CH 10 - 7 Investing in emerging markets

Question 1

1. Definition and Key Characteristics of emerging markets

Answer 1

Emerging Markets: Stock markets in developing economies (e.g., Brazil, China, Mexico, Singapore).

Attractions: High expected returns due to rapid industrialization.

Risks: Markets are volatile and risky.

Question 2

2. Factors to Consider Before Investing in emerging markets

Answer 2

1. Current market valuation: Potential to buy undervalued assets.
2. Economic growth rate: High growth rates in developing economies.
3. Currency stability and strength: Volatile currencies pose risks.
4. Marketability: Stocks may have low liquidity.
5. Political stability: Risk of unstable governments impacting returns.
6. Market regulation: Often less regulated than developed markets.
7. Restrictions on foreign investment: Limits on ownership by foreigners.
8. Range of companies: Limited industries compared to developed markets.
9. Communication problems: Language barriers, time zones, and data presentation.
10. Availability and quality of information: Poorer quality than in developed markets.

Question 3

3. Attractions of Emerging Markets

Answer 3

Current Market Valuation:
* Inefficient markets: Potential to buy cheaply due to pricing anomalies.
* Example: Perceived riskiness of Manila vs. London leads to lower demand and prices in Manila.

Rapid Economic Growth:
* Developing economies grow faster than developed ones, offering higher returns.
* Example: Growth rates exceeding 6% per year in emerging markets.

Better Diversification:
* Economies of smaller countries are less interdependent with major powers.
* Provides exposure to industries unavailable domestically.

Question 4

4. Drawbacks of Emerging Markets

Answer 4

Volatility:
* Large capital flows can make markets and currencies highly volatile.
* Example: Asian market crash of 1997.

Marketability:
* Stocks are less liquid and harder to sell.

Political Stability:
* Unstable governments can increase return volatility.

Market Regulation:
* Poorly regulated markets lead to risks like insider trading and fraud.

Restrictions on Foreign Investment:
* Barriers to ownership and repatriation of funds.

Communication Problems:
* Issues include language barriers, time zones, and poor-quality information.

Question 5

5. Anomalous Pricing in Emerging Markets

Answer 5

Reasons for More Pricing Anomalies:
* Fewer buyers/sellers lead to inefficient price setting.
* High dealing costs discourage active trading.
* Less sophisticated investment analysts and investors.
* Inferior quality of information available to investors.

Impact on Investors:
* Good for well-informed or lucky investors who can exploit anomalies.
* Bad for less-informed investors who face higher risks.