International Finance - PowerPoint PPT Presentation


PPT – International Finance PowerPoint presentation | free to view - id: 127c33-ZTVjO


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation

International Finance


For example, in 1998, the institutional traders in the data represented 135 ... China's Qualified Foreign Institutional Investor (QFII) program allows selected ... – PowerPoint PPT presentation

Number of Views:52
Avg rating:3.0/5.0
Slides: 81
Provided by: kel8155


Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: International Finance

International Finance
  • Dr. Darius Miller

The Good of International Investing
  • We just saw, International stocks can lower
    portfolio risk because of there low correlation
    with other markets
  • This creates a positive shift in the Risk-Return
    trade off, which is good.
  • However.

Country Risk may not be captured by traditional
risk measures (such as covariance)
  • High Transactions Costs and Illiquidity
  • Lengthy Settlement (or complete lack of)
  • Lack of transparency and information disclosure
  • Corruption
  • Capital Controls
  • Ownership Restrictions
  • Cultural differences
  • Political Risk

Recall How do we asses a stocks risk?
  • One option is to use classic finance tools
  • For example Mean/Variance Analysis
  • However, there are many important cross-country
    differences that matter
  • Country Risk
  • Lets look at one risk that may not be captured by
    traditional risk measures, Information Risk

Information Production is not an accident
  • Accounting firms are perhaps the most fundamental
    and important institutions of information in
    financial markets
  • Why do they work so well in the US?
  • US Disclosure Laws Securities Act of 1933,
    Reporting Act of 1934
  • Mandate quarterly and annual filings of all
    public firms
  • The rules are well-understood standards (GAAP)
    that are audited and certified
  • The rules are enforced with rigor by the US
    government (SEC)

Information Production is not an accident
  • Information production is results from a
    deliberate effort to establish
  • Laws
  • Institutions
  • In the US, we take this for granted. However, in
    many countries the view is that the secrecy of
    corporate information is more important than the
    dissemination of information to the investor.

International Accounting Practices An Investors
  • In Russia, one study reported that there are no
    regulations (including company law) that specify
    disclosure requirements in detail. Out of 5,000
    enterprises privatized, about 100 publish
    financial statements. Their balance sheets,
    however, consist of three lines on the assets and
    two lines on the liabilities, without footnotes,
    which is just nonsense

International Accounting Practices An Investors
  • A 1998 study by the United Nations reviewed the
    accounting practices in Korea, Thailand,
    Indonesia, Malaysia, and the Philippines and
  • Only 1/3 of the firms disclosed related-party
    borrowing and lending
  • Only 19 disclosed FX gains/losses under IAS
  • Over 80 did not disclose gains/losses of
    derivatives or even their terms
  • They concluded that poor accounting helped to
    magnify the size of the Asian crisis

International Accounting Practices An Investors
  • Alphatec, once Thailands preeminent high-tech
    firm, came crashing down in 1997 because of
  • ..the mingling of funds among listed and closely
    held companies run by the same family, the use of
    multiple sets of accounting books and misleading
    accounting methods, the highly paid, rubber stamp
    board,- these mirror the problems at other Thai
    companies that have brought this countrys
    economy to the brink of collapse
  • Wall Street Journal, Sept 8, 1997

International Accounting Practices An Investors
  • Because of the lack of disclosure laws and sound
    accounting standards, reported information can be
    misleading or just plain wrong
  • Even in countries that have well developed
    accounting systems, they may favor the firm over
    the investor
  • An example DaimlerChrysler

International Accounting Practices An Investors
  • WSJ, Setember 10, 1998
  • In Mexico, information is power.Just try to get
    your hands on any, from the mundane to the
    profound. Everything from the number of
    billboards in Mexico City to the details of the
    past presidential lives is closely guarded by
    government and business. What happened during the
    post 1994 bail out? Finance ministry officials
    say they are reluctant to give out sensitive
    information to Congress, citing the countrys
    bank secrecy laws, which, uniquely, protect not
    just data on deposits, but also on loans

International Accounting Practices An Investors
  • Lawmakers suspect the Ministry is trying to
    protect hundreds of well-connect businessman
    whose bum debts end up being bought by Mexicos
    deposit insurance fund which will, in the end, be
    borne by taxpayers
  • Another example When an event is not an event?

