Download Market - e

Globalization, Finance &
China
Jian Chen
[email protected]
Prepared for ESEUNE gemMBA Program
Beijing Campus
November 4th, 2013
1
Personal Bio
 Ph.D.
in Computational Finance, Smith
Business School, University of Maryland
 Serve on the Board of Directors of
GCREC
 Column writer for CAIXIN media
 Member of AREUEA
 CFA Charter Holder
2
Working Experience
 Managing
Director, IFE Group
 Director of Risk and Modeling, Freddie
Mac, 2010-2012
 Director of Capital Markets Risk
Management, Fannie Mae, 2001-2009
3
Teaching and Research

Teaching





Johns Hopkins Carey Business School
Georgetown University
Graduate School
Renmin University of China
Research






Real Estate Finance
International Finance
Urban Economics
Housing Policy
Fixed Income Pricing
Risk Management
4
Agenda
 Global
Financial System
 China’s Financial System
 Doing Business in China
 Housing Crisis and Its Impact
5
Global Financial System
 Why
is it important?
 International Monetary System
 FOREX Exposure & Risk Management
 Sourcing International Capital
 Making International Investment Decision
6
Road Map
International
Monetary
System
Sourcing
Capital in
Global Markets
International
Financial Risk
Management
Synthesis
Managing
FOREX
Exposure
Foreign
Investment
Decisions
7
Creating Firm Value in Global
Markets
8
The Theory of Comparative
Advantage

The theory of competitive advantage provides a
basis for explaining and justifying international
trade in a model assumed to enjoy





Free trade
Perfect competition
No uncertainty
Costless information
No government interference
9
The Theory of Comparative
Advantage: Limitations

Although international trade might have approached the
comparative advantage model during the nineteenth
century, it certainly does not today;




Countries do not appear to specialize only in those products that
could be most efficiently produced by that country’s particular
factors of production
At least two of the factors of production (capital and technology)
now flow easily between countries (rather than only indirectly
through traded goods and services)
Modern factors of production are more numerous than this
simple model
Comparative advantage shifts over time
10
The Theory of Comparative
Advantage

Comparative advantage is still, however, a
relevant theory to explain why particular
countries are most suitable for exports of goods
and services that support the global supply
chain of both MNEs and domestic firms
 The comparative advantage of the 21st century,
however, is one which is based more on
services, and their cross border facilitation by
telecommunications and the Internet
11
Global Outsourcing of
Comparative Advantage
12
What is Different About International
Financial Management?
13
Market Imperfections:
A Rationale for the MNE

Firms become multinational for one or several of the
following reasons:





Market seekers – produce in foreign markets either to satisfy
local demand or export to markets other than their own
Raw material seekers – search for cheaper or more raw
materials outside their own market
Production efficiency seekers – produce in countries where
one or more of the factors of production are cheaper
Knowledge seekers – gain access to new technologies or
managerial expertise
Political safety seekers – establish operations in countries
considered unlikely to expropriate or interfere with private
enterprise
14
International Monetary System





Learn how the international monetary system
has evolved from the days of the gold standard
to today’s eclectic currency arrangement
Discover the origin and development of the
Eurocurrency market
Analyze the characteristics of an ideal currency
Explain the currency regime choices faced by
emerging market countries
Examine how the euro, a single currency for the
European Union, was created
15
History of the International
Monetary System

The Gold Standard, 1876-1913




Countries set par value for their currency in terms of
gold
This came to be known as the gold standard and
gained acceptance in Western Europe in the 1870s
The US adopted the gold standard in 1879
The “rules of the game” for the gold standard were
simple
• Example: US$ gold rate was $20.67/oz, the British pound
was pegged at £4.2474/oz
• US$/£ rate calculation is $20.67/£4.2472 = $4.8665/£
16
History of the International
Monetary System

Because governments agreed to buy/sell gold on demand
with anyone at its own fixed parity rate, the value of each
currency in terms of gold, the exchange rates were
therefore fixed
 Countries had to maintain adequate gold reserves to back
its currency’s value in order for regime to function
 The gold standard worked until the outbreak of WWI,
which interrupted trade flows and free movement of gold
thus forcing major nations to suspend operation of the
gold standard
17
History of the International
Monetary System

The Inter-War years and WWII, 1914-1944

During WWI, currencies were allowed to fluctuate over wide
ranges in terms of gold and each other, theoretically, supply and
demand for imports/exports caused moderate changes in an
exchange rate about an equilibrium value
• The gold standard has a similar function

In 1934, the US devalued its currency to $35/oz from $20.67/oz
prior to WWI

From 1924 to the end of WWII, exchange rates were
theoretically determined by each currency's value in terms of
gold.

During WWII and aftermath, many main currencies lost their
convertibility. The US dollar remained the only major trading
currency that was convertible
18
History of the International
Monetary System

Bretton Woods and the IMF, 1944




Allied powers met in Bretton Woods, NH and created
a post-war international monetary system
The agreement established a US dollar based
monetary system and created the IMF and World
Bank
Under original provisions, all countries fixed their
currencies in terms of gold but were not required to
exchange their currencies
Only the US dollar remained convertible into gold (at
$35/oz with Central banks, not individuals)
19
History of the International
Monetary System



Therefore, each country established its exchange rate
vis-à-vis the US dollar and then calculated the gold
par value of their currency
Participating countries agreed to try to maintain the
currency values within 1% of par by buying or selling
foreign or gold reserves
Devaluation was not to be used as a competitive
trade policy, but if a currency became too weak to
defend, up to a 10% devaluation was allowed without
formal approval from the IMF
20
History of the International
Monetary System

