without a major price concession. • Fewer traders, bigger spreads. • Trading problems for asset managers. • Adverse impact on prices when moving large amounts of equity.

7. Asset Allocation • Most global equity funds allocate about 5% of total assets to emerging markets. • Note: this is quite sizeable in relation to the market capitalization of emerging stock markets. • In 2001 total emerging market exposure of global equity funds was approximately US$108 billion, about the size of Korea’s total market capitalization! • Review of emerging market problems: • The equity markets of the emerging markets tend to be much less liquid than emerging markets. • Emerging markets tend to be much more concentrated than developed markets.

8. Factors Affecting International Equity Returns • Macroeconomic factors • Imperfect correlation of international business cycles (not all countries experience ups/downs at same time). • Important with regard to diversification strategy • Exchange rates • Cross-correlation of equity and forex markets is low but positive. • Can’t count on exchange rate “kick” to portfolio. • Economic/Business Structure • Some countries are more similar; greater correlation of equity market to business activity • Politics and Sentiment

9. Trends in Equity Issuance • International equity issuance (raising funds outside of domestic market) has exceeded domestic issuances in recent years (2000/2001). • Has enabled top-quality emerging market companies to raise capital at lower cost. • Chinese companies. • But, might dampen efforts to develop local equity markets.

10. 7 Biggest Stock Markets, Capitalization End of 2003 • Exchange Trillions of U.S. dollars • NYSE $11.3 • Tokyo $ 3.0 • NASDAQ $ 2.8 • London $ 2.5 • Euronext $ 2.1 • Deutsche $ 1.1 • Canada Group $ 0.9

11. Change in Market Capitalization, 2002 to 2003, in U.S. dollars

12. Observations on Equity Markets • Stock markets are opening up all over the world. • In countries which a few years ago did not have a domestic equity market. • Opportunities for global investors and global companies. • Asia • Latin America • Eastern Europe • Africa/Middle East

13. Foreign Listings on Stock Exchanges, 2000

14. Foreign Listings on Domestic Stock Exchange • There are two basic methods by which firms can “cross-list” their stocks on a foreign stock market. These are: • Listing the company directly on a foreign exchange. • Listing the company in the form of a depository receipt (preferred choice today). • This “cross-listing” process represents the emerging “globalization” of equity markets • One way through which global asset managers internationalize their portfolios. • Other way is to buy directly on the foreign exchange.

15. Reasons for Cross-Listing • Expands the investor base for a firm. • Increasing demand may increase price and improve liquidity. • Establishes name recognition for the firm in new capital markets, thus paving the way for new debt or equity issues in the future. • Following cross listing with an IPO • Some companies go straight to IPO offerings, which then become listed! • May offer marketing advantages. • Investors becoming consumers of company’s products. • May make hostile takeovers more difficult. • Because of expanded global investor base

16. Cross Listing and Regulations • When a company cross lists its share it is subject to: • Both, home and host country regulations! • For foreign firms listing in the U.S. this means: • Meeting the disclosure requirements of the SEC, for example, reconsolidation of the company’s financial statements to U.S. standards. • Differences around the world in accounting standards. • Foreign firms can bypass these requirements through rule 144A (private placement) sales to qualified institution buyers. These buyers are generally pension funds, asset managers, or insurance companies • Meeting the Sarbanes-Oxley Act (2002): • To improve quality and transparency in financial reporting and independent audits. • The role of corporate governance and the role of those who manage corporate governance have changed substantially. Requires management certification of financial statements. • Fees as set by the foreign exchange • Listing and annual fees are charged!

