In this class, we consider the development of financial markets in transition and developing countries and examine the difference between developed and emerging financial markets.

Assignment Sheet
Emerging Markets Finance

Class #5, Thursday, October 27, 2005

Topic: Emerging Financial Markets

Case: China's Emerging Financial Markets, UVA-F-1393.

File: chnstk-assignment-v.2.xls

Assignment Questions:

A. Why were interest rates in China lower than the prevailing interest rates in the world financial market?

B. Imagine that you are the minister of finance in China. Suppose that you want to raise equity funds for state-owned enterprises by issuing SOE ownership shares (i.e., SOE stocks) to domestic and foreign investors. To be concrete, suppose that domestic investors are willing to pay a price of

P_A = 10 - S_A

(1)

for S_A shares of the SOE stock, while foreign investors are willing to pay a price of

P_B = 3 - 0.1 S_B

(2)

for S_B shares of the SOE stock. These relationships are also presented in the accompanying excel file in numerical and graphical formats.

Suppose that the opportunity cost of each incremental unit of share capital in the SOEs is 2 RMB. The economic profits or net revenues that you can earn from selling ownership shares to domestic investors are simply

$\begin{displaymath}\Pi_A = (P_A - 2)S_A \quad \quad \mbox{and} \quad \quad \Pi_B =$

(3)

1.: If you want to maximize the net revenues from selling shares, how many shares would you sell to domestic investors? How many share would you sell to foreign investors. What would be the price that domestic investors pay? What would be the price that foreign investors pay?
2.: If the prices that domestic and foreign investors pay are different, what would you do to prevent arbitrage?
3.: Identify the main differences in the prices that domestic and foreign investors are willing to pay for the SOE shares. (Hint: Compare equations (1) and (2).) Why would domestic and foreign investors value the same ownership shares differently?

C. What should Tom Lee recommend to his client?

D. Compare the financial market in China with that in the US. What the main differences? Is China unique?

E. What do these differences imply for valuing stocks and investment projects in China? In other emerging markets?