The Special Drawing Right (SDR) is an international
reserve assets created by the IMF to supplement
existing foreign exchange reserves
• It serves as a unit of account for the IMF and is also the base
against which some countries peg their exchange rates
• Defined initially in terms of fixed quantity of gold, the SDR
has been redefined several times
• Currently, it is the weighted average value of currencies of 5
IMF members having the largest exports
• Individual countries hold SDRs in the form of deposits at the
IMF and settle IMF transactions through SDR transfers
21
History of the International
Monetary System

Fixed exchange rates, 1945-1973

Bretton Woods and IMF worked well post WWII, but
diverging fiscal and monetary policies and external
shocks caused the system’s demise
• The US dollar remained the key to the web of exchange rates

Heavy capital outflows of dollars became required to
meet investors’ and deficit needs and eventually this
overhang of dollars held by foreigners created a lack
of confidence in the US’ ability to meet its obligations
Copyright © 2009
Pearson Prentice Hall.
All rights reserved.
22
History of the International
Monetary System






This lack of confidence forced President Nixon to suspend
official purchases or sales of gold on Aug. 15, 1971
Exchange rates of most leading countries were allowed to float
in relation to the US dollar
By the end of 1971, most of the major trading currencies had
appreciated vis-à-vis the US dollar; i.e. the dollar depreciated
A year and a half later, the dollar came under attack again and
lost 10% of its value
By early 1973 a fixed rate system no longer seemed feasible and
the dollar, along with the other major currencies was allowed to
float
By June 1973, the dollar had lost another 10% in value
23
The IMF’s Nominal Exchange
Rate Index of the Dollar
24
Current Exchange Rate
Arrangements





36 major currencies, such as the U.S. dollar, the Japanese
yen, the Euro, and the British pound are determined largely by
market forces.
50 countries, including the China, India, Russia, and
Singapore, adopt some forms of “Managed Floating” system.
41 countries do not have their own national currencies!
40 countries, including many islands in the Caribbean, many
African nations, UAE and Venezuela, do have their own
currencies, but they maintain a peg to another currency such
as the U.S. dollar.
The remaining countries have some mixture of fixed and
floating exchange-rate regimes.
Note: As of July 31, 2005.
25
The Euro

Product of the desire to create a more integrated
European economy.
 Eleven European countries adopted the Euro on
January 1, 1999:


The following countries opted out initially:




Austria, Belgium, Finland, France, Germany, Ireland,
Italy, Luxembourg, Netherlands, Portugal, and Spain.
Denmark, Greece, Sweden, and the U.K.
Euro notes and coins were introduced in 2002
Greece adopted the Euro in 2001
Slovenia adopted the Euro in 2007
26
FOREX Exposure and Risk
Management
 Risks
involved
 Foreign Exchange Market




Spot
Forward
Futures
Options
 Theory


of Foreign Exchange Rates
Purchasing Power Parity
Interest Rate Parity
27
Risk Management
-What is special about international finance?

Foreign exchange risk


Political risk


E.g., an unexpected overturn of the government
that jeopardizes existing negotiated contracts…
Market imperfections


E.g., an unexpected devaluation adversely affects
your export market…
E.g., trade barriers and tax incentives may affect
location of production…
Expanded opportunity sets

E.g., raise funds in global markets, gains from
economies of scale…
28
The Foreign Exchange Market

The FX market encompasses:


No central market place


Conversion of purchasing power from one currency to another;
bank deposits of foreign currency; credit denominated in foreign
currency; foreign trade financing; trading in foreign currency
options & futures, and currency swaps
World-wide linkage of bank currency traders, non-bank dealers
(IBanks, insurance companies, etc.), and FX brokers—like an
international OTC market
Largest financial market in the world



Daily trading is estimated to be US$3.21 trillion
Trading occurs 24 hours a day
London is the largest FX trading center
29
Global Foreign Exchange Market Turnover
Source: BIS Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in April 2007.
30
The Foreign Exchange Market

The FX market is a two-tiered market:

Interbank Market (Wholesale)
• Accounts for about 83% of FX trading volume—mostly
speculative or arbitrage transactions
• About 100-200 international banks worldwide stand ready to
make a market in foreign exchange
• FX brokers match buy and sell orders but do not carry
inventory and FX specialists


Client Market (Retail)
• Accounts for about 17% of FX trading volume
Market participants include international banks, their customers,
non-bank dealers, FX brokers, and central banks
Note: Data is from 2007.
31
Measuring Foreign Exchange Market
Activity: Average Electronic Conversions per
Hour
32
Spot Transactions
A
spot transaction in the interbank market
is the purchase of foreign exchange, with
delivery and payment between banks to
take place, normally, on the second
following business day


The settlement date is often referred to as the
value date
This is the date when most dollar transactions
are settled through the computerized Clearing
House Interbank Payment Systems (CHIPS)
in New York
33
Outright Forward Transactions



This transaction requires delivery at a future value date
of a specified amount of one currency for another
The exchange rate is agreed upon at the time of the
transaction, but payment and delivery are delayed
Forward rates are contracts quoted for value dates of
one, two, three, six, nine and twelve months


Terminology typically used is buying or selling forward
A contract to deliver dollars for euros in six months is both
buying euros forward for dollars and selling dollars forward for
euros
34
Swap Transactions

A swap transaction in the interbank market is the
simultaneous purchase and sale of a given amount of
foreign exchange for two different value dates
 Both purchase and sale are conducted with the same
counterpart
 A common type of swap is a spot against forward


