2 Why Invest Internationally? What are the advantages of international investment?
3 THE BENEFITS OF INTERNATIONAL EQUITY INVESTING I. THE BENEFITS OF INTERNATIONALEQUITY INVESTINGA. Advantages1. Offers more opportunities thana purely domestic portfolio2. Attractive investments overseas3. Impact on efficient portfolio with diversification benefits
4 Basic Portfolio Theory: What is the efficient frontier?It represents the most efficient combinations of all possible risky assets.
10 INTERNATIONAL DIVERSIFICATION 2. International diversification and systematic riska. Diversify across nations withdifferent economic cyclesb. While there is systematic riskwithin a nation, outside the country it may be nonsystematic and diversifiable
11 INTERNATIONAL PORTFOLIO INVESTMENT 3. Recent Historya. National stock markets have widedifferences in returns and risk.b. Emerging markets have higherrisk and return than developedmarkets.c. Cross-market correlations havebeen relatively low.
12 INTERNATIONAL PORTFOLIO INVESTMENT 3. Theoretical ConclusionInternational diversification pushes out the efficient frontier.
16 Investing in Emerging Markets D. Investing in Emerging Marketsa. Offers highest risk and returnsb. Low correlations with returnselsewherec. As impediments to capital market mobility fall, correlations are likely to increase in the future.
17 Barriers to International Diversification E. Barriers to International Diversification1. Segmented markets2. Lack of liquidity3. Exchange rate controls4. Underdeveloped capital markets5. Exchange rate risk6. Lack of informationa. not readily accessibleb. data is not comparable
18 Other Methods to Diversify F. Diversify by a1. Trade in American DepositoryReceipts (ADRs)2. Trade in American shares3. Trade internationally diversifiedmutual funds:a. Global (all types)b. International (no home country securities)c. Single-country
19 INTERNATIONAL PORTFOLIO INVESTMENT 4. Calculation of Expected Portfolio Return:rp = a rUS + ( 1 - a) rrwwhererp = portfolio expected returnrUS = expected U.S. market returnrrw = expected global return
20 Portfolio Return Sample Problem What is the expected return of a portfolio with 35% invested in Japan returning 10% and 65% in the U.S. returning 5%?rp = a rUS + ( 1 - a) rrw= (.05) + .35(.10)== 6.75%
21 INTERNATIONAL PORTFOLIO INVESTMENT Calculation of Expected Portfolio Riskwhere = the cross-marketcorrelationUS2 = U.S. returns variancer w2 = World returns variance
22 Portfolio RiskWhat is the risk of a portfolio with 35% invested in Japan with a standard deviation of 6% and a standard deviation of 8% in the U.S. and a correlation coefficient of .7?= [(.65)2 (.08) 2 + (.35) 2(.06) (.65)(.35)(.08)(.06)(.7)] 1/2= 6.8%
23 INTERNATIONAL PORTFOLIO INVESTMENT IV. MEASURING TOTAL RETURNSFROM FOREIGN PORTFOLIOSA. To compute dollar return of a foreign security:or
25 INTERNATIONAL PORTFOLIO INVESTMENT Bond (calculating return) formula:where R$ = dollar returnB(1) = foreign currency bond price at time 1 (present)C = coupon income during periodg = currency depreciation or appreciation
26 INTERNATIONAL PORTFOLIO INVESTMENT B. Stocks (Calculating return)Formula:where R$ = dollar returnP(1) = foreign currency stock price at time 1D = foreign currency annualdividend
27 U.S. $ Stock Returns: Sample Problem Suppose the beginning stock price if FF50 and the ending price is FF48. Dividend income was FF1. The franc depreciates from FF 20 /$ to FF21.05 /$ during the year against the dollar.What is the stock’s US$ return for the year?