CHAPTER TWENTYFIVE INTERNATIONAL INVESTING THE TOTAL INVESTABLE INTERNTATIONAL

CHAPTER TWENTY-FIVE INTERNATIONAL INVESTING

THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL MARKET PORTFOLIO n GLOBAL DISTRIBUTION OF CAPITAL (by market in trillions of US$) • Non-U. S. Bond & Equity Markets • Total World Portfolio • Fixed Income securities =$25 = 49. 1 = 25. 9

THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL MARKET PORTFOLIO n GLOBAL DISTRIBUTION OF CAPITAL (by country in trillions of US$) • Largest Market for common stock = U. S. • U. S & Japanese Assets as %Total = 63. 4% • U. S. , Japan, Germany, UK, France =82. 9%

THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL MARKET PORTFOLIO n GLOBAL EQUITY INDICES • MOST CLOSELY WATCHED: 4 FTSE 100 4 NIKKEI 225 4 TSE 300

THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL MARKET PORTFOLIO • INTERNATIONAL 4 EAFE (Morgan Stanley) 4 IFC (International Finance Corporation)

THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL MARKET PORTFOLIO n EMERGING MARKETS • COMMON FEATURES: 4 securities improved political and economic stability 4 available to foreign ownership 4 convertible currency 4 relatively low level of per capita GDP

THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL MARKET PORTFOLIO • EMERGING MARKET INDICES 4 Morgan Stanley 4 IFC: Emerging Market Index, national

RISK AND RETURN FROM FOREIGN INVESTING n THE ADDITIONAL RISKS • POLITICAL RISK 4 DEFINITION: refers to the uncertainty about the ability of an investor to convert foreign currency into local

RISK AND RETURN FROM FOREIGN INVESTING n THE ADDITIONAL RISKS • EXCHANGE RATE RISK 4 DEFINITION: refers to uncertainty about the rate at which a foreign currency can be exchanged for the investor’s local currency in the future

RISK AND RETURN FROM FOREIGN INVESTING n MANAGING EXCHANGE RATE RISK • involves using hedge instruments such as 4 currency forward contracts 4 currency options 4 currency futures

RISK AND RETURN FROM FOREIGN INVESTING n MANAGING EXCHANGE RATE RISK • TWO APPROACHES: 4 passive currency management

RISK AND RETURN FROM FOREIGN INVESTING n MANAGING EXCHANGE RATE RISK • TWO APPROACHES: 4 active currency management

RISK AND RETURN FROM FOREIGN INVESTING n passive currency management • involves a strategy of permanently controlling a portfolio’s exposure to risk

RISK AND RETURN FROM FOREIGN INVESTING n active currency management • involves a strategy of frequently changing currency exposures to take advantage of perceived short-run mispricings

FOREIGN AND DOMESTIC RETURNS n THE DOMESTIC RETURN • FORMULA

FOREIGN AND DOMESTIC RETURNS n THE FOREIGN RETURN • FORMULA

FOREIGN AND DOMESTIC RETURNS n FOREIGN INVESTMENT • Two Parts: 4 the investment in the country’s firm(s) 4 the currency exposure

FOREIGN AND DOMESTIC RETURNS n Calculating the return on foreign currency

FOREIGN AND DOMESTIC RETURNS we know and

FOREIGN AND DOMESTIC RETURNS n Calculating the return on foreign currency • the return on a foreign security ( r. F ) can be estimated by summing the domestic with the currency returns

EXPECTED RETURNS n ON A FOREIGN SECURITY • FORMULA • If expected return differential exists, interest rate parity equates the two rates

EXPECTED RETURNS n ON A FOREIGN SECURITY: An Example Assume an investor can buy either a 5% U. S. Treasury bond or a 7% German bond, which gives a better return? If the German mark is expected to depreciate by 2% against the U. S. $, neither bond offers a better return

FOREIGN AND DOMESTIC RISK n Calculating Portfolio Risk • Formula: where s. F= the risk of the foreign portfolio s. D = the risk of the foreign stock s. C = the risk of the foreign currency r. DC= the correlation between the currency change and the asset returns

FOREIGN AND DOMESTIC RISK n PORTFOLIO RISK • the smaller the value of the correlation coefficient, the lower the foreign portfolio risk

END OF CHAPTER 25