brian levin harvard summer school chapter 11: the global capital market
TRANSCRIPT
Brian Levin
Harvard Summer School
Chapter 11: The Global Capital Market
Functions of a Capital Market The capital market matches those who wish to
invest excess cash with those who wish to borrow
Intermediaries put the two parties together (‘Market Makers’)– Commercial Banks: pay depositors a rate of return
and make loans at a higher rate of return– Investment Banks: broker a direct transaction
between an investor and borrower
Advantage of a Global Capital Market For a borrower, it lowers the cost of capital
See Figure 11.2 in the textbook; global capital market acts like a supply shift in a supply/demand graph
For an investor, it allows for international portfolio diversification which theoretically decreases the risk of a portfolio (more on this later…)
Overall, the global capital market achieves a lower cost of capital which allows firms to take on more long term projects because the hurdle rate for the investment is lower (which leads to more economic growth, etc.)
Does the global capital market really achieve risk reduction for investors?
Research such as Solnik (1974) postulates that global markets are weakly correlated
According to portfolio theory, weak correlation leads to diversification and less systematic risk of the portfolio
While during ‘normal’ times this may be true, crisis are a different story!
Weak correlation? Japan Market
Weak Correlation? U.S. Market
Weak Correlation? U.K. Market
Strong Correlation! Benefit of a global market for investors may be
overstated because of a hidden risk - correlation risk– Very difficult to hedge!
Studies by Solnik and followers overlook the endogenous relationship of the development of global capital markets and correlation; the more investors shift money abroad, the more correlated all markets become the LESS diversified a portfolio becomes
Why? A crisis in one country leads investors to liquidate holdings across portfolio to make up for shortfall cascading fall in global markets!
Why do companies seek global equity? Improved liquidity Possible higher share price Increase the firm’s visibility with bankers,
suppliers, government, etc. “Acquisition currency” Compensate foreign management
Eurocurrency Markets Eurocurrency – any currency banked outside of its
country of origin. Eurodollars – dollars banked outside of the U.S.
– Euroyen, europound, euro-euro
1950 Eurocurrency Market is born as Eastern Europeans were afraid to deposit $ in the U.S. fearing that they would be seized to finance lost business from the Communist takeover of Europe. Continued expansion by OPEC nations during Oil spike in 1970’s.
– London was happy to take the money and paid higher interest rates (see the next slide).
Exhibit 11.4 Comparative Spreads Between Lending and Deposit Rates in the Eurodollar Market
3.000 %
7.000 %DomesticLoan Rate
DomesticDeposit Rate
Domestic Spreadof 4.000%
Eurodollar Loan Rate
Eurodollar Deposit Rate
Eurodollar Spread of 0.500%
Interest Rate
4.625 %
4.125 %
Why doesn’t everyone bank in eurodollars? Eurocurrency market is not regulated; no FDIC
insurance in the case of U.S. In the case of a bank failure, depositors don’t have the
recourse that they do in domestic banking Therefore, the higher rate of interest paid on deposits is
simply a risk/reward calculation During September/October 2008, eurocurrency deposit
rates and lending rates (LIBOR, etc.) sky rocketed because of this risk
Global Bond Markets Foreign bonds are bonds issued in one country by a
foreign issuer. – “Yankee Bonds” are bonds issued by a non-U.S. entity that are
traded in the U.S. – “Samurai Bonds” are bonds traded in Japan issued by a non-
Japanese entity. – “Bulldog bonds” are traded in the U.K. but issued by a non-U.K.
entity, – “Rembrandt Bonds” are bonds traded in the Netherlands by a
non-Dutch entity,– “Matador Bonds” are bonds traded in Spain issued by a non-
Spanish entity.
Eurobonds Eurobonds have the following characteristics:
– Underwritten by an international syndicate– Issued to investors in more than one country– Generally, not issued in the country that issues the currency in
which they are denominated.– Usually unregistered.
Note: Eurobonds are named in accordance with the currency in which they are denominated, not according to where they are issued.
– Eurodollar bonds are denominated in U.S. dollars but not issued in the U.S., Euroyen bonds are denominated in yen, but not issued in Japan.
