 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill 25-1 The Process of Portfolio Management

 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill 25-2 ObjectivesConstraintsPolicies Return RequirementsLiquidityAsset Allocation Risk ToleranceHorizonDiversification RegulationsRisk Positioning TaxesTax Positioning Unique NeedsIncome Generation Determinants of Portfolio Policies

 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill 25-3 Type of InvestorReturn RequirementRisk Tolerance Individual and Personal Trusts Life CycleLife Cycle Mutual FundsVariableVariable Pension FundsAssumed actuarial rateDepends on payouts Endowment FundsDetermined by income Generally needs and asset growth to conservative maintain real value Matrix of Objectives

 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill 25-4 Type of InvestorReturn RequirementRisk Tolerance Life InsuranceSpread over cost of Conservative funds and actuarial rates Nonlife Ins. Co. No minimum Conservative BanksInterest Spread Variable Matrix of Objectives (cont’d)

 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill 25-5 Liquidity - Ease (speed) with which an asset can be sold and created into cash Investment horizon - planned liquidation date of the investment Regulations - Prudent man law Tax considerations Unique needs Constraints on Investment Policies

 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill 25-6 International Diversification

 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill 25-7 Global market - US Market is 40% - 45% of all markets - Improved access & technology - New instruments Emphasis for our investigation - Risk assessment - Diversification Background

 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill 25-8 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

 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill 25-9 Evidence shows international diversification is beneficial Possible to expand the efficient frontier above domestic only frontier Possible to reduce the systematic risk level below the domestic only level Diversification Benefits

 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill Efficient Frontier with International Diversification Return Risk * * * * * * * * Dom Int’l

 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill Systematic Risk Level with International Diversification Risk Securities Int’l Dom

 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill Direct stock purchases American depository receipts Mutual Funds - Open-end funds - Closed-end funds - WEBS International Investment Choices

 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill Political Risks Expropriation of assets Restrictions on foreign exchange Political instability Risks in International Investing

 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill Foreign Exchange Risk Variation in return related to changes in the relative value of the domestic and foreign currency Total return = investment return & return on foreign exchange Not possible to completely hedge a foreign investment Risks in International Investing

 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill (1 + r US ) = (1 + r FM ) (1 + r FX ) r US = return on the foreign investment in US Dollars r FM = return on the foreign market in local currency r FX = return on the foreign exchange Returns with FX

 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill Initial Investment : $100,000 Initial Exchange: $2.00/ Pound Sterling Final Exchange:$2.10/ Pound Sterling Return in British Security: 10% Return in US Dollars (1 + r US ) = (1.10) (1.05) = (1.155) r US = 15.5% Return Example: Dollar Depreciates

 The McGraw-Hill Companies, Inc., 1999 INVESTMENTS Fourth Edition Bodie Kane Marcus Irwin/McGraw-Hill Initial Investment : $100,000 Initial Exchange: $2/ Pound Sterling Final Exchange: $1.85/ Pound Sterling Return in British Security: 10% Return in US Dollars (1 + r US ) = (1.10) (.9250) = (1.0175) r US = 1.75% Return Example: Dollar Appreciates