International Accounting Practices An Investors
  • Overall, there are notable international
    differences in financial disclosure requirements
  • This impacts the quality and quantity of
    information available for investors
  • Can lead to front-running or inside dealing
    You may get ripped off
  • Who gets hurt the most?

Transactions Costs
  • That is, How much does it cost to buy and sell
    securities. What do think are T.C.s components?
  • Direct costs Commissions, Fees, Taxes etc.
  • These get recorded in financial statements
  • Indirect Market Impact
  • These do not

In the U.S., these are relatively low, what about
  • Why is this important know?
  • T.C. can wipe out trading profits, so ignoring
    them lead to incorrect asset allocation
  • Price impact in emerging markets, a.k.a. hot
    money, can destabilize markets.
  • Large costs in foreign markets can lead firms to
    list their stock in the U.S., further hindering
    domestic market development

Until very recently, we didnt have any answers.
  • This is because it has been almost impossible to
    gather data from around the world that is
    comparable in all the dimensions of T.C.
  • Luckily, some famous finance professors recently
    quit the ivory tower and gave us some answers
  • Domowitz, Glen, and Madhavan

Liquidity, Volatility, and Equity Trading Costs
Across Countries and Across Time
  • Data from Elkins/McSherry Co., a firm that
    conducts cost studies for institutional traders
    and serves as a consultant to stock exchanges
  • Elkins/McSherry Co. receives trade data on all
    global trades by institutional traders and
    computes measures of trading costs.
  • For example, in 1998, the institutional traders
    in the data represented 135 firms, of whom 105
    are pension funds, 27 are investment managers,
    and 4 are brokers.
  • These institutions accounted for 28 billion
    shares in 632,547 trades, using 700 global
    managers and 1,000 brokers
  • Data runs from 1996-1998
  • Lets see what they find.

  • Enormous variation in one-way equity trading
    costs across countries, ranging from a high of
    198 bp in Korea to a low of 30 bp in France
  • Total T.C. in Emerging Markets are 95 larger
    relative to developed markets, with much of this
    difference coming from implicit T.C.
  • Considerable consistency in cost rankings from
    year to year
  • There is variation in the composition of costs
    across countries, but both implicit and explicit
    costs are economically substantial in all cases

  • Very important to returns The equally-weighted
    portfolio of all countries has one-way trading
    costs of 71.3 bp.
  • If this portfolio is turned over every six
    months, annual costs of 2X2X71.3285bp are
  • By contrast, the average annual portfolio return
    (pre-cost) is 4X3071228.
  • Trading costs constitute 23 percent of raw
    returns in this scenario.
  • Important stuff

  • After you place your order, when do you get the
    stock or get the
  • Related How long does it take to collect your
  • Many markets (Malaysia, Venezuela) have highly
    inefficient settlement (sometime use paper to
    record transactions)
  • When volume swells, it overloads the system

GSCS Settlement Benchmarks
  • Newsletter

  • Illegitimate payments and favors outside the rule
    of law
  • Corruption occurs to some extent in all
    countries, large differences across countries
  • And states, remember Im from Louisiana

Measuring Corruption
  • "There is no end in sight to the misuse of power
    by those in public office - and corruption levels
    are perceived to be as high as ever in both the
    developed and developing worlds," said Peter
    Eigen, Chairman of Transparency International,
    speaking today on the launch of the Corruption
    Perceptions Index.
  • Lets take a look at the latest index from
    Transparency International

Corruption in the Developed World
  • "Corruption in the most prosperous countries in
    the world has many manifestations, and
    Transparency International is increasing its
    efforts to stimulate actions to secure greater
    transparency in politics, business and banking.
    We aim to publish a new Bribe Payers Index in
    early 2002 to shine the spotlight on the
    propensity of western firms to use bribes in
    emerging market economies."