The dealer buys a currency in the spot market and
simultaneously sells the same amount back to the same bank in
the forward market
Since this transaction occurs at the same time and with the same
counterpart, the dealer incurs no exchange rate exposure
35
Size of the FOREX Market
 The
Bank for International Settlements
(BIS) estimates that daily global net
turnover in traditional FOREX market
activity to be US$3.2 trillion in April 2007



Spot transactions at $1,005 billion/day
Outright forward transactions at $363
billion/day
Swap transactions at $1,714 billion/day
36
Global Foreign Exchange Market Turnover,
1989-2007 (daily averages in April, billions
of U.S. dollars)
37
Size of the FOREX Market

The United Kingdom (London) and the United
States (New York) make up roughly 50% of the
foreign exchange market
 The London trade alone makes up 34.1% of
daily transactions in the foreign exchange
market
 Switzerland has grown in recent years and is
now the third largest market with 6.1% of world
trading
38
Foreign Currency Futures
A
foreign currency futures contract is
an alternative to a forward contract


It calls for future delivery of a standard
amount of currency at a fixed time and price
These contracts are traded on exchanges
with the largest being the International
Monetary Market located in the Chicago
Mercantile Exchange
39
Foreign Currency Futures

Contract Specifications



Size of contract – called the notional principal, trading
in each currency must be done in an even multiple
Method of stating exchange rates – “American terms”
are used; quotes are in US dollar cost per unit of
foreign currency, also known as direct quotes
Maturity date – contracts mature on the 3rd
Wednesday of January, March, April, June, July,
September, October or December
40
Foreign Currency Futures

Contract Specifications


Last trading day – contracts may be traded through
the second business day prior to maturity date
Collateral & maintenance margins – the purchaser or
trader must deposit an initial margin or collateral; this
requirement is similar to a performance bond
• At the end of each trading day, the account is marked to
market and the balance in the account is either credited if
value of contracts is greater or debited if value of contracts is
less than account balance
41
Foreign Currency Futures

Contract Specifications

Settlement – only 5% of futures contracts are settled
by physical delivery, most often buyers and sellers
offset their position prior to delivery date
• The complete buy/sell or sell/buy is termed a round turn


Commissions – customers pay a commission to their
broker to execute a round turn and only a single price
is quoted
Use of a clearing house as a counterparty – All
contracts are agreements between the client and the
exchange clearing house. Consequently clients need
not worry about the performance of a specific
counterparty since the clearing house is guaranteed
by all members of the exchange
42
Currency Futures and Forwards
Compared
43
Foreign Currency Options

A foreign currency option is a contract giving
the purchaser of the option the right to buy or
sell a given amount of currency at a fixed price
per unit for a specified time period


The most important part of clause is the “right, but not
the obligation” to take an action
Two basic types of options, calls and puts
• Call – buyer has right to purchase currency
• Put – buyer has right to sell currency

The buyer of the option is the holder and the seller of
the option is termed the writer
44
Foreign Currency Options

Every option has three different price elements




The strike or exercise price is the exchange rate at
which the foreign currency can be purchased or sold
The premium, the cost, price or value of the option
itself paid at time option is purchased
The underlying or actual spot rate in the market
There are two types of option maturities


American options may be exercised at any time
during the life of the option
European options may not be exercised until the
specified maturity date
45
Foreign Currency Options

Options may also be classified as per their
payouts



At-the-money (ATM) options have an exercise price
equal to the spot rate of the underlying currency
In-the-money (ITM) options may be profitable,
excluding premium costs , if exercised immediately
Out-of-the-money (OTM) options would not be
profitable, excluding the premium costs, if exercised
46
Foreign Currency Options
Markets

The increased use of currency options has lead
the creation of several markets where financial
managers can access these derivative
instruments

Over-the-Counter (OTC) Market – OTC options are
most frequently written by banks for US dollars
against British pounds, Swiss francs, Japanese yen,
Canadian dollars and the euro
• Main advantage is that they are tailored to purchaser
• Counterparty risk exists
• Mostly used by individuals and banks
47
Foreign Currency Options
Markets

Organized Exchanges – similar to the
futures market, currency options are traded
on an organized exchange floor
• The Chicago Mercantile and the Philadelphia
Stock Exchange serve options markets
• Clearinghouse services are provided by the
Options Clearinghouse Corporation (OCC)
48
International Parity Conditions
 The
economic theories which link
exchange rates, price levels, and interest
rates together are called international
parity conditions
 These theories may not always work out to
be “true” when compared to what students
and practitioners observe in the real world,
but they are central to any understanding
of how multinational business is conducted
49
Prices and Exchange Rates

The Law of one price states that all else being
equal (no transaction costs) a product’s price
should be the same in all markets
 Even if prices for a particular product are in
different currencies, the law of one price states
that
P$  S = P¥
Where the price of the product in US dollars (P$), multiplied
by the spot exchange rate (S, yen per dollar), equals the
price of the product in Japanese yen (P¥)
50
Prices and Exchange Rates
 Conversely,
if the prices were stated in
local currencies, and markets were
efficient, the exchange rate could be
deduced from the relative local product
prices
P¥
S $
P
51
Purchasing Power Parity &
The Law of One Price

If the Law of One Price were true for all goods,
the purchasing power parity (PPP) exchange
rate could be found from any set of prices
 Through price comparison, prices of individual
products can be determined through the PPP
exchange rate
 This is the absolute theory of purchasing
power parity
 Absolute PPP states that the spot exchange rate
is determined by the relative prices of similar
basket of goods
52
The Hamburger Standard

