Part V International Portfolio Investment and Asset Pricing

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Part VInternational Portfolio Investmentand
Asset Pricing
Chapter 19 International Capital Markets Chapter
20 International Portfolio Diversification Chapte
r 21 International Asset Pricing
Butler, Multinational Finance, 4e
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Chapter 19International Capital Markets
Learning objectives ? Domestic and international
capital markets Stocks and bonds around the
world ? International investment vehicles
Share prices in segmented markets ? Investment
styles Active vs. passive Asset
allocation vs. security selection ?
Cross-border financial statement analysis
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Publicly traded debt equity
International debt 19.5 trillion 19
Domestic debt 52.2 trillion 51
Equity 31.5 trillion 31
Sources Debt data from the Bank for
International Settlements, September 2007.
Equity data from the FTSE All-World Review,
2007.
Domestic international capital markets
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Public debt markets

• Domestic markets
• Domestic bonds are issued and traded domestically
  and denominated in the domestic currency
• GMAC zr 15 issued in dollars by General Motors
  Acceptance Corporation trade on the NYSE

Domestic international capital markets
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Major domestic debt issuers( trillions)
Source Bank for International Settlements (March
2007)
Domestic international capital markets
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Public debt markets

• International bond markets
• Foreign bonds are issued in a domestic market by
  a foreign borrower
• Toronto Dominion 6.45 09 trade OTC in the U.S.
• Eurobonds are placed outside the borders of the
  country issuing a currency
• FNMA 7.25 30 traded OTC outside the U.S.
• Global bonds trade in the Eurobond market as well
  as in one or more internal bond markets

Domestic international capital markets
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Major international debt issuers( trillions)
Source Bank for International Settlements (March
2007)
Domestic international capital markets
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Bond market taxonomyfrom a U.S. perspective

• International
• Domestic Foreign bonds Eurobonds
• GMAC Toronto FNMA
• zr 15 Dominion 7.25 30
• 6.45 09
• (NYSE) (US OTC) (non-US OTC)
• Internal External

Domestic international capital markets
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Internal bond market conventions

• Ownership Coupons Day count
• Canada Registered Semiannual Actual/365
• Japan Registered Semiannual Actual/365
• Switzerland Bearer Semiannual 30/360
• U.K. Bearer Semiannual Actual/365
• Euro-zone Bearer Semiannual Actual/Actual
• or annual
• United States
• Treasury Registered Semiannual Actual/365
• Corporate Registered Semiannual 30/360

Domestic international capital markets
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External bond market conventions

• Ownership Coupons Day count
• Eurobonds
• Fixed rate Bearer Annual 30/360
• Floating rate Bearer Quarterly or Actual/360
• semiannual
• Eurocurrencies
• LIBOR Registered Quarterly or Actual/360
• semiannual

Domestic international capital markets
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Major stock markets( trillions)
Source FTSE All-World Review (2007)
Domestic international capital markets
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Stock returns around the world
Dot.com bubble bursts
Global crash in 1987
1990 crash in Japan
1997 Asian contagion
Source Morgan Stanley Capital International
Indices
Domestic international capital markets
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Securities regulation in the U.S.

• Securities Exchange Commission
• A registration statement is required for public
  securities offerings of more than 1.5 million
• The Financial Services Modernization Act (1999)
  deregulated the financial services industry

Domestic international capital markets
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Securities regulation in Japan

• Ministry of Finance
• The registration procedure is similar to U.S.,
  but with a longer waiting period before
  issuance to the public
• The 1995 Big Bang allowed banks into investment
  banking and securities trading industries

Domestic international capital markets
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Securities regulation in the E.U.

