intfinchp15

7/28/2019 intfinchp15

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Foundations ofMultinational Financial

ManagementAlan Shapiro

John Wiley & Sons

Power Points byJoseph F. Greco, Ph.D.

California State University, Fullerton


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International Portfolio

Investment

Chapter 15


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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


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INTERNATIONAL DIVERSIFICATION

2. International diversification andsystematic risk

a. Diversifying across nations with

different economic cycles

b. While there is systematic risk

within a nation, it may be

nonsystematic and diversifiable

outside the country.


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INTERNATIONAL PORTFOLIOINVESTMENT

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.


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C. Correlations and the Gains FromDiversification

1. Correlation of foreign market betas

Foreign Correlation Std dev

market = with U.S. x for mkt.beta market std devU.S mkt.

Past empirical evidence suggests inter-national diversification reduces portfolio

risk.


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3. Theoretical Conclusion

International diversification pushes out

the efficient frontier.4. Calculation of Expected Return:

rp = a rUS + ( 1 - a) rrw

where rp = portfolio expected returnrUS= expected U.S. market return

rrw = expected global return


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5. Calculation of Expected Portfolio Risk

P = [a 2US2 + (1-a)2 r w2 + 2a(1-a) USrwUS,rw]1/2

where US,rw = the cross-marketcorrelation

US2

= U.S. returns variancer w2 = World returns variance


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CROSS-MARKETCORRELAITONS

6. Cross-market correlations

a. Recent markets seem to be most

correlated when volatility isgreatest

b. Result:

Efficient frontier retreats


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Investing in EmergingMarkets

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 toincrease in the future.


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Barriers to InternationalDiversification

E. Barriers to International Diversification

1. Segmented markets

2. Lack of liquidity3. Exchange rate controls

4. Less developed capital markets

5. Exchange rate risk6. Lack of information

a. readily accessibleb. comparable


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Methods to DiversifyF. Methods to Diversify

1. Trade in American Depository

Receipts (ADRs)

2. Trade in American shares

3. Trade internationally diversified

mutual funds:a. Globalb. Internationalc. Single-country


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BOND INVESTINGII. INTERNATIONAL BOND INVESTING

internationally diversified bond

portfolios offer superior performance

A. Empirical Evidence

1. Foreign bonds provide higherreturns2. Foreign portfolios outperform

purely domestic


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OPTIMAL INTERNATIONAL ASSET

ALLOCATION

III. OPTIMAL INTERNATIONAL ASSET

ALLOCATION

-a diversified combination of stocksand bonds

A. Offered better risk-return

tradeoffB. Weighting options flexible


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IV. MEASURING TOTAL RETURNS

FROM FOREIGN PORTFOLIOS

A. Bonds

Dollar = Foreign x Currencyreturn currency gain (loss)

return


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Bond return formula:

where R$ = dollar returnB(1) = foreign currency bond price

at time 1C = coupon incomeg = currency depreciation

or appreciation

$ (1) (0)1 1 (1 )(0)

B B CR gB


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B. Stocks (Calculating return)

Formula:

where R$ = dollar returnP(1) = foreign currency stock

price at time 1D = foreign currency annual

dividend

$

(1) (0)1 1 (1 )

(0)

P P DR g

P

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