Transparency International Bribe Payers Index
2002 The Supply Side
  • 835 business experts in 15 leading emerging
    market countries were asked In the business
    sectors with which you are most familiar, please
    indicate how likely companies from the following
    countries are to pay or offer bribes to win or
    retain business in this country?
  • A perfect score, indicating zero perceived
    propensity to pay bribes, is 10.0, and thus the
    ranking below starts with companies from
    countries that are seen to have a low propensity
    for foreign bribe paying.

Transparency International Bribe Payers Index
(No Transcript)
Transparency International Bribe Payers Index 2002
  • "The BPI results signal the rejection by
    multinational firms of the spirit of
    international anti-bribery conventions, while
    their actions lead to a huge misallocation of
    very scarce resources in developing countries,"
    said TI Advisory Council Chairman Kamal Hossain
    at a press conference in Hong Kong.
  • "The data also points to very heavy bribe-paying
    by domestic firms in developing countries.
    Today's BPI underscores the fact that we have a
    global problem of corporate bribe-paying that
    demands concerted global actions by official
    international organizations, civil society
    organizations and national governments," he said.

Bribery in business sectors
  • How likely is it that senior public officials in
    this country would demand or accept bribes, e.g.
    for public tenders, regulations, licensing in the
    following business sectors?
  • The scores are mean averages from all the
    responses on a 0 to 10 basis where 0 represents
    very high perceived levels of corruption, and 10
    represents extremely low perceived levels of

Bribery in business sectors
Bribery in business sectors
  • "The BPI shows that the most flagrant corruption
    is seen in the public works/construction and arms
    and defense sectors, which are plagued by endemic
    bribery by foreign firms. In a new study by the
    UK chapter of TI, it is estimated, for example,
    that foreign bribery is associated with tens of
    billions of dollars of defense deals," said Kamal
  • While even agriculture, the sector considered
    least likely to involve bribery by foreign
    companies, scored only 6.9 against a clean score
    of 10, public works/construction was deemed
    highly corrupt, with a score of 1.3, followed by
    arms and defense with 1.9, and the oil and gas
    sector with a score of 2.7.

Transparency International Bribe Payers Index
2002, Review
  • Russian, Chinese, Taiwanese and S. Korean
    companies widely seen using bribes in developing
  • High propensity to bribe overseas also seen for
    companies from Italy, Hong Kong, Malaysia, United
    States, Japan, France and Spain
  • Construction and arms industries top sectors of
    heaviest bribery

Are these Costs Large? The Cost of doing
Business Under the Table
  • World Bank Survey of over 3000 East European
    firms ten year after the collapse of communism
  • Also surveyed entrepreneurs and businesspeople in
    20 countries to estimate the bribe tax in each
    country, payment directly to government officials

The Cost of doing business Under the Table
Source Survey by the World Bank
  • Firms in Eastern Europe pay bribes that amount to
    as much as 8 of total revenues!
  • This is in addition to the already high
    official tax
  • The average bribe in the former Soviet Union is
    almost twice the size of firms in central and
    eastern Europe

  • Transition success countries like Poland and
    Hungary also bribe a lot!
  • Small companies bribe more often than large
  • Overall, bribes can hurt economic growth by
    misallocation of resources

What about Capital Controls ?
  • Various foreign exchange controls are often
    imposed, especially in EM.

Ownership Restrictions Example China
  • Chinas Qualified Foreign Institutional Investor
    (QFII) program allows selected global managers to
    invest in yuan-denominated securities, including
    Class A stocks
  • First Investment July 2003, by UBS
  • Total QFII Quota USD 4 billion, but just
    announced (7/2005) to expand to 10billion. (hot
    flows a good think for market given recent
  • Number of applicants 26
  • Largest Quota Holder UBS (800 Mill), Smallest
    Several with 50mil each
  • China Stock Market Capitalization 450Billion at
    end of 2004

Capital Controls cont.
  • Different class of shares and their pricing
    shares for foreign investors may sell at a
    discount or premium to domestic shares. (E.G., A
    B shares in China, Alien board in Thailand)
  • Other historical Examples FIIs in India,
    Industry restrictions (banking, defense),
    ownership restrictions in Korea, Brazil
  • Repatriation restrictions (see CGSC China report)
  • Differential Taxation Rates

One Stock, Two Prices? Infosys Techhologies
One Stock, Two Prices Infosys
  • Infosys Technologies
  • Is traded on both Nasdaq as well as Indian
    domestic stock (BSE) market, often much different
  • What could explain this? Think about the law of
    one price
  • What are the restrictions that could matter?

