International Equity Market pdf.docx

7/27/2019 International Equity Market pdf.docx

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INTERNATIONAL FINANCE

The International Equity Market

Project Submitted by :

Brijesh Gupta, M3214

Shashank Chaubal, M3209Sandeep Gupta, M3216

Shreyas Dicholkar, M3211

Kavita Yadav, M3258

NAVINCHANDTA MEHHTA INSTITUTE OF

TECHNOLOGU AND DEVELOPMENT (2013-14)


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The International Equity Market

Introduction :

International fund raising used to be the domain of multinational companies. MNCs not

only source raw material across the world or sell products at many geographical regions,

they also scout for capital all over the world and raise capital whereever it is cheaper.

However with globalization and increased cross-border capital flows, smaller companies

are also raising capital in the international market. Greater interaction among financial

markets has enabled companies to access global capital market. Big and small companies

are raising both debt and equity capital from the global market. Cross listing of shares

through issuance of depository receipts have become common occurrence. Investors

appetite for foreign company shares have also increased manifold and internationalization

of equity markets across globe is happening at a faster speed.

Though internationalization of equity markets has a broader connotation covering entire

gamut of FDI, portfolio investment by big ticket players like pension funds, hedge funds

and private equity funds.

Even relatively smaller companies are sourcing capital from foreign countries and do not

want to remain restricted to commercial banks and other lenders of home countries as

well as do not want to depend on the domestic equity market. With the globalization of

trade flows, liberalization of restrictive business polices, cross border sourcing of capital

has become hallmark of the day. Just to buttress on this aspect, many Indian companies,

big as well as small ones have tapped international market to raise funds.


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Foreign Institutional Investors (FIIs) :

SEBI defines FIIs as;

An institution established or incorporated outside India which proposes to make

investments in India in securities. Provided that a domestic asset management company or

domestic portfolio manager who manages funds raised or collected or brought from

outside India for investment in India on behalf of a sub-account, shall be deemed to be a

Foreign Institutional Investor."

In short ,FIIs refers to investments made by an individual or an institution of a country in

financial assets and production process of another country. Entities covered by the term FIIs

include; Overseas pension funds, mutual funds,investment trust, asset managementcompany,charitable trusts, charitable societies etc

Investments by FIIs :

Equity Investments(Up to 70% equity and 30% debt)

Securities of the primary and secondary market Units of schemes floated by the Unit Trust of India (UTI) and other domestic

mutual funds

Debt Route (100%)In case of Debt Route the FIIs can invest in the following instruments:

Debentures (Non Convertible Debentures, Partly Convertible Debentures etc.) Bonds Dated government securities Treasury Bills

Foreign Direct Investment (FDI) :

Foreign direct investment (FDI) is a direct investment into production or business in a country by

an individual or company in another country, either by buying a company in the target country or

by expanding operations of an existing business in that country. Foreign direct investment is in

contrast to portfolio investment which is a passive investment in the securities of another country

such as stocks and bonds.


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Broadly, foreign direct investment includes "mergers and acquisitions, building new facilities,

reinvesting profits earned from overseas operations and intra company loans".[1] In a narrow

sense, foreign direct investment refers just to building new facilities. The numerical FDI figures

based on varied definitions are not easily comparable.

As a part of the national accounts of a country, and in regard to the GDP equationY=C+I+G+(X-M), I is investment plus foreign investment, FDI is defined as the net inflows of

investment (inflow minus outflow) to acquire a lasting management interest (10 percent or more

of voting stock) in an enterprise operating in an economy other than that of the investor.[2] FDI

is the sum of equity capital, other long-term capital, and short-term capital as shown the balance

of payments. FDI usually involves participation in management, joint-venture, transfer of

technology and expertise. There are two types of FDI: inward and outward, resulting in a net FDI

inflow (positive or negative) and "stock of foreign direct investment", which is the cumulative

number for a given period. Direct investment excludes investment through purchase of shares.[3]

FDI is one example of international factor movements.

