EXAM 4
Level I Programs
- easiest and least restrictive listing requirements -Description: over the counter -Degree of disclosure: None home country standards apply -Listing Alternatives: OTC -Ability to raise capital: NA -Time table: 6 weeks
PEAD
- is the tendency for a stock's cumulative abnormal returns to drift in the direction of an earnings surprise for several weeks (even several months) following an earnings announcement.
Alpha
- often considered the active return on an investment, gauges the performance of an investment against a market index used as a benchmark, since they are often considered to represent the market's movement as a whole. The excess returns of a fund relative to the return of a benchmark index is the fund's
Active management
--Stock market is a zero-sum game -: If one trader is making money, then another trader is losing money -active fund outperformance should wash out -Implication: performance of active funds in aggregate will look very similar to the market's performance
Level III Programs
-: for firms that want to sell new equity shares on a U.S. exchange -Description:US listed ADR program -Degree of disclosure: Rigorous Sarbanes Oxley -Listing Alternatives: US stock exchange -Ability to raise capital: Yes public offering -Time table: 14 weeks
Availability of capital:
-A multinational firm's marginal cost of capital is constant for considerable ranges of its capital budget -This statement is not true for most small domestic firms (as they do not have equal access to capital markets), nor for MNEs located in countries that have illiquid capital markets (unless they have gained a global cost and availability of capital)
Although cross listing
-Although cross-listing and equity issuance can occur together, their impacts are separable and significant in and of themselves. -MNEs list in markets where they have substantial physical operations mostly for political reasons. -The establishment of a local liquid market for the firm's equity may aid in financing acquisitions and in the creation of stock-based management compensation programs for subsidiaries.
The domestic theory of optimal financial structures needs to be modified by four more variables in order to accommodate the case of the MNE:
-Availability of capital Diversification of cash flows Foreign exchange risk Expectations of international portfolio investors
Positive momentum stocks
-Buy
Choosing to raise debt or equity
-Choosing debt forces you to manage for cash flow, while, in a perfect world, taking on equity means you're placing a priority on growth. But in today's credit markets, raising equity may simply mean you can't borrow any more.
How Active Management adds value
-Diversification matters. Even if a fund does not outperform, it can still add value if exhibits a low correlation with existing asset classes. -However, high fees will cut into those benefits. --hedge funds, alternative investments, etc. can offer value to an investor other than simply out-performance.
IPO process
-First a prospectus is published -The (blank) typically represents 15% to 25% of ownership -Later issues by the firm are considered "seasoned offerings" -With public issuance of shares comes greater public disclosure
three key critical elements to understanding the issues that any firm must confront when seeking to raise equity capital.
-First, a public or private equity placement -Then, where to list the offering -Finally, the type of issuance
the four major equity alternatives available to multinational firms today
-IPO -Euroequity issue -Directed public/private issue -Private placement
Stock exchanges
-New York and London are the most liquid stock exchanges. -Most exchanges have moved heavily into electronic trading in recent years, which has allowed hedge funds and other high-frequency traders to dominate the market.
Private placement market
-One type of directed issue with a long history as a source of both equity and debt is the
ADR Program Structures
-Sponsored are created at the request of the foreign firm wishing to be listed in the U.S. -Unsponsored are a result of investor demand and initiated by a U.S. securities firm—these must be approved by the firm whose shares are being listed.
what if an active manager outperformed, and his outperformance is completely explained by the value factor?
-The active manager invested in value stocks)
Raising Debt Globally
-The international debt market offers the borrower a wide variety of different maturities, repayment structures, and currencies of denomination. -The markets and their many different instruments vary by source of funding, pricing structure, maturity, and subordination or linkage to other debt and equity instruments.
Expectations of International Portfolio Investors:
-The key to gaining a global cost and availability of capital is attracting and retaining (blank) -If a firm wants to raise capital in global markets, it must adopt global norms that are close to the U.S. and U.K. norms as these markets represent the most liquid and unsegmented markets
Factor return construction
-The performance differential between the two groups of stocks refers to the factor return. -In this case, positive momentum stocks generally outperform negative momentum stocks.
