Chapter 13 FIN 417

There are approximately major national stock markets.

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Turnover ratio

§The higher the ratio, the more liquid the market. §Turnover ratios are relatively stable over time for most national stock exchanges. Many national stock exchanges had relatively high turnover ratios, with over 40 percent of the exchanges in most years in excess of 30 percent turnover per month

Dealer market

-The stock is sold by dealers, who stand ready to buy and sell the security for their own account. -In the U.S., the OTC market is a dealer market.

Market order

An order to your broker to buy or sell share immediately at the market price.

Automated exchanges

Computers match buy and sell orders.

Primary markets

Shares offered for sale directly from the issuing company.

Industrial Structure

Studies examining the influence of industrial structure on foreign equity returns are inconclusive.

Compare and contrast the various types of secondary market trading structures

There are two basic types of secondary market trading structures: dealer and agency. In a dealer market, the dealer serves as market maker for the security, holding an inventory of the security. The dealer buys at his bid price and sells at his asked price from this inventory. All public trades go through the dealer. In an agency market, public trades go through the agent who matches it with another public trade. Both dealer and agency markets can be continuous trade markets, but non-continuous markets tend to be only agency markets. Over-the-counter trading, specialist markets, and automated markets are types of continuous market trading systems. Call markets and crowd trading are each types of non-continuous trading market systems. Continuous trading systems are desirable for actively traded issues, whereas call markets and crowd trading offer advantages for smaller markets with many thinly traded issues because they mitigate the possibility of sparse order flow over short time periods.

Volvo ADR (example)

•A good example of a familiar firm that trades in the U.S. as an ADR is Volvo AB, the Swedish car maker. •Volvo trades in the U.S. on the NASDAQ under the ticker VOLVY. -The depository institution is JPMorgan ADR Group. -The custodian is a Swedish firm, S E Banken Custody. •Of course, Volvo also trades on the Stockholm Stock Exchange under the ticker VOLVB.

Empirical Findings on Cross-Listings and ADRs

•An internationally diversified portfolio of ADRs outperforms both a U.S. stock market and a world stock market benchmark on a risk-adjusted basis. •For most stocks, the home-market price and the ADR price is within 20-85 basis points—thus limiting any arbitrage opportunities.

iShares MSCI

•Country-specific baskets of stocks designed to replicate the country indexes of 22 countries. •iShares are exchange-traded funds that trade on the American Stock Exchange and are subject to U.S. SEC and IRS diversification requirements. -Low cost, convenient way for investors to hold diversified investments in several different countries.

Cross-Listing of Shares

•Cross-listing refers to a firm having its equity shares listed on one or more foreign exchanges. •The number of firms doing this has exploded in recent years.

Magnitude of International Equity Trading

•During the 1980s world capital markets began a trend toward greater global integration. •This trend was caused by diversification, reduced regulation, improvements in computer and communications technology, and an increased demand from MNCs for global issuance.

Exchange Rates

•Exchange rate movements in a given country appear to reinforce the stock market movements within that country. •One should be careful not to confuse correlation with causality.

American Depository Receipts

•Foreign stocks often trade on U.S. exchanges as ADRs. •It is a receipt that represents the number of foreign shares that are deposited at a U.S. bank. •The bank serves as a transfer agent for the ADRs.

Secondary markets

Provide market participants with marketability and share valuation.

Discuss any benefits you can think of for a company to (a) cross-list its equity shares on more than one national exchange, and (b) to source new equity capital from foreign investors as well as domestic investors.

A MNC that has a product market presence or manufacturing facilities in several countries may cross-list its shares on the exchanges of these same countries because there is typically investor demand for the shares of companies that are known within a country. Additionally, a company may cross-list its shares on foreign exchanges to broaden its investor base and therefore to increase the demand for its stock. An increase in demand will generally increase the stock price and improve its market liquidity. A broader investor base may also mitigate the possibility of a hostile takeover. Additional, cross-listing a company's shares establishes name recognition and thus facilitates sourcing new equity capital in these foreign capital markets.

Why might it be easier for an investor desiring to diversify his portfolio internationally to buy depository receipts rather than the actual shares of the company?

A depository receipt can be purchased on the investor's domestic exchange. It represents a package of the underlying foreign security that is priced in the investor's local currency and in a trading range that is typical for the investor's marketplace. The investor can purchase a depository receipt directly from his domestic broker, rather than having to deal with an overseas broker and the necessity of obtaining foreign funds to make the foreign stock purchase. Additionally, dividends are received in the local currency rather than in foreign funds that would need to be converted into the local currency.

As an investor, what factors would you consider before investing in the emerging stock market of a developing country?

