CHAPTER TWENTYFIVE

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CHAPTER TWENTY-FIVE

• INTERNATIONAL INVESTING

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THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL
MARKET PORTFOLIO

• GLOBAL DISTRIBUTION OF CAPITAL
• (by market in trillions of US)
• Non-U.S. Bond Equity Markets 25
• Total World Portfolio 49.1
• Fixed Income securities 25.9

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THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL
MARKET PORTFOLIO

• GLOBAL DISTRIBUTION OF CAPITAL
• (by country in trillions of US)
• Largest Market for common stock U.S.
• U.S Japanese Assets as Total 63.4
• U.S.,Japan, Germany,UK, France 82.9

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THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL
MARKET PORTFOLIO

• GLOBAL EQUITY INDICES
• MOST CLOSELY WATCHED
• FTSE100
• NIKKEI225
• TSE 300

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THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL
MARKET PORTFOLIO

• INTERNATIONAL
• EAFE (Morgan Stanley)
• IFC (International Finance Corporation)

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THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL
MARKET PORTFOLIO

• EMERGING MARKETS
• COMMON FEATURES
• securities improved political and economic
  stability
• available to foreign ownership
• convertible currency
• relatively low level of per capita GDP

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THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL
MARKET PORTFOLIO

• EMERGING MARKET INDICES
• Morgan Stanley
• IFC Emerging Market Index, national

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RISK AND RETURN FROM FOREIGN INVESTING

• THE ADDITIONAL RISKS
• POLITICAL RISK
• DEFINITION refers to the uncertainty about the
  ability of an investor to convert foreign
  currency into local

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RISK AND RETURN FROM FOREIGN INVESTING

• THE ADDITIONAL RISKS
• EXCHANGE RATE RISK
• DEFINITION refers to uncertainty about the rate
  at which a foreign currency can be exchanged for
  the investors local currency in the future

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RISK AND RETURN FROM FOREIGN INVESTING

• MANAGING EXCHANGE RATE RISK
• involves using hedge instruments such as
• currency forward contracts
• currency options
• currency futures

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RISK AND RETURN FROM FOREIGN INVESTING

• MANAGING EXCHANGE RATE RISK
• TWO APPROACHES
• passive currency management

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RISK AND RETURN FROM FOREIGN INVESTING

• MANAGING EXCHANGE RATE RISK
• TWO APPROACHES
• active currency management

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RISK AND RETURN FROM FOREIGN INVESTING

• passive currency management
• involves a strategy of permanently controlling a
  portfolios exposure to risk

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RISK AND RETURN FROM FOREIGN INVESTING

• active currency management
• involves a strategy of frequently changing
  currency exposures to take advantage of perceived
  short-run mispricings

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FOREIGN AND DOMESTIC RETURNS

• THE DOMESTIC RETURN
• FORMULA

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FOREIGN AND DOMESTIC RETURNS

• THE FOREIGN RETURN
• FORMULA

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FOREIGN AND DOMESTIC RETURNS

• FOREIGN INVESTMENT
• Two Parts
• the investment in the countrys firm(s)
• the currency exposure

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FOREIGN AND DOMESTIC RETURNS

• Calculating the return on foreign currency

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FOREIGN AND DOMESTIC RETURNS

• we know
• and

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FOREIGN AND DOMESTIC RETURNS

• Calculating the return on foreign currency
• the return on a foreign security ( rF ) can be
  estimated by summing the domestic with the
  currency returns

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EXPECTED RETURNS

• ON A FOREIGN SECURITY
• FORMULA
• If expected return differential exists, interest
  rate parity equates the two rates

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EXPECTED RETURNS

• ON A FOREIGN SECURITY An Example
• Assume an investor can buy either a 5 U.S.
  Treasury bond or a 7 German bond, which gives a
  better return?
• If the German mark is expected to depreciate
  by 2 against the U.S., neither bond offers a
  better return

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FOREIGN AND DOMESTIC RISK

• Calculating Portfolio Risk
• Formula
• where
• sF the risk of the foreign portfolio
• sD the risk of the foreign stock
• sC the risk of the foreign currency
• rDC the correlation between the
  currency change and the asset returns

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FOREIGN AND DOMESTIC RISK

• PORTFOLIO RISK
• the smaller the value of the correlation
  coefficient, the lower the foreign portfolio risk

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• END OF CHAPTER 25