Diversification of cash flows:
-The theoretical possibility exists that multinational firms are in a better position than domestic firms to support higher debt ratios because their cash flows are (blank) internationally -As returns are not perfectly correlated between countries, an MNE might be able to achieve a reduction in cash flow variability (much in the same way as portfolio investors who diversify their security holdings globally)
Sourcing Equity Globally
-To implement the goal of gaining access to global capital markets a firm must begin by designing a strategy that will ultimately attract international investors. -This would mean identifying and choosing alternative paths to access global markets. -This would also require some restructuring of the firm, improving the quality and level of its disclosure, and making its accounting and reporting standards more transparent to potential foreign investors.
Foreign exchange risk and the cost of debt
-When a firm issues foreign currency denominated debt, its effective cost equals the after-tax cost of repaying the principal and interest in terms of the firm's own currency -This amount includes the nominal cost of principal and interest in foreign currency terms, adjusted for any foreign exchange gains or losses
DR Markets today
-Who: mix of major multinationals, but participation has shifted back toward industrial countries. -What: split between IPO and follow-on offerings -Where: mostly New York and London
Depository receipt
-a certificate of ownership in the shares of a company issued by a bank, representing a claim on underlying foreign securities. -In the US they are termed American deposit receipts, and when sold globally GDR
Seasoned public offering
-a subsequent sale of additional shares in the publicly traded company, raising additional equity capital -shares issued later
Efficient Markets Hypothesis
-and argued that stock prices do, in fact, represent all available information (and demonstrated it empirically) -The basic idea: If markets are efficient, then it should be extremely difficult for an investor to trade on publicly-available information -Noble prize in 2013 Eugene Fama was interested in the extent to which stock prices reflect all available information
ADR
-are sold, registered, and transferred in the US in the same manner as any share of stock with each (blank) representing some multiple of the underlying foreign share (allowing for (blank) pricing to resemble conventional US share pricing between $20 and $50 per share).
Private equity
-equity investments in firms by large limited partnerships, institutional investors, or wealthy private investors, with the intention of taking the subject firms private, revitalizing their businesses and then selling them publicly or privately in 1-5 years
Factors
-is a basic building block of expected return Computed as one group's average return minus another group's average return (e.g., value factor = high BTM - low BTM) It is a systematic phenomenon (widespread across all stocks) Any individual firm has its own exposure to the factor, and it contributes to its expected return going forward (like Beta) The CAPM has one factor: the market It can be related to risk (where high risk firms compensate investors over the long-run) or behavioral (where one group generates higher returns because of investor behavior or mistakes)
Global Registered Shares
-is a share of equity that is traded across borders and markets without conversion, where one share on the home exchange equals one share on the foreign exchange. -Different from a global depositary receipt in that the DR is bundled or split so that the price represents a typically traded value for that market. A (blank) has the same value everywhere and is not bundled (or split) for purposes of trading.
Buffet's outperformance
-is largely explained by the tendency of profitable, low beta stocks to outperform. Here's the point: stocks that are low risk, cheap, high quality, high profitability tend to outperform... not just the ones Warren Buffett buys! We can replicate his portfolio using a simple strategy that systematically buys stocks with these characteristics. Importantly, Buffett takes positions in relatively safe companies, and then applies leverage! (Approximately 1.6 to 1)
Private placement
-is the sale of a security to a small set of qualified institutional buyers under SEC Rule 144A. -now exist in most countries -Private equity funds are usually limited partnerships of institutional and wealthy individual investors that raise their capital in the most liquid capital markets. -These investors then invest the private equity fund in mature, family-owned firms located in emerging markets. -The investment objective is to help these firms to restructure and modernize in order to face increasing competition and the growth of new technologies. -Private equity funds differ from traditional venture capital funds as private equity funds operate in many countries, fund companies in many industry sectors and often have a longer time horizon for exiting. -Equity Funds have become well-known as vehicles for takeover of firms. They leverage their investments with large amounts of borrowing and have significant tax advantages -the sale of a security (equity or debt) to a private investor. The private investors are typically institutions such as pension funds, insurance companies, or high net worth private entities -placement of public shares -interest -equity -Strategic partner/alliance
A firm seeking to raise equity capital
-is ultimately in search of an issuance (IPO or SPO), although it need not be public.
Optimal finance structure
-must be modified considerably to encompass the multinational firm. -Most finance theorists are now in agreement about whether an (blank) exists for a firm, and if so, how it can be determined. -When taxes and bankruptcy costs are considered, a firm has an (blank) determined by that particular mix of debt and equity that minimizes the firm's cost of capital for a given level of business risk. -As the business risk of new projects differs from the risk of existing projects, the optimal mix of debt and equity would change to recognize tradeoffs between business and financial risks.
