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Multinational Financial Management Alan Shapiro
7th Edition J.Wiley & SonsPower Points byJoseph F. Greco, Ph.D.California State University, Fullerton
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CHAPTER 15
INTERNATIONAL PORTFOLIO INVESTMENT
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CHAPTER OVERVIEW:
I. THE BENEFITS OF INTERNATIONAL EQUITY INVESTINGII. INTERNATIONAL BOND INVESTINGIII.OPTIMAL ASSET ALLOCATIONIV. MEASURING THE TOTAL RETURNV. MEASURING EXCHANGE RISK ON FOREIGN SECURITIES
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I. THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
I. THE BENEFITS OF INTERNATIONALEQUITY INVESTINGA. Advantages
1. Offers more opportunities than
a domestic portfolio only2. Larger firms often are
overseas
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THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
B. International Diversification1. Risk-return tradeoff: may be greater basic rule-the broader the diversification,more stable the returns and the more diffuse the risk.
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THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
2. International diversification and systematic risk
a. Diversifying across nations with
different economic cycles
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THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
b. While there is systematic riskwithin a nation, it may benonsystematic and diversifiableoutside the country.
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THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
3. Recent Historya. National stock markets have
widedifferences in returns and risk.
b. Emerging markets have higherrisk and return than developed markets.
c. Cross-market correlations havebeen relatively low.
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THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
C. Correlations and the Gains From Diversification
1. Correlation of foreign market betas
Foreign Correlation Std dev market = with U.S. x for. mkt.
beta market std dev U.S. mkt.
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THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
2. Past empirical evidence suggests inter-
national diversification reduces portfolio risk.
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THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
3. Theoretical ConclusionInternational diversification pushes
outthe efficient frontier.
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THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
4. Calculation of Expected Return:
rp = a rUS + ( 1 - a) rrw
where rp = portfolio expected return
rUS = expected U.S. market return
rrw = expected global return
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THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
5. Calculation of Expected Portfolio Risk = (P )
P = [a 2US2 + (1-a)2 r w
2 + 2a(1-a)
USrw US,rw]1/2
where US,rw = the cross-market correlation
US2 = U.S. returns variance
r w2 = World returns variance
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THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
6. Cross-market correlationsa. Recent markets seem to
be most correlated when volatility is greatest
b. Result: Efficient frontier retreats
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THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
D. Investing in Emerging Marketsa. Offers highest risk and returnsb. Low correlations with returns
elsewherec. As impediments to capital
marketmobility fall, correlations are
likely to increase in the future.
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THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
E.Barriers to International Diversification1. Segmented markets2. Lack of liquidity3. Exchange rate controls4. Less developed capital markets5. Exchange rate risk6. Lack of information
a. readily accessibleb. comparable
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THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
F. Methods to Diversify1. Trade in American Depository
Receipts (ADRs)2. Trade in American shares3. Trade internationally diversified
mutual funds:a. Globalb. Internationalc. Single-country
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II. INTERNATIONAL BOND INVESTINGII. INTERNATIONAL BOND INVESTING
-internationally diversified bond portfolios offer superior
performance
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INTERNATIONAL BOND INVESTING
A. Empirical Evidence
1. Foreign bonds provide higher
returns
2. Foreign portfolios outperform
purely domestic
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III. OPTIMAL INTERNATIONAL ASSET ALLOCATION
III. OPTIMAL INTERNATIONAL ASSETALLOCATION-a diversified combination of stocks and
bonds
A. Offered better risk-return tradeoff
B. Weighting options flexible
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IV. MEASURING TOTAL RETURNSFROM PORTFOLIO INVESTING
IV. MEASURING TOTAL RETURNSA. Bonds
Dollar = Foreign x Currency return currency gain (loss)
return
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MEASURING TOTAL RETURNSFROM PORTFOLIO INVESTINGBond return formula:
1 + R$ =[1 +B(1) - B(0) + C ](1+g)
B(0)where R$ = dollar return
B(1) = foreign currency bond price at time 1C = coupon incomeg = depreciation/appreciation
of foreign currency
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MEASURING TOTAL RETURNSFROM PORTFOLIO INVESTING
B. Stocks (Calculating return)Formula:
1 + R$ =[ 1+ P(1) - P(0) + D ](1+g) P(0)
where R$ = dollar returnP(1) = foreign currency stock
price at time 1D = foreign currency annual
dividend