Ownership Restrictions in India for Infosys
  • Non-Indian investors can own DRs or the domestic
    shares, but government has restricted the of
    foreing ownership. These vary from industry to
  • For IT companies, since 2001 the limited was
    100, but no single foreign investor can hold
    more than 10. In July 2002, Infosys shareholders
    passed a resolution allowing 100 foreign
  • Infosys is a limited Depositary Receipt
    program Investors can convert existing shares
    into DR only if some DRs from the initial
    issuance have been converted back into domestic
  • Lets see how many are converted back

First, a unrestricted two way DR program
Infosys cont
So, limits to arbitrage can allow a premium. But
WHY would investors pay a premium?
  • Lower cost of capital for DR investors?
  • Recall that foreign investors can purchase the
    domestic shares
  • Taxes?
  • If foreign (US) investors pay higher taxes on
    dividends and capital gains when buying domestic
    shares, then they may be willing to pay a premium
  • US investors who trade in Indian domestic stocks
    do not pay taxes on dividends, but pay a 30
    short-term capital gains tax on stocks held less
    than one year, and a 10 long-term capital gains
    tax, that can be used as a foreign tax credit to
    offset US taxes.
  • -therefore, taxes dont seem to be it

So, limits to arbitrage can allow a premium. But
WHY would investors pay a premium?
  • Lower transactions costs?
  • Indian government requires that foreign
    institutional investors who want to invest in
    domestic shares register with the Securities and
    exchange Board of India (SEBI) and the Reserve
    Bank of India, as well as provide detail
    background information (and pay a 10,000 fee).
  • What kind of investors do you think will be

Average share ownership of DR holders and
Foreign Institutional Investors (FIIs) over time
Downward sloping demand curves?
  • Since the supply of DRs is limited, investors
    with the highest reservation price will set the
  • Since riskless arbitrage is not possible, the
    domestic and DR price may be priced
  • Lets look some major corporate events and track
    the two prices

(No Transcript)
Other evidence the prices are set differently
  • The variation in the Infosys DR is better
    explained by variation in the NASDAQ composite
    index (R-sqared is 0.55) than by variation in the
    Indian stock market index (r-squared is 0.35)
  • On the other hand, the variation in the infosys
    domestic returns is better explained by the
    variation in the Indian stock market (R-squared
    is 0.47) than the variation in the NASDAQ
    composite (R-squared is 0.37)

Can firms benefit from the premium?
Infosys is a cash rich firm
So, what would you do?
  • In a tender offer, Infosys invited domestic
    shareholders to tender their domestic shares for
    conversion to DRs. The allotment for conversion
    was done on a proportionate basis, so more shares
    were tendered by large shareholders.
  • Not surprising, the first tender offer was
  • 10, 164 domestic sharholders tendered 14.86
    million shares for conversion into DRs. Infosys
    only accepted three million
  • The founders, directors and executives of infosys
    accounted for over 30 of the shares, and
    shareholders with over 1 ownership accounted for
    over 60

One Stock, Two Prices
Political Risk
  • Violent political conflict (i.e., civil war,
    terrorism, racial and ethnic discord, coup
    d'etat, and systemic collapse) can have profound
    negative effects on foreign direct and indirect
  • The business environment is also influenced by
    elections, government corruption, labor disputes,
    institutional reform, and shifts in public

This is the last bond issued by the Russian
Czarist Government in 1917 before the Soviet
How about a safe international Government Bond?
Measuring Political Risk
  • Political risk measurements can be used in
    project financing. (discount rates)
  • Measuring political risks is still an art rather
    than a science.

