Module V: International Capital Markets

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Module VInternational 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
Country Price Index (1988100) Year-to-Date Total Return ()
China 44.89 -4.51
South Korea 51.09 -7.29
Taiwan 117.96 -15.95
Asia 106.96 N/a
East Europe 71.32 N/a
Latin America 531.87 N/a
Composite 198.21 -21.3
SourceIFC SP/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 1990s
• Emerging country specific risk has increased
  dramatically since the crises of the 1990s 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 1980s
• 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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ADRs on NYSE 2000
Country/ Region ADR Issues Shares (mill) Volume ( mill) Market Cap ()
China 13 166.5 5,631.0 2,480.3
Japan 13 242.8 22,588.0 10,594.5
S. Korea 5 351.0 15,469.9 6,649.5
Taiwan 4 229.1 14,299.0 2,858.8
Asia 64 2,346.1 920,617.6 45,331.2
Europe 174 9,763.3 514,235.1 399,607.2
L. America 103 3,563.4 141,416.9 79,795.9
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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