The “Big Mac Index,” as it has been christened
by The Economist is a prime example of this law
of one price :



Assuming that the Big Mac is identical in all countries,
it serves as a comparison point as to whether or not
currencies are trading at market prices
Big Mac in China costs Yuan 11.0 (local currency),
while the same Big Mac in the US costs $3,41
The actual exchange rate was Yuan 7.60/$ at the
time
53
The Hamburger Standard

The price of a Big Mac in Chinese Yuan in U.S. dollarterms was therefore:
Yuan 11.0
Yuan 7.60/$

=
$1.45
The Economist then calculates the implied purchasing
power parity rate of exchange using the actual price of
the Big Mac in China over the price of the Big Mac in
U.S. dollars:
Yuan 11.0
$3.41
=
Yuan
3.23/$
54
The Hamburger Standard

Now comparing the implied PPP rate of
exchange, Yuan 3.23/$, with the actual
market rate of exchange at that time, Yuan
7.60/$, the degree to which the Chinese yuan
is either undervalued or overvalued versus
the U.S. dollar is calculated:
Yuan 3.23/$ - Yuan 7.60/$
=
Yuan
7.60/$
-58%
55
Cash and Carry:
The Hamburger Standard
56
Interest Rates and Exchange
Rates


Prices between countries are related by exchange rates
and now we discuss how exchange rates are linked to
interest rates
The Fisher Effect states that nominal interest rates in
each country are equal to the required real rate of return
plus compensation for expected inflation. As a formula,
i = r + + r
The Fisher Effect is

Where i is the nominal rate, r is the real rate of interest, and
 is the expected rate of inflation over the period of time
The cross-product term, r , is usually dropped due to its
relatively minor value
57
Interest Rates and Exchange
Rates
 Applied
to two different countries, like the
US and Japan, the Fisher Effect would be
stated as
$
$
$
i = r + ;
¥
¥
¥
i = r +
It should be noted that this requires a forecast of the future rate of
inflation, not what inflation has been, and predicting the future can
be difficult!
58
Interest Rates and Exchange
Rates

The international Fisher effect, or Fisher-open,
states that the spot exchange rate should change
in an amount equal to but in the opposite direction
of the difference in interest rates between
countries

if we were to use the US dollar and the Japanese yen,
the expected change in the spot exchange rate between
the dollar and yen should be (in approximate form)
S1  S2
$
x 100  i  i¥
S2
59
Interest Rates and Exchange
Rates
 Justification
for the international Fisher
effect is that investors must be rewarded
or penalized to offset the expected change
in exchange rates
 The international Fisher effect predicts that
with unrestricted capital flows, an investor
should be indifferent between investing in
dollar or yen bonds, since investors
worldwide would see the same opportunity
and compete it away
60
Interest Rates and Exchange
Rates

The Forward Rate



A forward rate is an exchange rate quoted today for
settlement at some future date
The forward exchange agreement between
currencies states the rate of exchange at which a
foreign currency will be bought or sold forward at a
specific date in the future (typically 30, 60, 90, 180,
270 or 360 days)
The forward rate is calculated by adjusting the current
spot rate by the ratio of euro currency interest rates of
the same maturity for the two subject currencies
61
Interest Rates and Exchange
Rates
 The
Forward Rate
FC/$
90
F
S
FC/$

 FC 90 
 1   i x 360 



x

 $ 90 
 1   i x 360 



62
Interest Rates and Exchange
Rates
 The
Forward Rate example with spot rate
of Sfr1.4800/$, a 90-day euro Swiss franc
deposit rate of 4.00% p.a. and a 90-day
euro-dollar deposit rate of 8.00% p.a.
Sfr/$
F90
90  
 
 1   0.400x 360 


 Sfr1.4800x
90  
 
 1   0.800x 360 


 Sfr1.4800x
1.01
 Sfr1.4655/$
1.02
63
Interest Rates and Exchange
Rates

The forward premium or discount is the
percentage difference between the spot and
forward rates stated in annual percentage terms

When stated in indirect terms (foreign currency per
home currency units, FC/$) then formula is
f
FC
Spot - Foward 360

x
x 100
Foward
days
For direct quotes ($/FC), then F-S/S should be applied
64
Currency Yield Curves and the
Forward Premium
65
Interest Rates and Exchange
Rates

Using the previous Sfr example, the forward
discount or premium would be as follows:
f
f
Sfr
FC
Spot - Foward 360

x
x 100
Foward
days
Sfr1.4800 - Sfr1.4655 360

x
x 100   3.96% p.a.
Sfr1.4655
90
The positive sign indicates that the Swiss franc is selling
forward at a premium of 3.96% per annum (it takes 3.96%
more dollars to get a franc at the 90-day forward rate)
66
Interest Rate Parity (IRP)

Interest rate parity theory provides the linkage
between foreign exchange markets and
international money markets
 The theory states that the difference in the
national interest rates for securities of similar risk
and maturity should be equal to, but opposite
sign to, the forward rate discount or premium for
the foreign currency, except for transaction costs
67
Interest Rate Parity (IRP)

In the diagram in the following slide, a US
dollar-based investor with $1 million to invest,
is shown indifferent between dollardenominated securities for 90 days earning
8.00% per annum, or Swiss francdenominated securities of similar risk and
maturity earning 4.00% per annum, when
“cover” against currency risk is obtained with
a forward contract
68
Interest Rate Parity (IRP)
69
Sourcing International Capital
 Cost



of Capital and Capital Structure
Cost of Equity
Cost of Debt
Optimal Capital Structure
 Raising
International Equity Capital
 Raising International Debt Capital
70
Weighted Average Cost of
Capital
E
D
k WACC  k e  k d (1  t)
V
V
Where
kWACC = weighted average cost of capital
ke
= risk adjusted cost of equity
kd
= before tax cost of debt
t
= tax rate
E
= market value of equity
D
= market value of debt
V
= market value of firm (D+E)
71
Cost of Equity and Debt