Types of Foreign Direct Investment: An Overview

FDIs can be broadly classified into two types: outward FDIs and inward FDIs. This classification

is based on the types of restrictions imposed, and the various prerequisites required for these

investments. An outward-bound FDI is backed by the government against all types of associated

risks. This form of FDI is subject to tax incentives as well as disincentives of various forms. Risk

coverage provided to the domestic industries and subsidies granted to the local firms stand in the

way of outward FDIs, which are also known as "direct investments abroad." Different economicfactors encourage inward FDIs. These include interest loans, tax breaks, grants, subsidies, and

the removal of restrictions and limitations. Factors detrimental to the growth of FDIs include

necessities of differential performance and limitations related with ownership patterns. Other

categorizations of FDI exist as well.

Vertical Foreign Direct Investment

Vertical Foreign Direct Investment takes place when a multinational corporation owns some

shares of a foreign enterprise, which supplies input for it or uses the output produced by the

MNC.

Horizontal foreign direct investments


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Horizontal foreign direct investments happen when a multinational company carries out a similar

business operation in different nations. Foreign Direct Investment is guided by different motives.

FDIs that are undertaken to strengthen the existing market structure or explore the opportunities

of new markets can be called "market-seeking FDIs." "Resource-seeking FDIs" are aimed atfactors of production which have more operational efficiency than those available in the home

country of the investor. Some foreign direct investments involve the transfer of strategic assets.

FDI activities may also be carried out to ensure optimization of available opportunities and

economies of scale. In this case, the foreign direct investment is termed as "efficiency-seeking."

Benefits of Foreign Direct Investment :

* Growth of capital stock

* Incorporated technologies

* Possibilities to gain managerial and labor skills

* Higher incomes and economic development. (Taxation for public sector)

- Finance education

- Finance health

- Finance infrastructure development, etc.

- Resource -transfer

- Employment

- Balance-of-payment (BOP)

* Import substitution

* Source of export increase

Costs of Foreign Direct Investment :


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* Adverse effects on the BOP

- Capital inflow followed by capital outflow + profits

- Production input importation

* Threat to national sovereignty and autonomy

- Loss of economic independence

Advantages :

Economic development

Foreign direct investment is that it helps in the economic development of the particular country

where the investment is being made. This is especially applicable for the economically

developing countries. During the decade of the 90s foreign direct investment was one of the

major external sources of financing for most of the countries that were growing from an

economic perspective. It has also been observed that foreign direct investment has helped several

countries when they have faced economic hardships. An example of this could be seen in some

countries of the East Asian region. It was observed during the financial problems of 1997-98 that

the amount of foreign direct investment made in these countries was pretty steady. The otherforms of cash inflows in a country like debt flows and portfolio equity had suffered major

setbacks. Similar observations have been made in Latin America in the 1980s and in Mexico in

1994-95.

Transfer of technologies

Foreign direct investment also permits the transfer of technologies. This is done basically in theway of provision of capital inputs. The importance of this factor lies in the fact that this transfer

of technologies cannot be accomplished by way of trading of goods and services as well as

investment of financial resources. It also assists in the promotion of the competition within the

local input market of a country.


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Human capital resources

The countries that get foreign direct investment from another country can also develop the

human capital resources by getting their employees to receive training on the operations of aparticular business. The profits that are generated by the foreign direct investments that are made

in that country can be used for the purpose of making contributions to the revenues of corporate

taxes of the recipient country.

Job opportunity

Foreign direct investment helps in the creation of new jobs in a particular country. It also helps inincreasing the salaries of the workers. This enables them to get access to a better lifestyle and

more facilities in life. It has normally been observed that foreign direct investment allows for the

development of the manufacturing sector of the recipient country. Foreign direct investment can

also bring in advanced technology and skill set in a country. There is also some scope for new

research activities being undertaken.

Income generation

Foreign direct investment assists in increasing the income that is generated through revenues

realized through taxation. It also plays a crucial role in the context of rise in the productivity of

the host countries. In case of countries that make foreign direct investment in other countries this

process has positive impact as well. In case of these countries, their companies get an

opportunity to explore newer markets and thereby generate more income and profits.

Export/Import

It also opens up the export window that allows these countries the opportunity to cash in on their

superior technological resources. It has also been observed that as a result of receiving foreign

direct investment from other countries, it has been possible for the recipient countries to keep

their rates of interest at a lower level.