An investor in emerging market stocks needs to be concerned with the depth of the market and the market's liquidity. Depth of the market refers to the opportunities to invest in the country. One measure of the depth of the market is the concentration ratio of a country's stock market. The concentration ratio frequently is calculated to show the market value of the ten largest stocks traded as a fraction of the total market capitalization of all equities traded. The higher the concentration ratio, the less deep is the market. That is, most value is concentrated in only a few companies. While this does not necessarily imply that the largest stocks in the emerging market are not good investments, it does, however, suggest that there are few opportunities for investment in that country and that proper diversification within the country may be difficult. In terms of liquidity, an investor would be wise to examine the market turnover ratio of the country's stock market. High market turnover suggests that the market is liquid, or that there are opportunities for purchasing or selling the stock quickly at close to the current market price. This is important because liquidity means you can get in or out of a stock position quickly without spending more than you intended on purchase or receiving less than you expected on sale.

Limit order

An order to your broker to buy or sell at a price you want, when and if he can. If immediate execution is more important than the price, use a market order.

Market Capitalization

At year-end 2015, total market capitalization of the 80 organized stock exchanges tracked by the World Federation of Exchanges stood at $67,125 billion.

Auction market

Organized exchanges have specialists who match buy and sell orders. Buy and sell orders may get matched without the specialist buying and selling as a dealer.

Why do you think the empirical studies about factors affecting equity returns basically showed that domestic factors were more important than international factors, and, secondly, that industrial membership of a firm was of little importance in forecasting the international correlation structure of a set of international stocks?

While national security markets have become more integrated in recent years, there is still a tremendous amount of segmentation that brings about the benefit to be derived from international diversification of financial assets. Monetary and fiscal policies differ among countries because of different economic circumstances. The economic policies of a country directly affect the securities traded in the country, and they will behave differently than securities traded in another country with other economic policies being implemented. Hence, it is not surprising that domestic factors are found to be more important than international factors in affecting security returns. Similarly, industrial activity within a country is also affected by the economic policies of the country; thus firms in the same industry group, but from different countries, will not necessarily behave the same in all countries, nor should we expect the securities issued by these firms to behave alike.

Advantages of Cross-Listing

•It expands the investor base for a firm. -Very important advantage for firms from emerging market countries with limited capital markets. •Establishes name recognition for the firm in new capital markets, paving the way for new issues. •May offer marketing advantages. •Cross-listing into developed markets with strict securities regulations and information discloser may signal investors that improved corporate governance is forthcoming. •May mitigate possibility of hostile takeovers.

Factors Affecting International Equity Returns

•Macroeconomic factors •Exchange rates •Industrial structure

Trading in International Equities

•Magnitude of international equity trading •Cross-listing of shares •Yankee stock offerings •The European stock market •American Depository Receipts (ADRs)

Emerging Markets

•Standard & Poor's Emerging Markets Database classifies a stock market as "emerging" if it meets at least one of two general criteria: -It is located in a low- or middle-income economy as defined by the World Bank. -Its investable market capitalization is low relative to its most recent GNI figures.

Macroeconomic Factors Affecting International Equity Returns

•The data do not support the notion that equity returns are strongly influenced by macro factors. •This is correspondent with findings for U.S. equity markets.

Yankee Stock Offerings

•The direct sale of new equity capital to U.S. public investors by foreign firms. -Privatization in South America and Eastern Europe. -Equity sales by Mexican firms trying to "cash in" following implementation of NAFTA.

Measures of Liquidity

•The equity markets of the developed world tend to be much more liquid than emerging markets. -Liquidity refers to how quickly an asset can be sold without a major price concession. •So, while investments in emerging markets may be profitable, the investor's focus should be on the long term.

Global Registered Shares (advantages / disadvantages)

•The main advantage of GRSs over ADRs appears to be that all shareholders have equal status and direct voting rights. •The main disadvantage of GRSs appears to be the greater expense in establishing the global registrar and clearing facility. •GRSs have met with limited success; many companies that considered them opted instead for ADRs. •Deutsche Bank, UBS, and NYSE Euronext also trade as GRSs.

Global Registered Shares

•The merger of Daimler Benz AG and Chrysler Corporation in November 1998 created DaimlerChrysler AG, a German firm. The merger simultaneously created a new type of equity share, called Global Registered Shares (GRSs). •GRSs are traded globally, unlike ADRs, which are traded on foreign markets. •The company was renamed Daimler AG in October 2007 when it spun off Chrysler. The primary exchanges for Daimler GRSs are the Frankfurt Stock Exchange and the NYSE; however, they are traded on a total of 20 exchanges worldwide. •The shares are fully fungible—a GRS purchased on one exchange can be sold on another. They trade in both U.S. dollars and euro.

Advantages of ADRs

•There are many advantages to trading ADRs as opposed to direct investment in the company's shares: -ADRs are denominated in U.S. dollars, trade on U.S. exchanges, and can be bought through any broker. -Dividends are paid in U.S. dollars. -Most underlying stocks are bearer securities and the ADRs are registered. -ADR trades clear in 3 business days whereas settlement practices for the underlying stock vary in foreign countries.