Title: INTERNATIONAL PORTFOLIO INVESTMENT
1CHAPTER 19
- INTERNATIONAL PORTFOLIO INVESTMENT
2CHAPTER OVERVIEW
- I. THE BENEFITS OF INTERNATIONAL EQUITY
INVESTING - II. INTERNATIONAL BOND INVESTING
- III. OPTIMAL ASSET ALLOCATION
- IV. MEASURING THE TOTAL RETURN
- V. MEASURING EXCHANGE RISK ON FOREIGN
SECURITIES
3I. THE BENEFITS OF INTERNATIONAL EQUITY
INVESTING
- I. THE BENEFITS OF INTERNATIONAL
- EQUITY INVESTING
- A. Advantages
- 1. Offers more opportunities than
- a domestic portfolio only
- 2. Larger firms often are overseas
4THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
- B. International Diversification
- 1. Risk-return tradeoff may be greater
- basic rule-
- the broader the diversification,
- more stable the returns and the more
diffuse the risk.
5THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
- 2. International diversification and
systematic risk - a. Diversifying across nations with
- different economic cycles
-
6THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
- b. While there is systematic risk
- within a nation, it may be
- nonsystematic and diversifiable
- outside the country.
7THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
- 3. Recent History
- a. National stock markets have wide
- differences in returns and risk.
- b. Emerging markets have higher
- risk and return than developed
- markets.
- c. Cross-market correlations have
- been relatively low.
8THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
- C. Correlations and the Gains From
Diversification - 1. Correlation of foreign market betas
- Foreign Correlation Std dev
- market with U.S. x for.
mkt. - beta market std dev
- U.S. mkt.
-
9THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
- Past empirical evidence suggests inter-
- national diversification reduces portfolio
- risk.
10THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
- 3. Theoretical Conclusion
- International diversification pushes out
- the efficient frontier.
-
11THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
- 4. Calculation of Expected Return
- rp a rUS ( 1 - a) rrw
- where rp portfolio expected return
- rUS expected U.S. market return
- rrw expected global return
12THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
- 5. Calculation of Expected Portfolio Risk (?P )
- ?P a 2?US2 (1-a)2 ?r w2 2a(1-a) ?US?rw
?US,rw1/2 - where ?US,rw the cross-market
- correlation
- ?US2 U.S. returns variance
- ?r w2 World returns variance
13THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
- 6. Cross-market correlations
- a. Recent markets seem to be most
correlated when volatility is greatest - b. Result
- Efficient frontier retreats
14THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
- D. Investing in Emerging Markets
- a. Offers highest risk and returns
- b. Low correlations with returns
- elsewhere
- c. As impediments to capital market
- mobility fall, correlations are likely to
increase in the future.
15THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
- E. Barriers to International Diversification
- 1. Segmented markets
- 2. Lack of liquidity
- 3. Exchange rate controls
- 4. Less developed capital markets
- 5. Exchange rate risk
- 6. Lack of information
- a. readily accessible
- b. comparable
16THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
- F. Methods to Diversify
- 1. Trade in American Depository
- Receipts (ADRs)
- 2. Trade in American shares
- 3. Trade internationally diversified
- mutual funds
- a. Global
- b. International
- c. Single-country
17II. INTERNATIONAL BOND INVESTING
- II. INTERNATIONAL BOND INVESTING
- -internationally diversified bond
- portfolios offer superior performance
-
18INTERNATIONAL BOND INVESTING
- A. Empirical Evidence
- 1. Foreign bonds provide higher
- returns
- 2. Foreign portfolios outperform
- purely domestic
19III. OPTIMAL INTERNATIONAL ASSET ALLOCATION
- III. OPTIMAL INTERNATIONAL ASSET
- ALLOCATION
- -a diversified combination of stocks and
- bonds
- A. Offered better risk-return tradeoff
- B. Weighting options flexible
20IV. MEASURING TOTAL RETURNSFROM FOREIGN
PORTFOLIOS
- IV. MEASURING TOTAL RETURNS
- FROM FOREIGN PORTFOLIOS
- A. Bonds
- Dollar Foreign x Currency return
currency gain (loss) - return
21IV. MEASURING TOTAL RETURNSFROM FOREIGN
PORTFOLIOS
- Bond return formula
- 1 R 1 B(1) - B(0) C (1g)
- B(0)
- where R dollar return
- B(1) foreign currency bond price
at time 1 - C coupon income
- g depreciation/appreciation
- of foreign currency
-
22IV. MEASURING TOTAL RETURNSFROM FOREIGN
PORTFOLIOS
- B. Stocks (Calculating return)
- Formula
- 1 R 1 P(1) - P(0) D (1g)
- P(0)
- where R dollar return
- P(1) foreign currency stock price
at time 1 - D foreign currency annual
- dividend