Cost of equity is calculated using the Capital Asset Pricing Model
(CAPM)
k e  k rf   (k m  k rf )
Where
ke
krf
km
= expected rate of return on equity
= risk free rate on bonds
= expected rate of return on the
β
= coefficient of firm’s systematic
market
risk
• The normal calculation for cost of debt is analyzing the various
proportions of debt and their associated interest rates for the firm
and calculating a before and after tax weighted average cost of debt
72
Cost of Debt
73
Optimal Capital Structure
Market Value of The Firm
Maximum value of firm
Costs of
financial distress
PV of interest
tax shields
Value of levered firm
Value of
Un-levered
firm
Optimal amount
of debt
Debt/Total Assets
74
Sourcing Equity Globally

Depositary Receipts

Depositary receipts are negotiable certificates
issued by a bank to represent the underlying shares
of stock, which are held in trust at a foreign custodian
bank
• Global Depositary Receipts (GDRs) – refers to certificates
traded outside the US
• American Depositary Receipts (ADRs) – are certificates
traded in the US 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
75
Sourcing Equity Globally
 Depositary



Receipts
This multiple allows the ADRs to possess a
price per share conventional for the US
market
ADRs are either sponsored or unsponsored
Sponsored ADRs are created at the request
of a foreign firm wanting its shares traded in
the US; the firm applies to the SEC and a US
bank for registration and issuance
76
Exhibit 13.2 Mechanics of American
Depositary Receipts (ADRs)
77
Exhibit 13.3
Characteristics of Depositary Receipt
Programs Traded in the United States
78
Foreign Equity Listing &
Issuance

By cross-listing and selling its shares on a foreign
stock exchange a firm typically tries to accomplish
one or more of the following objectives:





Improve the liquidity of its existing shares and support a liquid
secondary market
Increase its share price by overcoming mispricing in a
segmented and illiquid home market
Increase the firm’s visibility and political acceptance to its
customers, suppliers, creditors & host governments
Establish a secondary market for shares used for acquisitions
Create a secondary market for shares that can be used to
compensate local management and employees in foreign
subsidiaries
79
Size and Liquidity of Markets
 Three
key trends in the evolution of
modern exchanges:



Demutualization or the end of market
ownership by a small, privileged group of
“seat owners”
Diversification by exchanges to trade a
broader range of products
Globalization or effectively another form of
diversification through several techniques
80
Foreign Equity Listing &
Issuance

Cross-listing is a way to encourage investors to
continue to hold and trade shares that may or
may not be listed on an investors home market
or in a preferred currency
 Cross-listing is usually done through ADRs (in
the United States, where they are traded and
quoted in U.S. dollars)
 Global Registered Shares (GRSs), on the other
hand, are able to be traded on equity exchanges
around the globe in a variety of currencies and
are traded electronically
81
Effect of Cross-Listing
on Share Price
 The
impact on price of cross-listing on a
foreign stock market depends on the
degree to which the markets are
segmented
 As was the situation experienced by Novo,
a firm can benefit if a foreign market
values a company more highly than a
home market (in a highly-segmented
situation)
82
International Debt Markets

These markets offer a variety of different
maturities, repayment structures and currencies
of denomination
 They also vary by source of funding, pricing
structure, maturity and subordination
 Three major sources of funding are



International bank loans and syndicated credits
Euronote market
International bond market
83
International Debt Markets

Bank loan and syndicated credits


Traditionally sourced in eurocurrency markets
Also called eurodollar credits or eurocredits
• Eurocredits are bank loans denominated in eurocurrencies
and extended by banks in countries other than in whose
currency the loan is denominated

Syndicated credits
• Enables banks to risk lending large amounts
• Arranged by a lead bank with participation of other bank

Narrow spread, usually less than 100 basis points
84
International Debt Markets
 Euronote


market
Collective term for medium and short term
debt instruments sourced in the Eurocurrency
market
Two major groups
• Underwritten facilities and non-underwritten
facilities
• Non-underwritten facilities are used for the sale
and distribution of Euro-commercial paper (ECP)
and Euro Medium-term notes (EMTNs)
85
International Debt Markets

Euronote facilities
• Established market for sale of short-term, negotiable
promissory notes in eurocurrency market
• These include Revolving Underwriting Facilities, Note
Issuance Facilities, and Standby Note Issuance Facilities

Euro-commercial paper (ECP)
• Similar to commercial paper issued in domestic markets with
maturities of 1,3, and 6 months

Euro Medium-term notes (EMTNs)
• Similar to domestic MTNs with maturities of 9 months to 10
years
• Bridged the gap between short-term and long-term euro debt
instruments
86
International Debt Markets
 International

bond market
Fall within two broad categories
• Eurobonds
• Foreign bonds

The distinction between categories is based
on whether the borrower is a domestic or
foreign resident and whether the issue is
denominated in a local or foreign currency
87
International Debt Markets

Eurobonds



A Eurobond is underwritten by an international
syndicate of banks and sold exclusively in countries
other than the country in whose currency the bond is
denominated
Issued by MNEs, large domestic corporations,
governments, government enterprises and
international institutions
Offered simultaneously in a number of different
capital markets
88
International Debt Markets