Global Equity Markets
Source: www.world-exchanges.org
Market Capitalization May 2009 (USD Billions)
Americas 15, 257
Asia Pacific 11, 602
Europe, Middle East, Africa 10, 515
TOTAL 37, 374
China’s Equity Markets Shanghai Stock
Exchange (SHSE)
Shenzhen Stock Exchange (SZSE)
Exchange Shanghai SE Shenzhen SE Hong Kong NYSE
End 1990 299 1,774End 1991 357 1,989End 1992 413 1,750End 1993 477 1,945End 1994 529 2,128End 1995 542 2,242End 1996 583 2,476End 1997 658 2,626End 1998 680 2,670End 1999 708 3,025End 2000 790 2,468End 2001 646 508 867 2,400End 2002 715 508 978 2,366End 2003 780 505 1,037 2,308End 2004 837 536 1,096 2,293End 2005 833 544 1,135 2,270
Number of Listed Companies
Source: world-exchanges.org
Exchange Shanghai SE Shenzhen SE Hong Kong NYSE
End 1990 NA NA 83,385.9 2,692,123.0End 1991 NA NA 121,880.9 3,484,340.3End 1992 NA NA 171,983.5 3,798,238.1End 1993 NA NA 385,042.7 4,212,956.0End 1994 NA NA 269,507.8 4,147,936.7End 1995 NA NA 303,705.3 5,654,815.4End 1996 NA NA 449,218.8 6,841,987.6End 1997 NA NA 413,322.6 8,879,630.6End 1998 NA NA 343,566.5 10,277,899.8End 1999 NA NA 609,090.4 11,437,597.3End 2000 NA NA 623,397.7 11,534,612.9End 2001 NA NA 506,072.9 11,026,586.5End 2002 306,443.6 156,647.6 463,054.9 9,015,270.5End 2003 360,106.3 152,872.4 714,597.4 11,328,953.1End 2004 314,315.7 133,404.6 861,462.9 12,707,578.3End 2005 286,190.3 115,661.9 1,054,999.3 13,310,591.6
Market Capitalization (in US millions)
Source: world-exchanges.org
HK less than 1/3 the size of NYSE NYSE had 18x the Market Cap
Sourcing Equity Globally Designing a Strategy to Source Equity Globally
American depository receipts (ADRs) are certificates traded in the United States and denominated in US dollars.
– ADRs are sold, registered, and transferred in the US in the same manner as any share of stock with each ADR representing some multiple of the underlying foreign share (allowing for ADR pricing to resemble conventional US share pricing between $20 and $50 per share).
ADRs Levels Level I
– OTC only
Level II– Listed on a U.S. stock exchange.
New York Stock Exchange (NYSE), NASDAQ, and the American Stock Exchange (AMEX).
Level III– Firm can also raise money
Popular ADRs
Bank of New York: www.adrbny.comJP Morgan: www.adr.com
Novartis – Biotech SwedenHSBC – Banking UKNestle – SwitzerlandLan.com – Airline ChileEricsson – Telecom Switzerland Vodafone – Telecom UKWipro – IT IndiaNokia – Telecom FinlandElan – Biotech Ireland
Islamic Finance Muslims represent 1/4th of the world’s population. Under Islam, the following beliefs affect business and
finance:– Making money from money is not permissible– Earning interest is prohibited– Profit and loss should be shared– Speculation is prohibited– Investments should only support activities that are legal under
Islamic law
Islamic Finance An Islamic bank cannot pay interest to depositors who
are Muslim.– So depositors are considered shareholders and the returns they
receive are a function of the bank’s investments.– Returns are not guaranteed, because profit and loss must be
shared. To buy a home under Islamic law:
– The buyer selects a property which is purchased by the bank.– The bank then resells the property to the buyer at a higher price
and the buyer is allowed to pay off the bank over a period of time.
– One problem: in the U.S. and the U.K. the difference is not a tax deductible expense for the homeowner.
Implications for Managers Global Market Opportunities Currency Management
– Forecasting & Hedging Activities– Strategic Flexibility
Dispersed Production Outsourcing