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It becomes easier for the business entities to borrow finance at lesser rates of interest. The

biggest beneficiaries of these facilities are the small and medium-sized business enterprises.

Foreign direct investment leads to increase in profits within different industries as well as tax

cuts and expanded marketability for singularly differing industries. Often times procurement of

properties, buildings, and labor can be obtained at a fraction of the cost in host countries than

would be the case within the company's home country. While this may seem unfair, it is a good

idea to keep in mind the host countries economy and market. Companies are often forced to

abide by local regulations rather than the regulations of their home country. On the other side of

the coin, the host country benefits due to the increase in jobs it produces in the regional labor

market to which the investment companies reach out to. Often times dying economies can be

revived in the process of becoming a host for certain industries or markets in which that industryor market had not previously been. This is especially the case with third world countries that are

trying to catch up to industrial nations or who need a boost due to changes in regional climates or

in the advent of recovery from the aftermath of civil or world war.

Brief Introduction to ADRs and GDRs

International equity market has developed through cross listing of shares in different

stock exchanges. Cross listing indicates that a company lists its shares in foreign stock

exchanges besides listing its shares in domestic exchanges. For example, investors from

US can invest in Infosys equity shares as Infosys shares are listed in NASDAQ.

Cross listing of shares normally happens through depository receipts (DRs) or registered

shares. Depository receipts can be ADRs (American Depository Receipts) or GDRs

(Global Depository Receipts) or for that matter any country specific depository receipts

can be issued. GDRs are primarily issued and traded in London or Luxembourg stock

exchanges. ADRs by default issued in USD. All most all GDRs are also denominated in

USD. But GDRs can be issued in EURO.


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Similarly like ADRs/GDRs, If a foreign company lists its shares in Chinese Stock

exchange, then these will be known CDRs (Chinese Depository Receipts). A foreign

company can list its IDRs (Indian Depository Receipts) in any Indian stock exchanges.

These depository receipts are negotiable receipts of securities issued by foreign

companies but listed and traded in domestic stock exchanges denominated in the home

currency of the domestic country. Each depository receipt has specific number of

companys shares as underlying. For example, HDFC Bank ADR has three shares

representing one ADR. This ratio is known as DR/Underlying share ratio. There is no

hard and fast rule regarding the number of underlying shares representing one depository

receipt. In a DR, the company declares the dividend in its home currency.This dividend

is converted to the home currency of the DR investor. In other words, the DR investors,

receive the dividend in their home currency. For all practical purpose, these depository

receipts behave like domestic securities.

It is important to understand why foreign company equity shares listed in a

domestic stock exchange is known as depository receipts. When a foreign company listsits

shares in a domestic stock exchange, it cannot directly list its equity shares. Thereasons for so are as follows:

As the equity shares are denominated in home currency of the foreign company, the

domestic investor may not be interested to trade in the issuers home currency. For

example, an investor from UK will not be interested to invest in ICICI Bank shares

denominated in Indian Rupees, even if it is possible to trade ICICI Bank shares at

London Stock Exchange. By doing so, the investor would take foreign currency risk.

Secondly, investors will not be get his/her own grievances redressed by the regulatory

body of its country as the regulatory body may not have the jurisdiction to govern a

foreign company which is registered in a foreign country. If the investors from the

UK agrees to invest in ICICI bank shares listed in Indian stock exchange ( willing


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taking foreign exchange risk), but still can not approach the UK regulator for any

grievance against ICICI bank as the UK regulator may not have any control over

ICICI bank which is listed in India.To circumvent these two important risks, all foreign equity

listing is done through a

depository which is a registered body in the home country of the investor. In fact, the

depository is liable for any misconduct by the foreign company and the regulatory body

of the investor can penalize the depository. The depository ensures that the foreign

company abides by the listing and other regulatory requirements put forwarded by home

country regulators from time to time.

Before issuing DRs, the foreign company has to first appoint depository which is a

registered body in the domestic market. The foreign company issues equity shares to the

depository, which in turn issues depository receipts which are listed and traded in

domestic stock exchange.