Eurobonds

Several different types of issues
• Straight Fixed-rate issue
• Floating rate note (FRN)
• Equity related issue – convertible bond

Foreign bonds


Underwritten by a syndicate and sold principally within the
country of the denominated currency, however the issuer is from
another country
These include
• Yankee bonds
• Samurai bonds
89
Exhibit 14.5 International Debt
Markets and Instruments
90
International Debt Markets

Unique characteristics of Eurobond markets

Absence of regulatory interference
• National governments often impose controls on foreign
issuers of securities, however the euromarkets fall outside of
governments’ control


Less stringent disclosure
Favorable tax status
• Eurobonds offer tax anonymity and flexibility

Rating of Eurobonds & other international issues

Moody’s, Fitch and Standard & Poor’s rate bonds just
as in US market
91
International Investments
 Where
to Invest?
 How to Invest?
 Global Diversification and Risk
92
Where to Invest

Two related behavioral theories behind FDI that
are most popular are



Behavioral approach to FDI
International network theory
Behavioral Approach – Observation that firms
tended to invest first in countries that were not
too far from their country in psychic terms

This included cultural, legal, and institutional
environments similar to their own
93
Where to Invest

International network theory – As MNEs grow
they eventually become a network, or nodes that
operate either in a centralized hierarchy or a
decentralized one



Each subsidiary competes for funds from the parent
It is also a member of an international network based
on its industry
The firm becomes a transnational firm, one that is
owned by a coalition of investors located in different
countries
94
How to Invest Abroad: Modes
of FDI

Exporting vs. production abroad

Advantages of exporting are
• None of the unique risks facing FDI, joint ventures,
strategic alliances and licensing
• Political risks are minimal
• Agency costs and evaluating foreign units are avoided

Disadvantages are
• Firm is not able to internalize and exploit its advantages
• Risks losing market to imitators and global competitors
95
How to Invest Abroad: Modes
of FDI

Licensing/management contracts versus control
of assets abroad


Licensing is a popular method for domestic firms to
profit from foreign markets without the need to commit
sizable funds
Disadvantages of licensing are
• License fees are likely lower than FDI profits although ROI
may be higher
• Possible loss of quality control
• Establishment of potential competitor
• Possible improvement of technology by local license which
then enters firm’s original home market
96
How to Invest Abroad: Modes
of FDI
• Possible loss of opportunity to enter licensee’s market with
FDI later
• Risk that technology will be stolen
• High agency costs


Management contracts are similar to licensing insofar
as they provide for some cash flow from foreign
source without significant investment or exposure
These contracts lessen political risk because the
repatriation of managers is easy
97
How to Invest Abroad: Modes
of FDI

Joint ventures versus wholly owned subsidiary



A joint venture is a shared ownership in a foreign
business
This is a viable strategy if the MNE finds the right
local partner
Some advantages include
• The local partner understands the market
• The local partner can provide competent management at all
levels
• Some host countries require that foreign firms share
ownership with local partner
98
How to Invest Abroad: Modes
of FDI
 Joint
ventures versus wholly owned
subsidiary

Advantages of joint ventures
• The local partner’s contacts & reputation enhance
access to host country’s capital markets
• The local partner may possess technology that is
appropriate for the local environment
• The public image of a firm that is partially locally
owned may improve its position
99
How to Invest Abroad: Modes
of FDI

Joint ventures versus wholly owned subsidiary

Disadvantages of joint ventures
• Political risk is increased if wrong partner is chosen
• Local and foreign partners have divergent views on strategy
and financing issues
• Transfer pricing creates potential for conflict of interest
• Financial disclosure between local partner and firm
• Ability of a firm to rationalize production on a worldwide basis
if that would put local partner at disadvantage
• Valuation of equity shares is difficult
100
How to Invest Abroad: Modes
of FDI

Greenfield investment versus acquisition

A greenfield investment is establishing a facility
“starting from the ground up”
• Usually require extended periods of physical construction
and organizational development

Here, a cross-border acquisition may be better
because the physical assets already exist, shorter
time frame and financing exposure
• However, problems with integration, paying too much for
acquisition, post-merger management, and realization of
synergies all exist
101
How to Invest Abroad: Modes
of FDI

Strategic alliances can take several different
forms




First is an exchange of ownership between
two firms
It can be a defensive strategy against a takeover
In addition to exchanging shares, a separate joint
venture can be developed
Another level of cooperation may be a joint marketing
or servicing agreement
102
The FDI Sequence: Foreign Presence and
Foreign Investment
103
Optimal Domestic Portfolio
Construction
104
Internationalizing the Domestic
Portfolio
 If
the investor is allowed to choose among
an internationally diversified set of
securities, the portfolio set of securities
shifts to upward and to the left
 This is called the internationally
diversified portfolio opportunity set
105
The Internationally Diversified
Portfolio Opportunity Set
106
Internationalizing the Domestic
Portfolio
 This
new opportunity set allows the
investor a new choice for portfolio
optimization
 The optimal international portfolio (IP)
allows the investor to maximize return per
unit of risk more so than would be
received with just a domestic portfolio
107
The Gains from International Portfolio
Diversification
108
International Diversification
 Kroenckez
and Schindler[2011]
 Ten Regions: US Australia, Canada,
France, Hong Kong, Japan, the
Netherlands, Singapore, Sweden, and the
UK
 Three Major Asset Classes: Equity,
Government Bond, Real Estate
 27 Years of Monthly Return: 1984-2010
 With and without hedging FX risk.
109
110
111
Road Map
International
Monetary
System
Sourcing
Capital in
Global Markets
International
Financial Risk
Management
Synthesis
Managing
FOREX
Exposure
Foreign
Investment
Decisions
112
China’s Financial System
 Overview
 Decision Making System
 Policy Bank
 Commercial Bank
 China’s
 China’s
Equity Market
Bond Market
113
Growth of China
114
Overview
 Over
the past two decades, financial
sector reform has been lagged behind due
to sensitivity and complexity issues.
 Financial market is featured as being
transitional and innovative.
 90% of the financing is made through
indirect financing controlled by banking
system, with direct financing lacking.
115
Decision Making System of China’s
Financial Sector
 People’s bank of China
 Ministry of finance
 National development and reform
commission
 Ministry of commerce
 China banking regulatory commission
 China securities regulatory commission
 China insurance regulatory commission
116
Policy Banks
 National

