Asset Management Lecture 16. Outline for today International Diversification Emphasis for our investigation Risk assessment Diversification 3rd Case The.
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Outline for today International Diversification Emphasis for our investigation Risk assessment Diversification 3rd Case The question set will be posted On April 22, Wednesday. The report is due on May 1, Friday.
Market Capitalization of Stock Exchanges in Developed Countries
Table 25.2 Market Capitalization of Stock Exchanges in Emerging Markets
What are the risks involved in investment in foreign securities? How do you measure benchmark returns on foreign investments? Are there benefits to diversification in foreign securities? Issues
Example: British T-bill pays 10% per year The exchange rate is $2 per pound The U.S. investor invests $20,000 What is the payoff in one year’s time? If the exchange rate does not change £10,000*1.1=£11,000=$22,000 If the pound depreciate to $1.8 by the end of the year £10,000*1.1=£11,000=$19,800 Foreign Exchange Risk
1. Return in the foreign market 2. Return on the foreign exchange In our example, when E 0 =$2/£, E 1 =$1.8/£ 1+r(US)=1.1*1.8/2=0.99 r(US)=-1% Returns with Foreign Exchange
Stock Market Returns in U.S. Dollars and Local Currencies for 2005
Rates of Change in the U.S. Dollar Against World Currencies, 2001 – 2005 Partly diversifiable exchange rate risk
Hedging Exchange Rate Risk The use of futures or forward contracts In our example: The U.S. investor can lock in a riskless dollar-denominated return either by investing in UK bills and hedging exchange rate risk or by investing riskless U.S. assets
Hedging Exchange Rate Risk Interest rate parity, covered interest arbitrage E.g. The forward exchange rate F 0 =$1.93/£ (1+0.1)*1.93/2=1.0615 The hedge would only be perfect if foreign return is risk-free
Political Risk Services Group Ratings Rank countries with respect to political risk financial risk economic risk Country Specific Risk
Composite Risk Rating for country risk Popular support, legislative strength Unemployment, consumer confidence, poverty Payment delays, contract viability Civil war, terrorism Judicial system, law enforcement