For example, Deutsche Bank is the depository bank of Infosys ADR program. It is

important to note that these depository receipts are denominated in the home currency of

investors.For example, Infosys shares are quoted and traded in Indian Rupees in Indian

stock exchanges, but Infosys ADRs are listed and traded in US Dollar in US stock

exchanges.

In context to ADRs, many-a-times, we come across term American depository shares

(ADSs). There is minor difference between ADRs and ADSs. The entire issue is called

an American Depositary Receipt (ADR) and the individual shares are known as ADSs.

Same is the case of GDRs and GDSs, or for that matter any depository receipt program

But before we proceed to understand more about these ADRs/GDRs, let us understand

little more on why companies issue these depository receipts first of all or for that matter

why investors would prefer investing in ADR.


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Benefits/Costs of Depository Receipt to Issuers and Investors

As we know, unless both the issuer company and investors benefit from

issuance/investment in a securities, no new type of securities will be ever issued. The

security must have features so that it is a win-win proposition for the issuer company and

the investors. In this section, we briefly highlight the benefits to both parties.

Benefits to Issuers :

Companies are able to raise capital denominated in USD and that to huge amount

of capital which may be difficult to raise from the issuers home country.

By issuing securities in a new market, it is able to expand the investor base.

When a foreign companys share listed in a domestic market, analysts in the

domestic market start analyzing the company, its product, its market share etc.,

thus indirectly helping in advertising the company.

When a foreign companys shares are listed in a domestic exchange and the

foreign company wants to acquire another domestic company, then share swap

can be an option for the foreign company. In fact many Indian companies having

ADRs have swapped ADRs to acquire US based companies. The US investors

would have no problem adding ADR to their portfolio. Without the ADRs,

swapping domestic shares are not feasible as US investors may not be interested

to hold shares of foreign company which is listed in foreign companys home

country. Precisely for this reason, ADRs are known as M& A Currency. The

report prepared by Citigroup titled ADRs in the M&A environment (available at

http://wwss.citissb.com/adr/pdf/ma0701.pdf) highlights the benefit of ADRs.

This report mentions that If a non-US company wants to make a US acquisition


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using equity, ADRs offer the most direct method. ADRs trade like US

instruments. They can be held by investors prohibited from entering foreign

markets.

Benefits to the Investors:

Investors are able to invest in foreign company shares without taking foreign

exchange exposure.

Investors get the benefit of portfolio diversification without worrying to operate in

foreign market. The article ADRs in the M&A environment (available at

http://wwss.citissb.com/adr/pdf/ma0701.pdf) succinctly summarizes the

benefits of ADRs. US Investors see the ADR as a great way to expand their

portfolio geographically without having the burden of having foreign custody

accounts. Since ADRs are reconciled to US Gaap, they trade, clear, and settle in

accordance with well understood US market practices. They look and feel like

domestic US securities, and maybe thats why 90 percent of ADR trading

involves US buyers and US sellers. Furthermore, those transactions cost the same

as trading US securities. This is significant since it is estimated that the cost for

US investors to clear and settle trades in Europe is 20 times higher than the US.

GDRGlobal Depositary Receipts :

A negotiable certificate held in the bank of one country representing a specific number of

shares of a stock traded on an exchange of another country.

To raise money in more than one market, some corporations use GDRs to sell their stock on

markets in countries other than the one where they have their headquarters.

Objective of GDR:

Enable investors in diversifying their funds in international securities.


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For the Investor:

Buying into a GDR immediately turns an investors portfolio into a global one. Investors gain the

benefits of diversification, while trading in their own market under familiar settlement and

clearance conditions. More importantly, GDR investors will be able to reap the benefits of these

usually higher-risk, higher-return equities, without having to endure the added risks of goingdirectly into foreign markets, which may pose lack of transparency or instability resulting from

changing regulatory procedures. It is important to remember that an investor will still bear some

foreign-exchange risk, stemming from uncertainties in emerging economies and societies. On the

other hand, the investor can also benefit from competitive rates the U.S. dollar and euro have to

most foreign currencies.