Function: Providing long-term financing support for
key projects promoted by government economic
plan, e.g. three gorges, gas transfer, etc.
 China


Development Bank
Import & Export Bank
The institution fully owned by government,
Providing export credit,
 Agricultural

Development Bank
Mainly to provide current fund for
procurement of grain, cotton, oil, etc
117
Commercial Banks

The Big Five national commercial banks
 中国工商银行


中国农业银行


Bank of China
中国建设银行


China Agriculture Bank
中国银行


China Industrial and Commercial Bank
China Construction Bank
交通银行

Bank of Communications
118
China’s Banking System Reform by Phases
o
1984－1994，
o
o
1994－2003，



o
Specialization reform: dual function with division of responsibility
among banks
Reform of State-owned commercial banks
1994,Separation of policy financing and commercial financing
1997, with lessons from Asian financial crisis, formed 4 capital
asset management corporation to deal with bad loans in
commercial banks, to issue special national bond to supplement
capital asset of commercial banks, etc.
2004 - Now，
o
2004, State dominated share holding system reform in
commercial bank.
119
Other Banks
 City



Banks
Formerly credit unions
Beijing Bank
Shanghai Bank, etc.
 Joint-Stock


Banks
Minsheng Bank （民生银行）
Merchants Bank of Zhejiang （浙商银行）
 Post
Savings Bank （邮政储蓄）
120
The Financial System in China

The most salient aspect of the system is the
dominant role of the State. The State owns
controlling stakes in the five largest commercial
banks and 100% of the three policy banks. (See
Table 1.) The State also holds significant equity
stakes in the remaining shareholding
commercial banks and all of the postal savings
banks, and has a heavy influence on the rural
cooperative banks and credit societies
Equity Market in China
 Only
20 years of history, rapidly grow into
a market with more than1300 public
companies.
 Possessing the characteristics of an
emerging and transitional market
 With 6 years of depression, investors’
confidence was hit heavily. Nevertheless,
many blue-chip companies remain.
 Ongoing a reform, aiming at liberalizing
trade of formerly non-tradable stock.
122
Growth of China’s Stock Market
H 股
A 股
B 股
1287
1353
1213
1060
1133
923
825
720
514
287
311
177
53
14
10
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
123
China’s Bond Markets
 Insight
 Size
into Chinese Bond Market
and composition of Chinese Bond Market
 China’s
124
Bond Market Outlook
China’s OTC Market at a
Glance
Indonesia
Hong Kong, China
Singapore
Thailand
Data source: www.bis.org; www.adb.org ; www.chinabond.com.cn
Malaysia
Taipei, China
Mexico
Austria
Sweden
India
Demark
Belgium
Australia
Korea
Holland
Brazil
Canada
UK
Spain
China
Germany
France
Italia
Japan
USA
125
Treasury bond
Corporate bond
(USD billion)
Size of Local Currency Bond Markets
Bond Issuance
 By the end of 2009, the RMB bond issuance reached 8.65 CNY trillion.
 Compared with 2008, the issuance amount grew 22%.
Bond Issuance
100,000.00
100%
80,000.00
71%
66%
80%
79%
54%
60,000.00
60%
53%
35%
32%
40%
40%
22%20%
40,000.00
1%
0%
-11%
20,000.00
-30%
Issuance (CNY billion)
Data Source: www.chinabond.cn
126
Growth Rate (%)
2009
2008
2007
2006
2005
2004
2003
2001
2002
-40%
2000
1999
1998
0.00
-20%
Bond Issuers Profile
 The MOF, central bank and policy banks are the major issuers. The Issuance
of treasury bonds, central bank bills and policy bank bonds are 78% of the total
bond issuance.
ISSURANCE VOLUMES BY BOND TYPE (2009)
Commercial Papers
5.35%
International
institution bonds
0.01%
ABS Mid-term Notes
0.00%
7.98%
Collecting notes
0.01%
Treasury Bonds
18.80%
Corporate Bonds
4.93%
Policy Bank Bonds
13.54%
Commercial Bank
Bonds
3.30%
Treasury Bonds
Commercial Bank Bonds
ABS
International institution bonds
Data Source: www.chinabond.cn
127
Central Bank Bonds
46.08%
Central Bank Bonds
Corporate Bonds
Mid-term Notes
Policy Bank Bonds
Commercial Papers
Collecting notes
Bond Issuance Maturity
 The bond maturity favors shorter than 3 year.
Bond Maturity Profile (2009)
Issuance by Bond Maturity(2009)
40000
35000
30000
25000
20000
15000
10000
5000
0
5%
7%
6%
8%
10%
<1Y
64%
1-3Y
3-5Y
5-7Y
Data Source: www.chinabond.cn
128
7-10Y
>10Y
<1Y
1-3Y
3-5Y
5-7Y
7-10Y
>10Y
Bond Deposit Value
 By the end of 2009, the RMB bond outstanding reached CNY 17.5 trillion, about
52.3% of GDP.
 Treasury bond, central bank bills and policy bank bonds are the main depository bond
type.
Depository Balance by Bond Type (2009)
200,000
1,800
180,000
1,600
160,000
1,400
140,000
1,200
120,000
1,000
100,000
800
80,000
600
60,000
40,000
400
20,000
200
0
0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Data Source: www.chinabond.cn
129
0%
3%
0% 0% 0%
5%
Number under custody
Depository Balance (CNY Billion)
The RMB Bond Depository Balance
3%
6%
33%
26%
24%
Treasury Bonds
Policy Bank Bonds
Corporate Bonds
Mid-term Notes
ABS
others
Central Bank Bonds
Commercial Bank Bonds
Commercial Papers
Collecting notes
International institution bonds
Bond Investors Profile
 Commercial banks are the major investors of RMB bond
RMB Bonds Investores Profile
0%
0%
4%
1%
3%
9%
1%
2%
0%
11%
69%
Special Members
Non-bank Financial institutions
Funds
Exchanges
Commercial Banks
Securuties Companies
Non-financial institutions
Others
Notes: commercial banks include national banks and foreign banks.
Data Source: www.chinabond.cn
130
Credit Cooperative Banks
Insurance Institutions
Individuals
Bond Investors Profile
 Foreign banks’ holdings in China’s bond markets are rising.
Foreign Hondings of RMB Bonds
(USD billion)
157.63
95.79
13.35
2005
117.83
38.63
2006
Data Source: www.chinabond.cn
131
173.78
2007
2008
2009
2010.4
Bond Settlement
 By the end of 2009, the bond settlement of OTC market achieved 122 CNY
trillion.
Bond Settlement
140000
350.00
325.37
300.00
120000
100000
226.59
250.00
250.87
200.00
80000
150.75
60000
159.13
150.00
78.76
40000
42.37
20000
100.00
67.83
64.59
60.50
-15.54
50.00
20.47
0.00
0
-50.00
1998
1999
2000
2001
2002
2003
Settlement (CNY billion)
Data Source: www.chinabond.cn
132
2004
2005
2006
Growth Rate (%)
2007
2008
2009
Bond Settlement
 Central bank bills and policy bank bonds generated the highest bond
settlement values.
Bond Settlement by Bond Type
Bond Settlement by Bond Type (%)
(CNY Trillion)
450
400
350
300
250
200
150
100
50
0
374
0%
Treasuy Bond
401
17%
19%
Central Bank Bills
237
208
Policy Bank Bonds
0
Treasuy Bond Central Bank
Bills
Policy Bank
Bonds
Data Source: www.chinabond.cn
133
Corporate
Bonds
International
Institutuion
Bonds
Corporate Bonds
33%
31%
International Institutuion
Bonds
China’s Bond Market Outlook

