2008_ERB_IM_CHAP_08.DOC

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Department
Business Administration
Course
Business Administration 4440Q/R/S/T
Professor
Brad Bisho
Semester
Spring

Description
CHAPTER 8 INTERNATIONAL EQUITY MARKETS SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS QUESTIONS 1. Get a current copy of The Economist. The Economic and Financial Indicators on the last page report Stock Market indices for many countries. Examine the 12-month changes for the various national indexes. How do the changes from the most recent issue of The Economist compare with the 12-month changes from the sample provided in the textbook as Exhibit 8.5? Are the same national indexes positive and negative in both listings? Discuss your findings. Answer: This question is designed to provide an intuitive understanding of the benefits from international diversification of equity portfolios. The Economist is a convenient source for Canadian students. It is unlikely that students will find many, if any, national market indexes that have 12- month returns that are even close to the same level as in Exhibit 8.5. Over different time periods, time-specific and country- specific market forces affect each national market in unique ways. Likewise, of course, exchange rates differ over time and affect returns recorded to a common currency (say the US dollar.) Some markets that previously yielded a positive return will now show a negative return, and vice versa. Similarly, some markets that had yielded a large positive (negative) return may now show only a small positive (negative) return. 2. As an investor, what factors would you consider before investing in an emerging stock market? Answer: An investor in emerging market stocks ought to be concerned with the depth of the market and the market’s liquidity. Depth of the market refers to the opportunities to invest in the country. One measure of depth is the concentration ratio of a country’s stock market. The concentration ratio is the market value of, for example, the ten largest stocks traded as a fraction of total market capitalization. The higher the concentration ratio, the shallower the market, i.e., most value is concentrated in only a few companies. While this does not necessarily imply that the largest stocks in the emerging market are not good investments, it does however suggest there are few opportunities for investment in that country and that proper diversification within the country may be difficult. In terms of liquidity, an investor would be wise to examine the market turnover ratio of the country’s stock market. High market turnover suggests IM-8 that the market is liquid, or that there are opportunities for purchasing or selling the stock quickly at close to the current market price. This is important because liquidity means you can get in or out of a stock position quickly without spending more than you intended on purchase or receiving less than you expected on sale. Exhibit 8.3 presents the Turnover Ratio in equity markets in 8 industrial nations over the past 10 years. The consistently rising turnover is indicative of increasing liquidity in these well-developed markets. 3. Compare and contrast the various types of secondary market trading structures. Answer: There are two basic types of secondary market trading structures: dealer and agency. In a dealer market, the dealer serves as market maker for the security, holding an inventory of the security. The dealer buys at his bid price and sells at his asked price from this inventory. All public trades go through the dealer. In an agency market, public trades go through the agent who matches it with another public trade. Both dealer and agency markets can be continuous trade markets, but non-continuous markets tend to be only agency markets. Over-the-counter trading, specialist markets, and automated markets are types of continuous market trading systems. Call markets and crowd trading are each types of non-continuous trading market systems. Continuous trading systems are desirable for actively traded issues, whereas call markets and crowd trading offer advantages for smaller markets with many thinly traded issues because they mitigate the possibility of sparse order flow over short time periods. 4. Discuss any benefits for a company to (a) cross-list its equity shares on more than one national exchange, and (b) to source new equity capital from foreign investors as well as domestic investors. Answer: Cross-listing shares on foreign markets is motivated by the prospect of greater, broader demand for the stock which could raise the price of the stock and lower the firm’s cost of equity capital. A MNC that has a product market presence or manufacturing facilities in several countries may cross-list its shares on the exchanges of these same countries because there is typically investor demand for the shares of companies that are known within a country. Cross-listing may improve the market liquidity of the company’s stock, another favourable consequence. A broader investor base may also mitigate the possibility
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