SEC rule 144A
-private placement sales are sales of securities to qualified institutional buyers in the US without SEC registration. -QIBS are nonbank firms that own and invest in 100 million or more on a discretionary basis
Designing a Strategy to Source Equity Globally
-requires that management agree upon a long-run financial objective and then choose among the various alternative paths to get there. -Often, this decision-making process is aided by an early appointment of an investment bank as an official advisor to the firm. -Investment bankers are in touch with potential foreign investors and know what they currently require, and can also help navigate the numerous institutional and regulatory barriers in place. Incremental steps to bridge this gap include conducting an international bond offering and/or cross-listing equity shares on more highly liquid foreign stock exchanges
Equity listing
-shares of a publicly traded firm are listed for purchase or sale on an exchange. An investment banking firm is typically retaine to make a market in the shares
Negative momentum
-stocks sell short
The most serious barriers to cross-listing and/or selling equity abroad include
-the future commitment to providing full and transparent disclosure of operating results and balance sheets as well as a continuous program of investor relations
Euroequity
-the initial sale of shares in two or more markets and countries simultaneously -The "Euro" market (a generic term for international securities issues originating and being sold anywhere in the world), was created by the same financial institutions that had previously created an infrastructure for the Euronote and Eurobond markets
Initial Public offering
-the initial sell of shares to the public of a private company. They raise capital and typically use underwriters -for the first time open to the public
Cross listing
-the listing of a company's shares on an exchange in a different country market. -It is intended to expand the potential market for the firm's shares to a larger universe of directors
Directed issue
-the sale of shares by a publicly traded company to a specific target investor or market, public or private, often in a different country -shares sold to a specific set of private interests -is defined as one that is targeted at investors in a single country and underwritten in whole or in part by investment institutions from that country -The issue might or might not be denominated in the currency of the target market. -The shares might or might not be cross-listed on a stock exchange in the target market.
Berkshire's sources of leverage
1. Debt Its great credit rating has allowed it to borrow for cheap (it had AAA most of its life). 2. Insurance float Issuing life insurance contracts and receiving the premiums (to potentially payout later) is similar to borrowing money at a low cost 3. Selling derivative contracts E.g., selling put options is akin to borrowing money
Profitability
= Profitable firms - Unprofitable firms Evidence is moderate, and existence is contested. Complementary to value.
Factor-based Investing
= Research-based investing - helps an investor avoid taking risk that is not compensated E.g., had you invested $100 in the least volatile stocks in 1970, you would have over $1800 today. However, had you invested $100 in the most volatile stocks, you would have less than $5!!! It also helps an investor take advantage of potential mispricing and market mistakes
Backtesting an Investment Strategy
A way to test the hypothetical returns of an investment strategy Rebalance periodically (every month, quarter, or year) according to a specific set of rules For example, the rules of a simple momentum strategy might be to buy the top third of stocks with the best past year stock return (while selling short the bottom third with the worst performance) The point is to establish whether there is a statistical difference in performance between the best and worst performers. E.g., positive momentum stocks consistently outperform negative momentum stocks
Unique Characteristics of Eurobond Markets
Absence of regulatory interference -National governments often impose tight controls on foreign issuers of securities denominated in local currencies, although governments generally have less stringent limitations for securities denominated in foreign currencies and sold within their markets Less stringent disclosure: -Disclosure requirements less stringent than those of the SEC Favorable tax status: -Eurobonds offer tax anonymity and flexibility
value, and momentum factors
Any given factor can underperform any given year or years, but over time they produce positive returns (blank) factors work great together because they tend to have a negative correlation, even though each produces positive returns independently -value and momentum factors work outside of the US
Value
High BTM - Low BTM Evidence is strong, and it tends to also work with other measures of value, such as price/earnings, price/sales, etc.
Cross-listing attempts to accomplish one or more of many objectives:
Improve the liquidity of its shares and support a liquid secondary market for new equity issues in foreign markets Increase its share price by overcoming mispricing in a segmented and illiquid home capital market Increase the firm's visibility and acceptance to its customers, suppliers, creditors, and host governments Establish a liquid secondary market for shares used to acquire other firms in the host market and to compensate local management and employees of foreign subsidiaries
Jegadeesh and Titman (1993)
Introduced momentum Stocks with recent 6-12 month performance tend to continue performing relatively well Subsequent research has shown that return momentum is strongest among firms that are the most difficult to value (distressed, uncertain, etc) Other research shows that momentum is possibly generated by a gradual information dissemination into stock prices
Global Investing
Investing only in US limits your opportunity set by half US stocks are exposed to US systematic risk International stocks offer diversification away from US systematic risk (by adopting some foreign systematic risk) international stocks have vastly underperformed...
