international financial management vicentiu covrig 1 international portfolio investment (chapter 11)

International Financial ManagementVicentiu Covrig

11

International Portfolio InvestmentInternational Portfolio Investment(chapter 11)(chapter 11)


22

International Correlation Structure and International Correlation Structure and DiversificationDiversification

Main benefit of international investing is diversification The cross-country correlations are less then one, and for some

pair of countries less than 0.5

Correlations between countries are not stable through time

Security returns are much less correlated across countries than within a country.


33

The Optimal International PortfolioThe Optimal International Portfolio

0

0.5

1

1.5

2

2.5

3

0 2 4 6 8

Standard Deviation (monthly)

Mea

n R

etur

n (m

onth

ly)

OIP1.53

4.2%

UKUS

CN

FR

JP

GM


44

Optimal International Portfolio SelectionOptimal International Portfolio Selection The correlation of the U.S. stock market with the returns on the

stock markets in other nations varies. The correlation of the U.S. stock market with the Canadian stock

market is 0.7. The correlation of the U.S. stock market with the Japanese stock

market is 0.24. A U.S. investor would get more diversification from investments

in Japan than Canada.


55

Effects of Changes Effects of Changes in the Exchange Ratein the Exchange Rate

The realized dollar return for a U.S. resident investing in a foreign market will depend not only on the return in the foreign market but also on the change in the exchange rate between the U.S. dollar and the foreign currency.

The realized dollar return for a U.S. resident investing in a foreign market is given by

Ri$ = (1 + Ri)(1 + ei) – 1

= Ri + ei + Riei

Where

Ri is the local currency return in the ith market

ei is the rate of change in the exchange rate between the local currency and the dollar ($/FC)


66

Effects of Changes Effects of Changes in the Exchange Ratein the Exchange Rate

For example, if a U.S. resident just sold shares in a Mexican firm that had a 20% return (in pesos) during a period when the peso depreciated 5%, his dollar return is :

Ri$ = (1 + .2)(1 –0.05) – 1 = 0.14 or 14%


77

International Diversification through International International Diversification through International Mutual FundsMutual Funds

A U.S. investor can easily achieve international diversification by investing in a U.S.-based international mutual fund.

The advantages include:

1. Savings on transaction and information costs.

2. Circumvention of legal and institutional barriers to direct portfolio investments abroad.

3. Professional management and record keeping.


88

International Diversification through Country FundsInternational Diversification through Country Funds Recently, country funds have emerged as one of the most

popular means of international investment. A country fund invests exclusively in the stocks of a single

county. This allows investors to:1. Speculate in a single foreign market with minimum cost.2. Construct their own personal international portfolios.3. Diversify into emerging markets that are otherwise

practically inaccessible.

World Equity Benchmark Shares (WEBS)

-Country-specific baskets of stocks designed to replicate the country indexes of 14 countries.


99

Trading in International EquitiesTrading in International Equities

The easiest way is to trade ADRs There are many advantages to trading ADRs as opposed to direct

investment in the company’s shares:

- ADRs are denominated in U.S. dollars, trade on U.S. exchanges and can be bought through any broker.

- Dividends are paid in U.S. dollars.

- Most underlying stocks are bearer securities, the ADRs are registered.


1010

Why Home Bias in Portfolio Holdings?Why Home Bias in Portfolio Holdings? Home bias refers to the extent to which portfolio investments are

concentrated in domestic equities. Explanations for home bias:


1111

Learning outcomes:- what are the benefits of investing internationally (with a focus on diversification)- discuss three ways in which a US investor can diversify internationally- What is home bias and what are the factors that explain it- Recommended end-of-chapter questions: 1, 2, 5, 6, 10, 11- Recommended end-of-chapter problems: 1, 2, 4

international financial management vicentiu covrig 1 international portfolio investment (chapter 11)

Documents