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International Securities Markets

International Securities Markets. Diversification and Globalization. The World Equity Market. World equity markets grew rapidly from 1992 to 2006 Market capitalization (value) of developed countries stock markets was $33 trillion at year end 1999. By year end 2002 it was $20.9 trillion

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International Securities Markets

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  1. International Securities Markets Diversification and Globalization

  2. The World Equity Market • World equity markets grew rapidly from 1992 to 2006 • Market capitalization (value) of developed countries stock markets was $33 trillion at year end 1999. By year end 2002 it was $20.9 trillion • By 2005 the developed markets had recovered and their market capitalization reached $36.5 trillion

  3. The World Equity Market • Markets fluctuate with economic activity • Over time markets recover with the economy • World markets had a strong recovery in 2003 and continued into 2007. • Developed world securities markets continue to expand • Major growth also in the “emerging” markets • Argentina - Brazil - China – Taiwan -- Mexico

  4. Emerging Markets Share2002 and 2005 • 2002 2005 • Mideast and Africa 18% > 31% • South Asia 12% > 14% • East Asia 48% < 29% • Eastern/Central Europe 7% > 11% • Latin America 15% = 15%

  5. Diversification Benefits • Invest in foreign markets fordiversification • Foreign markets do NOT move in harmony with each other • Diversified portfolio from many countries is less volatile than domestic portfolio - could even have a higher rate of return As the world markets become more global, returns between countries may become more harmonized.

  6. Diversification Benefits cont. • Correlation between the historical returns of different countries is less than 1.0 • Richard Roll: Most significant factor relating to the size of the market decline in each country was the beta, β, of that market to the world market index • No country continually outperforms the others on an annual basis

  7. Risk Reduction with International Securities

  8. Degree of Diversification • Measure correlation of stock movements Correlation Coefficient: Measures movement of one series of data over time to another series of data - in this case stock market returns

  9. Assets with correlation coefficient of less than 1 reduce amount of risk

  10. Correlation Coefficients Between Foreign Markets and U.S. Markets in $ rates of Return

  11. Correlations of Total Return between U.S. Markets and Emerging Markets in U.S. Dollars 2000-2005

  12. Return Potential in International Markets + Less risk exposure Possible higher returns International diversification Several countries had long-term growth rates superior to U.S. in terms of real GDP: • Norway • Singapore • China

  13. Returns in Developed Markets In U.S. $

  14. 5 Yr. Returns in Emerging Markets in U.S. $ 2000-2005

  15. Return Potential in International Markets • Many countries are highly competitive in • automobiles, steel, & consumer electronics • Germany • Japan • France • Canada Enjoy higher individual savings rates than U.S. 3. Capital formation and potential investment opportunity

  16. Annualized rates of return of world indexes over 32-yr. period 1969-2001

  17. Current Quotations on Foreign Market Performance • Track performance of selected world markets • 1st index EAFE =Europe, Australia, FarEast • Quotes are in local currencies & in U.S. $ • U.S. investors compare returns in U.S. against an investment in U.S. stock market www.msci.com Instructions to navigate msci website: on Power Point tool bar click View, choose Notes Page

  18. Other Market Differences • Culture • Willingness to take risk • Desire for dividend income versus growth in share value • Number & type of companies available to stockholders • Bureaucratic differences

  19. Other Market Differences cont. • Accounting conventions • Government regulation of markets • Problem with comparing P/E ratios: Earnings calculated differently according to local or regional accounting

  20. Currency Fluctuations and Rates of Return • Tracking foreign markets requires adjustments • Reported returns adjusted for foreign currency effects • How important is the foreign currency effect in relation to overall return performance in foreign currency? • Do foreign exchanges overpower actual return on investments in foreign countries?

  21. Currency Fluctuations and Rates of Return • Foreign currency effect is about 10 to 20% as significant as the actual return performance in the foreign currency • If dollar is rising/falling rapidly over a short period the impact can be much greater

  22. Currency Fluctuations and Rates of Return • Investment in Switzerland: 10% return • CHF declines by 5% against U.S. $ • CHF profits are worth less in $ Gain on investment: • 110% (Investment with 10% profit) • Adjusted value of CHF relative to U.S. $ • = 0.95 =1.00 - 0.05 decline in currency • 104.5% (= 110 x 0.95) of original investment • Actual return in U.S. $ 4.5% insteadof 10% Swiss franc = CHF

  23. Currency Fluctuations and Rates of Return • Examine currency effects in Sweden YTD • Return in local currency 4.58% (3rd column) • Return in U.S. $............. 6.31% (7th column) • Change in $/SEK made a positive return in kronor become a negative return in U.S. $ See Table 19-8 next 2 slide Swedish currency Krona (pl. Kronor) symbol SEK

  24. Currency Fluctuations and Rates of Return Computed returns: • 104.58% (Investment with 4.58% profit) • (Adjusted value of the SEK to U.S. $) 0.896 (1.000 - 0.104 decline in currency) • 93.7% (= 104.58 x 0.896) of original investment See Table 19-8 next slide

