what is emerging market

Global Capital Market – Lecture 1W Capital Market Theories Emerging Market Finance CAU MBA CAU Bruce Wonil Lee, Ph.D, & CFA What is Emerging Market? March, 2015 What defines an Emerging Market?  In 1981, IFC promoted 1 st mutual fund investing in “developing countries” which were not emerged yet.  These countries do not have matured equity and bond markets, currency markets and sometimes even not industrialized  Developing countries are emerging markets who are growing economically but markets are remaining infancy  Nowadays, Brazil, Russia, India, China, Turkey, Chile, Columbia, Indonesia, etc. are generally considered as EM  EM is not stable in the short-run and often exposed to “Contagion Effect” EM have been major source of global growth  Historically, EM have been growing fast such as the US in 1800s, Japan in 1960-80s, China in 2000, etc.  EM tends to have long term population growth so abundant labor supply and tends to have less debt compared with developed markets  EM are newly industrializing center to produce less sophisticated commodities for developed markets  In the short run, EM are not stable financially but growing fast in the long term  EM are less correlated with developed markets – good diversification EM tends to have economic crisis  EM are not stable. Many EM experienced economic crisis for the past 50 years.  South east Asian Countries such as Thailand, Indonesia, Malaysia, Philippines, even Korea in 1997. So called Asian Currency Crisis.  Eastern European Countries such as Hungary, Turkey, Ukraine, Bulgaria, Poland, Russia, etc.  South American Countries such as Argentina, Brazil, Mexico, Honduras, etc.  These crisis stems from many causes such as foreign exchange issue, default risk issues, and spilled over contagion effects, etc. Frontier Emerging (Pre-emerging) Markets  Lately, countries in between underdeveloped and emerging markets are defined as Frontier Emerging Markets  Less advanced capital markets from the developing world. Countries with investable stock markets that are less established than those in emerging markets.  These markets tends to have political instability, poor liquidity, inadequate regulation, substandard financial reporting and large currency fluctuations.  South Africa, Qatar, UAE, Vietnam, Bangladesh, Mongolia, Phillipines, etc. Multi-national Companies and EM  Multinational companies are expanding their business to EM and frontier EM for growth potential.  Developed market investors who have high risk high return profile tends to invest EM  EM investing has been a trend since 1980s as investors start to seek higher return with better diversified risk  Typically, doing business in EM has obstacles for multinational firms – inadequate market data, lack of information, poor visibility on regulatory environment, political uncertainty, lack of reliable market research, language and cultural differences, etc. Capital Market Theories 1863, NYSE 1959 , Markovitz Model 1964, CAPM 1974, ERISA 1997, Asian Currency Crisis 2002, Nasdaq Bubble 1987, Black Monday 1962, DDM 1973, Black & Scholes Model 2007, US Sub Prime Equilibrium Price (Force of Demand = Force of Supply) Equilibrium Quantity Equilibrium Price P 1 P 2 Q 1 Q 2 Excess supply Excess demand Price Quantity Milestones in the Development of Portfolio and Capital Market Theory  Portfolio Theory – Markowitz, Harry (1959): Portfolio Selection - Efficient Diversification of Investments, New York, John Wiley & Sons  Capital Asset Pricing Model – Sharpe, William F. (1964): Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk, Journal of Finance 19, September  Efficient Market Hypothesis – Fama, Eugene (1970): Efficient Capital Market, Journal of Finance 25, May 1970  Arbitrage Pricing Theory – Ross, Stephen (1976): The Arbitrage Theory of Capital Asset Pricing, Journal of Economic Theory 13, December  Option Pricing Model – Ross, Stephen and Mark Rubinstein (1979): Option Pricing: A Simplified Approach, Journal of Financial Economics, September Step of Investment Decision I. Choose what kind of asset you will invest to. (real estate, equity and etc.) II. Research expected rate of return and risk. Result: group of dots Risk E(σ p ) Expected rate of return E(R p ) [...]... If we can find out how risky an asset is, it would be possible to find whether the asset is overpriced or under priced => CML!!! CML : The Capital Market Line Expected rate of return E(Rp) Under priced A B Over priced Risk-free rate of return Risk E(σp) APM : Arbitrage Pricing Model CAPM assumed that there is only one risk factor; the Market Risk Is it possible? The Market Risk is just one of them we... return for every given level of risk, or the maximum risk for every given level of return Risk E(σp) CAPM: Capital Asset Pricing Model Expected rate of return E(Rp) M (Ideal portfolio) Risk Free Rate Risk E(σp) Implication of CAPM β is the Key Factor  The Equation: of CAPM!!! E(Ri)= Rf + βi {E(Rm)-Rf}  CAPM emphasizes the only one risk factor (the market risk)  The market portfolio plays a central... the first node is the value of the option The Gap between Theories and Practices  Global Capital Market has more than 200 years of history but theories were at most 60 years old  These theories are based on developed markets which often cannot explain emerging markets  Practices in the market cannot be fully explained by the theories which are only tools to help our understanding what is happening... happening the actual Market  Contemporary issues in the recent Global Capital Market cannot be fully explained by the Theories – Private Equity Fund: Lone Star, KKR, Blackstone, etc – Hedge Fund: Millennium, Farallon Capital, Cerberus Capital, etc – Shareholder Activism, Corporate Governance: CaLPERs, Karl Ichan, etc – Sovereign Fund: GIC, KIC, Dubai Gov, etc – Pension Fund – Emerging markets Disclaimer ... is based on sources believed by us to be reliable, but is not guaranteed and we do not warrant nor do we accept liability as to adequacy, accuracy, reliability or completeness of such information obtained from or based on external sources The information is given on the understanding that any person who acts upon it or otherwise changes his or her position in reliance thereon does so entirely at his... thereon does so entirely at his or her own risk without liability on our part This is not an offer to buy or sell or a solicitation or incitement of offer to buy or sell any securities referred to herein It should also be appreciated that under certain circumstances the redemption of units/shares may be suspended Investment involves risk Past performance is not indicative of future performance Please... we can imagine There are more! The Equation: E(Ri)= Rf + βi {E(Rm)-Rf} E(Ri)= Rf+ βF1 {E(RF1)-Rf} + βF2{E(RF2)-Rf} + … + + βFK {E(RKF)-Rf}  APT model can have multiple sources of risk  The APT does not tell what the risk factors are, so we are forced to choose those economic factors that we think might be important  APT holds for all diversified portfolios and should hold for most individual securities . Capital Market – Lecture 1W Capital Market Theories Emerging Market Finance CAU MBA CAU Bruce Wonil Lee, Ph.D, & CFA What is Emerging Market? March, 2015 What defines an Emerging Market? .  These crisis stems from many causes such as foreign exchange issue, default risk issues, and spilled over contagion effects, etc. Frontier Emerging (Pre -emerging) Markets  Lately,. and emerging markets are defined as Frontier Emerging Markets  Less advanced capital markets from the developing world. Countries with investable stock markets that are less established