17. Foreign Listing Requirements in Japan • Minimum number of share to be listed • Depends upon average price (on home exchange). Varies from 20 million shares (average price less than ¥500) to 20,000 (average price ¥100,000 or more)! • Market capitalization and time of incorporation of company • At least ¥2 billion; at least 3 years since incorporation. • Financial statements to be provided • Minimum 2 years, audited independently • Initial listing fees: • Examination fee: ¥1 million • Fixed fee: ¥2.5 million • Annual listing fee: • ¥0.0225 x number of shares listed (to a maximum of ¥13.5 million)

18. Depository Receipts • Rather then listing shares directly, foreign companies prefer to list their shares through a depository receipt form. • A receipt that represents some designated number of shares of stock in the listed company. • Depository receipt trades on overseas stock exchange. • Actual shares are held on deposit at a bank. • Bank acts as the transfer agent • Recording ownership changes; paying declared dividends!

19. American Depository Receipts • Refers to foreign companies cross listing on U.S. stock markets. • First began trading in 1927! • Initially seen as a means of reducing the risk associated with holding shares overseas and reducing the trading times. • By 2002, there were about 2,200 ADR programs, representing companies from more than 80 countries. • ADR web site: http://www.adr.com/

20. Country Number of Companies Sweden 7 Companies Venezuela 2 Companies Argentina 10 Companies France 23 Companies Turkey 1 Companies South Africa 6 Companies Brazil 33 Companies Norway 5 Companies Portugal 3 Companies Switzerland 11 Companies India 6 Companies Italy 12 Companies Russian Fed 19 Companies Japan 29 Companies Denmark 3 Companies Taiwan 3 Companies Netherlands 27 Companies Belgium 1 Companies Czech Republic 1 Companies Malaysia 2 Companies Thailand 1 Companies Country Number of Companies United Kingdom 62 Companies Philippines 5 Companies Hungary 4 Companies Hong Kong 14 Companies Chile 15 Companies Finland 4 Companies Austria 3 Companies Spain 7 Companies Australia 12 Companies Peru 2 Companies New Zealand 1 Companies Ireland 6 Companies China 5 Companies Israel 6 Companies Germany 24 Companies Luxembourg 1 Companies Indonesia 2 Companies Singapore 4 Companies Greece 3 Companies Korea 5 Companies Mexico 18 Companies ADRs by Selected Country, Oct 2003

21. Advantages of ADRs Over Buying Stock on Foreign Exchange • Denominated in U.S. dollars • Trade on a U.S. stock exchange • Can be purchased through U.S. brokerage firms. • Dividends collected by transfer agent bank, converted into dollars and paid to shareholders of record. • ADRs clear in 3 business days. • Must satisfy SEC requirements. • Trade in multiples of underlying foreign stock. • Bring stock up to reasonable price range in U.S.

22. ADRs as Multiples: Examples • COMPANY ADR:SHARE RATIO SECTOR • ALL NIPPON AIRWAYS 1 : 2 AIRLINES • BRIDGESTONE CORP 1 : 2 AUTO PARTS & EQUIPMENT • CALPIS CO LTD 1 : 10 BEVERAGES • CANON INC 1 : 1 OFFICE EQUIPMENT • DAIWA SECURITIES 1 : 10 FINANCIAL SERVICES • FUJI PHOTO FILM CO LTD 1 : 1 MANUFACTURING • HONDA MOTOR CO LTD 2 : 1* AUTO MANUFACTURERS • KIRIN BREWERY CO LTD 1 : 1 BEVERAGES • KOMATSU LTD 1 : 4 MACHINERY • PIONEER CORP 1 : 1 ELECTRONICS • YAMAHA CORP 1 : 1 ELECTRONICS • *Honda could also be expressed as 1:0.5

23. Global Registered Shares • Global Registered Shares are shares traded worldwide (but not in the form of depository receipts). • First issued through the merger of Damiler and Chrysler in 1998. • Resulted in the creation of Damiler-Chrysler GRS. • Shares trade on 20 stock exchanges around the world. • Primarily on the Frankfurt and New York Stock Exchange • Trade in both euros and in U.S. dollars. • Required linking American and German transfer agents and clearing houses. • Have met with limited success; most firms still prefer depository receipts.