  25. Other Obstacles to International Investments • Political Risks • Tax Problems • Lack of Market Efficiency • Administrative Problems • Information Problems • Corruption

  26. Political Risks • Danger of nationalization of foreign firms • Restriction of capital flows to investors • Violent overthrow of political party in power • Not meeting their foreign debt obligations • Check the political/economic climate

  27. Tax Problems • Foreign countries may impose 15 to 30% withholding tax against dividends or interest paid to nonresidents • Tax-exempt U.S. investors can secure exemption or rebate • Taxable U.S. investors can claim a U.S. tax credit for taxes paid in foreign countries • Inconvenience rather than loss of funds

  28. Lack of Market Efficiency • U.S. capital markets the most liquid & efficient in the world • Investors accustomed to trading on NYSE will find it difficult to adjust to foreign markets • Larger spread between bid (sell) & ask (buy) price • Difficulty executing large transaction • Higher commission rates

  29. Elkins/McSherry Global Universe of Transaction Costs Developed Markets 4 factors: price, commission, fees, mkt impact

  30. Market Capitalization of Developed WorldMarkets (Year end 2005) in billions of U.S. $

  31. Market Capitalization of The Largest EmergingMarkets (year end 2005) in billions of U.S. $

  32. Market Capitalization of the Three Largest U.S. Companies in billions U.S. $

  33. Administrative Problems • Adjusting to various local systems For example, • Hong Kong, Swiss, & Mexican stock markets settle accounts one day after the transaction • London: two-week settlement • Different administrative procedures add extra difficulty in executing trades • Avoid these difficulties by going through mutual funds and other investment outlets

  34. Information Problems • U.S. securities markets are the best at providing investment information • S.E.C. has rigorous requirements for full disclosure information • FASB continually providing pronouncements on GAAP for financial reporting • Publicly traded companies required to provide stockholders with fully audited annual reports • Evaluative reports/ratings by Moody’s, Standard & Poor’s, Value Line, & other firms

  35. Information Problems • Extensive economic data provided by governmental sources e.g. • Department of Commerce • Federal Reserve System • International firms in less sophisticated foreign markets do not provide sufficient data • Language problems for the analyst

  36. Methods of Participating in Foreign Investments International investment • Investing in firms in foreign markets • Purchasing foreign shares trading in U.S. • Mutual funds investing overseas • Closed-end funds with global orientation • Buying shares of multinational corporations

  37. Methods of Participating in Foreign Investments • Direct Investments • Indirect Investments

  38. Direct Investments • Directly purchase shares of firm in foreign market • Use foreign broker/overseas branch of U.S. broker Difficulties and administrative problems: • Information-gathering problems • Tax problems • Stock-delivery problems • Capital-transfer problems • Communication difficulties in executing orders • Sophisticated money manager follow this approach

  39. Direct Investments • Purchase shares of foreign firms that trade in U.S. stock markets (NYSE) • Purchase ADRs ADRs represent ownership interest in a foreign company’s common stock www.nyse.com Go to: 1. International 2. Non-U.S. Listed Company Directory

  40. Direct Investments - Hyperlinks to some companies that have ADRs www.alcan.com www.britishairways.com www.honda.com www.nortelnetworks.com www.sony.com

  41. Indirect Investments Investments in international securities include: • Purchasing shares of multinational corporations • Mutual funds or closed-end investment funds specializing in worldwide investments • Investing in exchange traded funds (ETF) • Use a private firm specializing in foreign investment portfolio management

  42. (a)- Purchasing Shares of Multinational Corporations • Firms with operations in several countries • Opportunity for international diversification • Major oil companies e.g. Exxon, BP, Shell • Large banking firms e.g. Barclays, HSBC • Pharmaceuticals e.g. Glaxo, Novartis • Consumer Products e.g. Sony, Coca Cola

  43. (b)- Mutual Funds and Closed-End Investment Companies • Mutual funds offer • Diversification • Professional management • Invest in closed-end investment companies specializing in international equity investments May trade at premium/discount from NAV

  44. (c)- Exchange Traded Funds (ETFs) • Use ETFs to invest in international markets • Biggest market the American Stock Exchange • Lists over 40 international funds • ETF: basket of securities that track an index • Trades like an individual stock with all day • Trading • Price tracking www.amex.com

  45. Exchange Traded Funds (ETFs) • ETF mimics a major index, e.g. • Financial Times 100 for United Kingdom • DAX for Germany • ETF can track • A broad stock index • Bond index • Industry index • Sector index • Lower costs • Better tax efficiency than mutual funds • Ability to diversify using these funds www.amex.com

  46. (d)- Specialists in International Securities Large investors may engage services of firms with specialized expertise in foreign equities • Banks • Investment counselors • Morgan Guaranty Trust Company • State Street Bank and Trust Company • Batterymarch Financial Management • Fidelity Trust Company of New York • Minimum investment well in excess of $100,000 • Cater to large institutional investors

  47. Summary • Diversify by investing in international securities • Different foreign markets influenced by varying & contradictory factors • Effective risk reduction Example: Sharp & unexpected increase in energy prices negative impact on oil importers may be offset by positive impact on oil exporters

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