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INTERNATIONAL PORTFOLIO INVESTMENT

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chapter 19 international portfolio investment chapter overview: i. the benefits of international equity investing ii. international bond investing iii. – PowerPoint PPT presentation

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Title: INTERNATIONAL PORTFOLIO INVESTMENT


1
CHAPTER 19
  • INTERNATIONAL PORTFOLIO INVESTMENT

2
CHAPTER 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

3
I. 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

4
THE 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.

5
THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
  • 2. International diversification and
    systematic risk
  • a. Diversifying across nations with
  • different economic cycles

6
THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
  • b. While there is systematic risk
  • within a nation, it may be
  • nonsystematic and diversifiable
  • outside the country.

7
THE 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.

8
THE 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.

9
THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
  • Past empirical evidence suggests inter-
  • national diversification reduces portfolio
  • risk.

10
THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
  • 3. Theoretical Conclusion
  • International diversification pushes out
  • the efficient frontier.

11
THE 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

12
THE 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

13
THE 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

14
THE 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.

15
THE 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

16
THE 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

17
II. INTERNATIONAL BOND INVESTING
  • II. INTERNATIONAL BOND INVESTING
  • -internationally diversified bond
  • portfolios offer superior performance

18
INTERNATIONAL BOND INVESTING
  • A. Empirical Evidence
  • 1. Foreign bonds provide higher
  • returns
  • 2. Foreign portfolios outperform
  • purely domestic

19
III. 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

20
IV. MEASURING TOTAL RETURNSFROM FOREIGN
PORTFOLIOS
  • IV. MEASURING TOTAL RETURNS
  • FROM FOREIGN PORTFOLIOS
  • A. Bonds
  • Dollar Foreign x Currency return
    currency gain (loss)
  • return

21
IV. 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

22
IV. 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
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