Political Risk Measures
  • Institutional Investors Country Credit Ratings
  • Institutional Investor survey of Bankers
  • Published semiannually since 1979
  • Survey of 75-100 bankers on country risk
  • Since survey based, can be forward looking
  • Lets take a look at a sample

Political Risk Measures
Institutional Investors Country Credit Ratings
Other Political Risk Measures
  • Other Country Credit Risk Measures
  • Political Risk Services International Country
    Risk Guide
  • Explore risk surrogates
  • Political Risk,
  • Economic Risk,
  • Financial Risk and
  • Country Credit Ratings

Political Risk Measures
Political risk. International Country Risk Guide
Political Risk Measures
Financial risk. International Country Risk Guide
Political Risk Measures
Economic risk. International Country Risk Guide
Political Risk Measures
International Country Risk Guide Risk Categories
Political Risk Measures
Country Risk Ratings are correlated with
Sovereign bond ratings
Political Risk Measures
Country Risk Ratings are correlated with
Sovereign bond ratings
Political Risk Measures
Country Risk Ratings are correlated with
Sovereign bond ratings
(No Transcript)
4. Country Risk Rating Model
Time-series of ratings
So, barriers to capital flows exist
  • High Transactions Costs
  • Lengthy Settlement (or complete lack of)
  • Lack of transparency and information disclosure
  • Corruption
  • Capital Controls
  • Ownership Restrictions
  • Cultural differences
  • Political Risk

What can we do?
  • Invest in securities that overcome many of these
  • ADRs, Country Funds, WEBs,
  • More on these soon
  • Mitigate the remaining risks
  • Buy insurance
  • Structure deals accordingly

Strategies for managing country risk
  • Negotiate the investment environment with the
    host country prior to investment
  • The investment environment
  • The financial environment
  • Structure foreign operations to minimize country
    risk while maximizing expected return
  • Obtain political risk insurance

Political risk insurance
  • You trust your foreign customer. Do you trust
    your foreign customers Government?
  • Countries dont go bankrupt, do they?

Political risk insurance
  • Insurable political risks include
  • ConfiscationPolitical ViolenceWarAbrogationCha
    nge of LawDeprivationEmbargo Currency
    InconvertibilityForced AbandonmentForced
    DivestitureFailure to RepossessArbitration
    Award DefaultLicense CancellationSelective

Political risk insurance
  • Political risk insurers
  • International
  • World Banks Multilateral Investment Guarantee
  • Government export credit agencies
  • United States - Overseas Private Investment
  • United Kingdom - Export Credits Guarantee
  • Private
  • American International Group
  • Lloyds of London

Political risk and thestructure of foreign
  • Structure foreign operations to minimize country
    risk while maximizing expected return
  • Limit the scope of technology transfer to foreign
    affiliates to include only non-essential parts of
    the production process
  • Limit dependence on any single partner
  • Enlist local partners
  • Use more stringent investment criteria
  • Plan for disaster recovery

What does finance theory tell us about Country
Risk? Country risks and the MNCs cost of capital
  • From shareholders perspective, only
    nondiversifiable country risks should affect the
    cost of capital
  • Whether a particular country risk is
    diversifiable depends on whether investors are
    locally or globally diversified
  • From managers perspective, country risks are
    often not diversifiable
  • This creates an agency conflict as managers
    represent shareholders

The evidence onCountry risks and required returns
  • Erb, Harvey, and Viskanta found that country risk
    measures - particularly financial risk measures -
    are correlated with future equity returns and
  • A decrease (increase) in country risk tends to be
    followed by a rise (fall) in equity returns in
    that country.
  • Countries with high country risk tend to have
    more volatile returns than countries with low
    country risk.
  • Countries with high country risk tend to have
    lower betas (systematic risks) than countries
    with low country risk.

Where are we now?
  • We have seen the benefits to international
    investing in terms of mean-variance analysis
  • We have investigated the various risks in
    international capital markets
  • Now, we try to integrate these ideas into a
    framework to understand how they affect
    investors, security prices, and capital market
  • Law and Finance
  • But lets do a case first to illustrate the issues