The issuance, deposit and settlement values of
corporate bond are expected to grow fast.
COUNTRIES
US
KOREA
MALAYSIA
HONGKONG, CHINA
SIGAPORE
JAPAN
THAILAND
CHINA MAINLAND
PHILIPINES
INDONESIA
134
Ratio of Bonds Outstanding to GDP
Treasury Bond (%)
Corporate Bond (%)
70.41
169.15
52.3
61.6
51.4
42.8
25.6
35.6
48
33.8
169.6
18.9
51.6
13.5
43
9.2
33.4
4.6
15
1.6
Total (%)
239.56
113.9
94.2
61.2
81.8
188.5
65.1
52.2
38
16.6
China’s Bond Market Outlook
Growth Rate by Bond Type
Issuance values
Deposit values
Settlement values
150%
160%
140%
124%
120%
94%
100%
80%
68%
77%
60%
40%
20%
-7% -12%
0%
-20%
21%
18% 13%
Treasuy Bond
Central Bank Bills
-40%
Data Source: www.chinabond.cn
135
-22%
8%
Policy Bank Bonds
Corporate Bonds
China’s Bond Market Outlook
 The
number of non-legal representative
investors are expected to increase.


136
Since 2007, the central bank has permitted supplementary
pension, insurance products, trust units and asset management
plans to open account in the OTC market.
In 2009, the OTC market increased 941 investors, and the
number of increased non-legal representative investors are
525(55.8%).
China’s Bond Market Outlook



137
To allow qualified foreign investors to invest in the Chinese interbank bond market.
To allow qualified foreign institutions to issue RMB bonds in
China, such as the South Korean Government.
To regulate the credit rating system, allowing investors to choose
bond credit rating agencies by voting on
www.chinabond.com.cn.
Doing Business in China
“Doing business in China can be one of the riskiest yet
most rewarding undertakings for the most experienced
multinational corporations right through to companies
venturing abroad. It is not only the world’s most populous
nation with 1.2 billion consumers and one of the fastest
booming economies enjoying double-digit growth rates in
recent years but China is also a society experiencing
breakneck development, an ongoing shift to a market
economy and evolution in the rule of law. The opportunities
are obvious and so are the challenges.”
--Alastair da Costa, Managing Director, Asia, DLA Piper
138
Investing in China
 Import/Export
 Supply
Chain
 Real Estate
 Real Estate Investment Trusts
139
Sourcing Capital in China
 Obtaining
Financing
 Initial Public Offering
 Private Equity
 Venture Capital
140
Housing Crisis and Its Impact
 Subprime
Crisis in 2008
 Europe Sovereign Debt Crisis in 2011
 Why did it happen?
 What can we do about it?
141