Post-CAPM World
It wasn't until the mid to late 80's that researchers could compile and analyze a large dataset of stock returns But by that time, the CAPM and EMH theories had already taken a hold on industry practice Uh-oh. As it turns out, there is very little evidence to support the CAPM. In other words, the relationship between future stock returns and beta exposure is basically flat. Many experts refer to CAPM and beta as "dead" Furthermore, a variety of characteristics other than beta have shown to explain expected stock returns (termed "anomalies")
Betting-against-beta
Levered Low Beta - Delevered High Beta -High beta stocks have a horribly low future return
Volatility
Low Volatility - High Volatility Highly volatile firms tend to dramatically underperform
Active
Manager allocates portfolio to something other than the market portfolio (stock selection, strategic weighting scheme)
The "Smart Beta" Revolution
One of the biggest pros is that it can be implemented at a low cost since the factor-based strategies can be automated Check out Blackrock's iShares factor-based ETFs, for example Historically, these research-based strategies have been primarily implemented by hedge funds and sophisticated investors In recent years, more investment firms have adopted more of a factor-based approach
Passive
Portfolio resembles market (cap-weighted broad index)
Momentum
Positive Momentum - Negative Momentum Evidence is strong, but it is very volatile and experiences rare disastrous returns
Size
Small firms - Large firms Evidence is relatively weak, but it has an amplifying effect when combined with other factors like value and momentum
Early Research - Influence
The CAPM and EFH theories shaped the way industry made investment decisions Active managers (in aggregate) were shown to have little ability to "beat" the market All of this led to the formation of index funds, pioneered by John Bogle and others The index fund would simply track the market portfolio (it would hold a large set of equities and weight them by their market capitalization) Analysts shouldn't have an advantage since there is no better indication of the firm's value than the firm's observed stock price
The Scientific Approach to Investing
The approach taken by academic researchers and many in industry Similar to other social and physical sciences, this means developing theories, analyzing data, conducting experiments, etc to understand what drives stock returns I.e., we want an unbiased view of stock returns (not a pitch from a slick stockbroker) This includes figuring out what types of strategies worked in the past (i.e., backtesting) But not just knowing what worked... equally important is figuring out why it worked!!!
The Asset Allocation Problem
The practice of building an investment portfolio according to a set of objectives with respect to risk and return This will typically include stocks, bonds, commodities, alternative investments, and/or cash. The investor's job is to decide on an allocation that optimizes the risk/return trade-off High volatility assets dominate the portfolio's volatility. E.g., a simple 50/50 stock and bond portfolio will experience volatility dominated by the stock portion. Choosing risky assets carefully is extremely important Research helps us approach this question
Today
There have been a large number of papers researching firm characteristics that are related to future stock returns. Size, Value, and Momentum are the most widely known. It is not uncommon to see size and value "styles" among mutual funds. "Growth" originally referred to low BTM firms... Those with extremely high valuation ratios relative to the stock price. The market prices in a very high growth rate in earnings. Today, growth can mean a variety of things. Characteristics that are systematically related to future stock returns have been termed as "factors".
First of all, standard risk factors---size, value, and momentum--- do not explain his outperformance.
This means is alpha is positive and statistically significant even after accounting for these factors. Interestingly, he identifies himself as a value investor. He was a student of the legendary value investor, Benjamin Graham. Interestingly, however, Berkshire's performance is closely related to two important risk factors: Quality and Betting-against-beta
Foreign Equity Listing and Issuance
To maximize liquidity, it is desirable to cross-list and/or sell equity in the most liquid markets. Stock markets have been subject to two major forces which are changing their behavior and liquidity:
Eurocredits
are bank loans to MNEs, sovereign governments, international institutions, and banks denominated in eurocurrencies and extended by banks in countries other than the country in whose currency the loan is denominated.
