CHAPTER 13 INTERNATIONAL EQUITY MARKETS
ANSWERS & SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS
QUESTIONS
1. Exhibit 13.11 presents a listing of major national stock market indexes as displayed daily in
the print edition of the Financial Times. At www.ft.com you can find an online tracking of these
national stock market indexes that shows performance over the past day, month, and year. Go
to this website and compare the performance for several stock market indexes from various
regions of the world. How does the performance compare? What do you think accounts for
differences?
Answer: This question is designed to provide an intuitive understanding of the benefits from
international diversification of equity portfolios. Over different time periods, different market
forces will affect each national market in unique ways. Some markets will have yielded a
2. As an investor, what factors would you consider before investing in the emerging stock
market of a developing country?
Answer: An investor in emerging market stocks needs 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 the depth of the market is the concentration ratio of a country’s stock
market. The concentration ratio frequently is calculated to show the market value of the ten
largest stocks traded as a fraction of the total market capitalization of all equities traded. The
higher the concentration ratio, the less deep is the market. That is, most value is concentrated
in only a few companies. While this does not necessarily imply that the largest stocks in the
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
4. Discuss any benefits you can think of 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: 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.
Additionally, a company may cross-list its shares on foreign exchanges to broaden its investor
5. Why might it be easier for an investor desiring to diversify his portfolio internationally to buy
depository receipts rather than the actual shares of the company?
Answer: A depository receipt can be purchased on the investor’s domestic exchange. It
represents a package of the underlying foreign security that is priced in the investor’s local
currency and in a trading range that is typical for the investor’s marketplace. The investor can
6. Why do you think the empirical studies about factors affecting equity returns basically
showed that domestic factors were more important than international factors, and, secondly, that
industrial membership of a firm was of little importance in forecasting the international
correlation structure of a set of international stocks?
Answer: While national security markets have become more integrated in recent years, there is
still a tremendous amount of segmentation that brings about the benefit to be derived from
international diversification of financial assets. Monetary and fiscal policies differ among
countries because of different economic circumstances. The economic policies of a country
PROBLEMS
1. On the Tokyo Stock Exchange, Honda Motor Company stock closed at ¥3,945 per share on
Thursday, April 11, 2013. Honda trades as and ADR on the NYSE. One underlying Honda
share equals one ADR. On April 11, 2013, the ¥/$ spot exchange rate was ¥99.8270/$1.00.
a. At this exchange rate, what is the no-arbitrage U.S. dollar price of one ADR?
b. By comparison, Honda ADRs traded at $39.97. Do you think an arbitrage opportunity exists?
Solution:
b. It is unlikely that an arbitrage opportunity exists after transaction costs. Additionally the slight
difference in prices is likely accounted for by a difference in information contained in prices since
2. If Honda ADRs were trading at $44 when the underlying shares were trading in Tokyo at
¥3,945, what could you do to earn a trading profit? Use the information in problem 1, above, to
help you and assume that transaction costs are negligible.
Solution: As the solution to problem 1 shows, the no-arbitrage ADR U.S. dollar price is $39.52.
If Honda ADRs were trading at $44, a wise investor might sell short the relatively overvalued
MINI CASE: SAN PICO’S NEW STOCK EXCHANGE
San Pico is a rapidly growing Latin American developing country. The country is blessed
with miles of scenic beaches that have attracted tourists by the thousands in recent years to
new resort hotels financed by joint ventures of San Pico businessmen and moneymen from the
Middle East, Japan, and the United States. Additionally, San Pico has good natural harbors that
are conducive for receiving imported merchandise from abroad and exporting merchandise
produced in San Pico and other surrounding countries that lack access to the sea. Because of
these advantages, many new businesses are being started in San Pico.
Presently, stock is traded in a cramped building in La Cobijio, the nation’s capital.
Admittedly, the San Pico Stock Exchange system is rather archaic. Twice a day an official of the
exchange will call out the name of each of the 43 companies whose stock trades on the
exchange. Brokers wanting to buy or sell shares for their clients then attempt to make a trade
with one another. This crowd trading system has worked well for over one hundred years, but
the government desires to replace it with a new modern system that will allow greater and more
frequent opportunities for trading in each company, and will allow for trading the shares of the
many new start-up companies that are expected to trade in the secondary market. Additionally,
the government administration is rapidly privatizing many state-owned businesses in an attempt
to foster their efficiency, obtain foreign exchange from the sale, and convert the country to a
more capitalist economy. The government believes that it could conduct this privatization faster
and perhaps at more attractive prices if it had a modern stock exchange facility where the
shares of the newly privatized companies will eventually trade.
You are an expert in the operation of secondary stock markets and have been retained as a
consultant to the San Pico Stock Exchange to offer your expertise in modernizing the stock
market. What would you advise?
Suggested Solution to San Pico’s New Stock Exchange
Most new and renovated stock exchanges are being established these days as either a
partially or fully automated trading system. A fully automated system is especially beneficial for
a small to medium size country in which there is only moderate trading in most issues. Such a
system that deserves special note is the continuous National Integrated Market system of New
Zealand. This system is fully computerized and does not require a physical structure.