24. World’s Major Stock Exchanges • U.S. • NYSE • NASDAQ • London • London Stock Exchange (LSE) • Japan • Tokyo Stock Exchange (TSE) • Continental Europe • Frankfurt (Deutsche Borse) • Paris based Euronext

25. London Stock Exchange • Founded in 1792. • Initially used by British Government to raise funds (war with France). • Big Bang in 1986: series of reforms liberalizing commissions and introducing a screen based trading system. Paved the way for foreign ownership. • Currently lists around 2,900 stocks, depository receipts, and bonds. Largest market in Europe! • As of Sept 30, 2003, 445 foreign companies from over 60 countries are trading on the LSE (60 are U.S. companies). • Major stock index is the FTS 100 (largest 100 U.K. firms). • Official web site: http://www.londonstockexchange.com

26. LSE Listings

27. International Companies on the LSE

28. Foreign Listings on the LSE • Company Year Listed • All Nippon Airways 1991 • American Express 1977 • Anheuser-Bush 1986 • Bank of America 1996 • Campbell Soup 1982 • Daiwa Securities 1990 • Euro Disney 1989 • Ford Motor Co. 1966 • General Electric 1973 • Honda Motor Co. 1981 • J.P. Morgan 1983 • Company Year Listed • Kirin Brewery 1990 • Merrill Lynch 1972 • Sara Lee 1981 • Sony Corporation 1971 • State Bank of India 1996 • Tiger Brands 1947 • Toshiba 1980 • Toyota Motor 1999 • Vietnam Fund 2003 • Xerox 1972 • Zurich Financial 2000

29. Frankfurt Stock Exchange • Traces its history to a long tradition of trading (bills of exchange and government bonds) back to the 1600s. • Lost its status as an international market during most of the 20th century as a result of World Wars; regained its international position in the mid-1950s. • The Frankfurt Deutsche Borse’s major stock index is the DAX (representing the 30 largest German firms). • Official web site: http://deutsche-boerse.com/

30. Euronext • Euronext (Paris based holding company) formed in September 2000 by the merger of: • the Amsterdam and Brussels Exchanges and Paris Bourse. Added the Lisbon Exchange and London International Financial Futures Exchange (LIFFE) in 2002. • Has created a cross-border, electronic market for European and international equities and bonds. • Approximately 1,500 companies trade on Euronext. • Is currently Europe’s second largest exchange. • Euronext’s major stock index is the Euronext 100 (representing the 100 largest European companies). • Official web site: http://www.euronext.com/

31. Tokyo Stock Exchange • One of the oldest stock exchanges in Asia founded in 1878 (the oldest is the Bombay Stock Exchange founded in 1875). • There are four separate sections within the TSE market. • The first section is for the largest, most successful companies - often referred to as 'blue chips'. • The second section is for smaller companies with lower trading volume levels. • Mothers (market for growth and emerging stocks), established in November 1999, is for newer, innovative venture enterprises. • The foreign section is for companies from countries other than Japan. • Official web site: http://www.tse.or.jp/ • Major index is the TOPIX (TOkyo stock Price IndeX.Includes allFirst Section listed shares.

32. Tokyo Stock Exchange • Currently 2,147 companies are listed on the TSE • First Section: 1,525 • Second Section: 560 • Mothers: 62 • Foreign: 32 • The section for foreign stocks was opened in 1973 (when the TSE pushed to become an international exchange). • By 1991, 127 foreign companies were listed on the TSE. • However, as a result of delisting 32 foreign companies remain today (March 2004). Of these 12 are from the US, and 6 are from Germany. • View for a history of foreign listings and delistings: http://www.tse.or.jp/english/listing/companies/frhistorye.pdf

33. U.S. Companies on the Tokyo Stock Exchange, March 2004 • ALFAC • American International Group • Apple Computer • Bank of America • Boeing Corporation • Dow Chemical • IBM • JP Morgan Chase • Merrill Lynch • Motorola • Pepsi Corporation • Procter & Gamble

34. Cross Listings on the TSE

35. Stock Market Web Site • Stock markets around the world • Current data • Historical charts • http://quote.yahoo.com/m2?u