Procedure of making ADR/GDR:

Indian companies can raise foreign currency resources abroad through the issue of ADRs/

GDRs, in accordance with the Scheme for issue of Foreign Currency Convertible Bonds andOrdinary Shares (Through Depository Receipt Mechanism) Scheme, 1993 and guidelines issued

by the Government of India thereunder from time to time.

A company can issue ADRs / GDRs, if it is eligible to issue shares to persons resident

outside India under the FDI Scheme. However, an Indian listed company, which is not eligible to

raise funds from the Indian Capital Market including a company which has been restrained from

accessing the securities market by the Securities and Exchange Board of India (SEBI) will not be

eligible to issue ADRs/GDRs.

Unlisted companies, which have not yet accessed the ADR/GDR route for raising capital

in the international market, would require prior or simultaneous listing in the domestic market,

while seeking to issue such overseas instruments. Unlisted companies, which have already issued

ADRs/GDRs in the international market, have to list in the domestic market on making profit or

within three years of such issue of ADRs/GDRs, whichever is earlier.

After the issue of ADRs/GDRs, the company has to file a return in Form DR as indicated

in the RBI Notification No. FEMA.20/ 2000-RB dated May 3, 2000, as amended from time to

time. The company is also required to file a quarterly return in Form DR- Quarterly as indicated

in the RBI Notification ibid.

There are no end-use restrictions on GDR/ADR issue proceeds, except for an express ban

on investment in real estate and stock markets.

Erstwhile OCBs which are not eligible to invest in India and entities prohibited to buy,

sell or deal in securities by SEBI will not be eligible to subscribe to ADRs / GDRs issued by

Indian companies.


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The pricing of ADR / GDR issues including sponsored ADRs / GDRs should be made at

a price determined under the provisions of the Scheme of issue of Foreign Currency Convertible

Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993 and

guidelines issued by the Government of India and directions issued by the Reserve Bank, from

time to time.

International Capiatl Flows :

International capital flows are the financial side of international trade.1 When someone imports a

good or service, the buyer (the importer) gives the seller (the exporter) a monetary payment, just

as in domestic transactions. If total exports were equal to total imports, these monetary

transactions would balance at net zero: people in the country would receive as much in financial

flows as they paid out in financial flows. But generally the trade balance is not zero. The most

general description of a countrys balance of trade, covering its trade in goods and services,

income receipts, and transfers, is called its current account balance. If the country has a surplus

or deficit on its current account, there is an offsetting net financial flow consisting of currency,

securities, or other real property ownership claims. This net financial flow is called its capital

account balance.

When a countrys imports exceed its exports, it has a current account deficit. Its foreign trading

partners who hold net monetary claims can continue to hold their claims as monetary deposits or

currency, or they can use the money to buy other financial assets, real property, or equities

(stocks) in the trade-deficit country. Net capital flows comprise the sum of these monetary,

financial, real property, and equity claims. Capital flows move in the opposite direction to the

goods and services trade claims that give rise to them. Thus, a country with a current account

deficit necessarily has a capital account surplus. In balance-of-payments accounting terms, the

current-account balance, which is the total balance of internationally traded goods and services,

is just offset by the capital-account balance, which is the total balance of claims that domestic

investors and foreign investors have acquired in newly invested financial, real property, and

equity assets in each others countries. While all the above statements are true by definition of

the accounting terms, the data on international trade and financial flows are generally riddled

with errors, generally because of undercounting. Therefore, the international capital and trade

data contain a balancing error term called net errors and omissions.

Because the capital account is the mirror image of the current account, one might expect total

recorded world tradeexports plus imports summed over all countriesto equal financial

flowspayments plus receipts. But in fact, during 19962001, the former was $17.3 trillion,

more than three times the latter, at $5.0 trillion.2 There are three explanations for this. First,

many financial transactions between international financial institutions are cleared by netting

daily offsetting transactions. For example, if on a particular day, U.S. banks have claims on


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French banks for $10 million and French banks have claims on U.S. banks for $12 million, the

transactions will be cleared through their central banks with a recorded net flow of only $2

million from the United States to France even though $22 million of exports was financed.