• European Union Directives
• Capital Adequacy Directive (1996) specifies
  minimum risk standards for EU financial
  institutions
• Investment Securities Directive (1996) provides a
  passport to EU financial institutions
• Markets in Financial Instruments Directive (2004)
  widens the scope of the passport to other
  financial contracts (e.g. derivatives)

Domestic international capital markets
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Global equity offerings

• Cross-listing shares on more than one stock
  exchange can increase demand and enhance share
  price
• U.S. companies listing abroad experience less of
  an adverse price reaction than similar companies
  issuing equity in the United States
• Non-U.S. companies listing in the United States
  often increase in value

Domestic international capital markets
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Overcoming capital flow barriers

• Domestic-based MNCs
• Advantage
• Domestically-based MNCs are familiar and
  accessible to domestic investors
• Disadvantage
• MNC share prices move more closely with the
  domestic stock market than with international
  markets

International investment vehicles
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Overcoming capital flow barriers

• Domestic-based MNCs
• Individual foreign securities
• Direct purchase in the foreign market
• Direct purchase in the domestic market
• Foreign shares
• (American shares in the US)
• Depository receipts
• (ADRs in the US)

International investment vehicles
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Overcoming capital flow barriers

• Domestic-based MNCs
• Individual foreign securities
• Mutual funds of foreign assets
• Open-end vs closed-end funds
• Exchange-traded funds (ETFs)

International investment vehicles
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Overcoming capital flow barriers

• Domestic-based MNCs
• Individual foreign securities
• Mutual funds of foreign assets
• Hedge funds and private equity
• Hedge funds are private investment partnerships
• U.S. hedge funds have a general manager fewer
  than 100 limited partners
• There are a wide variety of hedge fund
  strategies, including yield curve arbitrage and
  funds-of-funds

International investment vehicles
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Overcoming capital flow barriers

• Domestic-based MNCs
• Individual foreign securities
• Mutual funds of foreign assets
• Hedge funds and private equity
• Hedge funds
• Private equity funds are hedge funds that
  specialize in private companies
• Venture capital funds are an example

International investment vehicles
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Overcoming capital flow barriers

• Domestic-based MNCs
• Individual foreign securities
• Mutual funds of foreign assets
• Hedge funds and private equity
• Other international investment vehicles
• Stock index futures
• Stock index options
• Stock index swaps

International investment vehicles
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Share prices in segmented markets

• Governments allow restricted access to their
  financial markets through
• Closed-end country funds (CECFs)
• (mutual funds invested in a single country)
• Unrestricted shares sold internationally
• (only domestic investors can own restricted
  shares)
• CECFs and unrestricted shares can trade at
  substantial premiums to net asset value (NAV)

Share prices in international markets
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Explanations for share pricesin segmented markets

• International asset pricing with investment
  restrictions
• A classic portfolio maximization argument
• Assumes rational investors maximizing the
  mean-variance efficiency of their portfolios

Share prices in international markets
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Explanations for share pricesin segmented markets

• International asset pricing with investment
  restrictions
• Investor sentiment
• Individual investors trade on their (possibly
  irrational) sentiment regarding future returns
  and risks

Share prices in international markets
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Explanations for share pricesin segmented markets

• International asset pricing with investment
  restrictions
• Investor sentiment
• Individual investors trade on their (possibly
  irrational) sentiment regarding future returns
  and risks
• Premiums are large when foreign investor demand
  is high

Share prices in international markets
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Global equity issues

• Share prices in seasoned equity offerings (SEOs)
  typically fall by a small amount in domestic
  markets
• In contrast, global shares offered to multiple
  national markets do not suffer the same adverse
  price reaction
• Possible explanations include
• Increased demand for these firms shares
• Improvement in the firms information
  environment

Share prices in international markets
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Portfolio investment styles

• Asset allocation policy
• A funds target weights on various asset classes
• Investment philosophy
• Passive fund management
• Benchmarked to an index
• Active fund management
• Active asset allocation
• Active security selection

Investment styles
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The market timers penalty
HK
Buy-and-hold investor
Naive market timer
Market timers penalty for random switches
between Hong Kong and U.S. stocks
US
Investment styles
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Financial accounting measurement

• Cross-country financial statement analysis is
  difficult because of national differences in the
  measurement of accounting income
• Differences show up in the construction of nearly
  every financial account
• National accounting differences can result in
  huge differences in reported income

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Financial accounting disclosure

• There are also cross-border differences in
  financial disclosure requirements
• Alternatives for providing financial information
  to investors in another country
• Do nothing
• Prepare convenience translations
• Using different accounting principles, such as
  IAS standards, in preparing the firms financial
  statements