Euronotes
are short- to medium-term debt instruments that are either underwritten and non-underwritten
As investors, our objective is not simply to find a good company, it's to find a good company
at a good price
Euro medium-term notes
bridge the gap between eurocommercial paper and a longer-term and less flexible international bond
ADR Mechanics
can be exchanged for the underlying foreign shares, or vice versa, so arbitrage keeps foreign and U.S. prices of any given share the same after adjusting for transfer costs -also convey certain technical advantages to U.S. shareholders. -are quoted only in U.S. dollars and traded only in the U.S., Global Registered Shares (GRSs) can be traded on equity exchanges around the globe in a variety of currencies
Level II Programs
for firms that want to list existing shares on a U.S. exchange—must meet SEC listing requirements -Description:US listed ADR program -Degree of disclosure: Detailed sarbanes oxley -Listing Alternatives:US stock exchange listing -Ability to raise capital: NA -Time table: 13 weeks
When valuations are low (ie, when stocks are cheap
future returns tend to be higher
Diversification:
growing diversity of both products and foreign companies/shares being listed.
The syndication of loans
has enabled banks to spread the risk of very large loans among a number of banks.
Bank Loans and Syndicates
have traditionally been sourced in the Eurocurrency markets; there is a narrow interest rate spread between deposit and loan rates of less than 1%.
Quantitative equity
hedge funds implement more sophisticated versions of research-based strategies
Berkshire invests in
high quality (high profitability), cheap stocks.
Fama and French (1992)
in 1992 showed that size and valuation are strong predictors of future returns They showed: small firms produce higher returns than large firms high book-to-market firms produce higher returns than low book-to-market firms While this contradicts the CAPM, it doesn't necessarily contradict the EMH, especially if size and value are important systematic risk factors In other words, size and value can be compensation for risk
How do most firms raise their initial capital
in their own domestic market -However, most firms that have only raised capital in their domestic market are not well known enough to attract foreign investors. -ncremental steps to bridge this gap include conducting an international bond offering and/or cross-listing equity shares on more highly liquid foreign stock exchanges
Quality
includes profitability as well as earnings variability, earnings quality (accruals), and investment quality
Eurocommercial paper
is a short-term debt obligation of a corporation or bank (usually denominated in US dollars)
The U.S. school of thought
is that the worldwide trend toward requiring fuller, more transparent, and more standardized financial disclosure of operating results and balance sheet positions may have the desirable effect of lowering the cost of equity capital
A foreign bond
is underwritten by a syndicate composed of members from a single country, sold principally within that country, and denominated in the currency of that country
A Eurobond
is underwritten by an international syndicate of banks and other securities firms and is sold exclusively in countries other than the country in whose currency the issue is denominated -differ from the Eurodollar markets in that there is an absence of regulatory interference, less stringent disclosure rules and favorable tax treatments for these bonds
Demutualization:
ongoing process by which the small controlling seat owners on a number of exchanges have been giving up their exclusive powers.
Theoretical
risks we expect to get compensated
Empirical
risks we observe gets compensated
As the debt ratio increases
the overall cost of capital (kWACC) decreases because of the heavier weight of low-cost (due to tax-deductibility) debt ([kd(1 - t)] compared to high-cost equity (ke).
Beta,
the sensitivity to the overall market return, represents the degree of a firm's systematic risk exposure, and it is the only risk that matters to a diversified investor Unsystematic risk gets diversified away -High (blank) stocks tend to be small, young, unprofitable, highly levered, and/or near financial distress According to the CAPM, these are the companies that should outperform over the long-run since the investor is compensated for taking the risk I.e., If you're a long-term investor, you want to hold high beta stocks because you expect to be compensated for it.
Evidence for EMH?
there have been a number of academic researchers showing evidence against market efficiency While markets are mostly efficient, they may not be completely efficient, but it is still not easy to consistently make money from inefficient markets. Trend-following and event-driven strategies have been shown to offer opportunity for return On a good earnings announcement, firms often will experience an initial jump in price and a subsequent drift afterward (PEAD) Stocks with relatively good recent performance tend to continue performing well (Momentum)
Early Research - CAPM
was developed in the 1960's by William Sharpe and others (eventually winning Sharpe the Nobel Prize in 1990) -is a one-factor model in which the only relevant factor is the market excess return (note that it is the equity risk premium) -has one factor: the market -is strong theoretically but weak empirically
Companies often become more attractively valued
when prices fall.
Global value strategies
work best for longer-time horizons