Second, since the 1970s, there have been sustained and unexplained balance-of-payments

discrepancies in both trade and financial flows; part of these balance-of-payments anomalies is

almost certainly due to unrecorded capital flows. Third, a huge share of export and import trade

is intrafirm transactions; that is, flows of goods, material, or semifinished parts (especially

automobiles and other nonelectronic machinery) between parent companies and their

subsidiaries. Compensation for such trade is accomplished with accounting debits and credits

within the firms books and does not require actual financial flows. Although data on such

intrafirm transactions are not generally available for all industrial countries, intrafirm trade for

the United States in recent years accounts for 3040 percent of exports and 3545 percent of

imports.3

The bulk of capital flows are transactions between the richest nations. In 2003, of the more than

$6.4 trillion in gross financial transactions, about $5.4 trillion (84 percent) involved the 24

industrial countries and almost $1.0 trillion (15 percent) involved the 162 less-developed

countries (LDCs) or economic territories, with the rest, less than 1 percent, accounted for by

international organizations.4 The shares of both industrial nations and the international

organizations have been receding from their highs in 1998: 90 percent for industrial nations and

5 percent for the international organizations. In that year the combination of the Russian debt

default and ruble devaluation, the south Asia financial crisis, and the lingering uncertainty about

financial consequences of the return of Hong Kong to Chinese sovereignty in July 1997 drove

the LDC share down to 5 percent of world capital flows.5 In the more tranquil five years

following these crises, 19992003, LDC financial transactions involving mainland China and

Hong Kong averaged 28 percent of the LDC total, and adding Taiwan, Singapore, and Korea

brings the share to 53 percent of the developing-country transactions. Of the remaining forty-

seven percentage points of developing-country transactions, Europe (primarily Russia, Turkey,

Poland, and the Czech Republic) and the Western Hemisphere (primarily Mexico, Brazil, and

Chile) each accounted for about sixteen percentage points, with the Middle East and Africa

combining for the remaining sixteen percentage points.

International Shocks :In economics, a shock is an unexpected or unpredictable event that affects an economy, either

positively or negatively. Technically, it refers to an unpredictable change in exogenous factors

that is, factors unexplained by economicswhich may have an impact on endogenous economic

variables.


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The response of economic variables, like output and employment, at the time of the shock and at

subsequent times, is called an impulse response function.

Global shocks :

A significant problem resulting from globalisation is the increased risk to national economiesfrom shocks over which they have little control. Globalisation means that economies are

increasingly interconnected, and interdependent, and while this generates long term gains in

terms of trade, growth and jobs, it also presents economies with risks and challenges.

One risk is that a shock originating in one part of the world, or in one industry or market, can

quickly ripple across a country, a region, or the whole global economy, leaving economic

turmoil in its wake. By their nature, shocks are often unexpected, but policies can be adopted

which help to reduce the impact of shocks.

Types of shock:

Temporary shocks, such as a terrorist attack, or a one-off change in a commodity price, like a

rise in wheat prices, which quickly return to the 'normal', long run trend.

Permanent shocks, such as an oil shock, which permanently alters the market for motor vehicles.

Some economists argue that the financial crisis of 2008-09, and the resultant impact on the motor

industry, will kick start a more carbon neutral approach to vehicle design.

Policy induced shocks, such as reducing interest rates or increasing the money supply tooquickly, creating an inflationary shock.

Asymmetric shocks, which are those affecting one region or one industry more severely than

another. For example, the collapse of the Argentinean peso on the 1990s affected Spain more

than the rest of Europe.

Symmetric shocks, which are shocks which affect all regions or industries in the same way.

Financial shocks, which are those starting in the financial markets, such as a sudden change in

the exchange rate, or the collapse of a major credit bank. See also: Banking crisis.

Supply side shocks, which may be related to costs, such as a sudden increase in commodity

prices, or related to changes in physical supply, such as labour strikes, or crop failures.

Demand side shocks, which are sudden changes affecting aggregate demand (AD), such as a

collapse in consumer confidence leading to a fall in household spending, or a sudden fall in

house prices creating a negative wealth effect.

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International Equity Market pdf.docx