Fin 2802 Investments Spring 2008 Dragon Tang Lecture
- Slides: 39
Fin 2802: Investments Spring, 2008 Dragon Tang Lecture 23 International Investing April 10/11, 2008 Readings: Chapter 25 Practice Problem Sets: 1, 4, 7 Fin 2802, Spring 08 - Tang Chapter 25: International Investing 1
Case Studies Recap • • • Warren Buffett: Investing in the value you know Jack Bogle: Passive investing with low costs Bill Miller: Contrarian, bargain hunter Intel valuation: Fragile market/analyst/investor GSAM Active Alpha Fidelity Magellan: Peter Lynch One Up on Wall Street Fin 2802, Spring 08 - Tang Chapter 24: Performance Evaluation 2
International Investing Objectives: 1. Risks in international investing 2. Benefits of international investing Fin 2802, Spring 08 - Tang Chapter 25: International Investing 3
Background • Global market – US market is approx. 45% of all markets – Emerging market development – Market capitalization and GDP Fin 2802, Spring 08 - Tang Chapter 25: International Investing 4
Figure 25. 1 Per Capita GDP and Market Capitalization as Percentage of GDP (log scale) Fin 2802, Spring 08 - Tang Chapter 25: International Investing 5
Issues • What are the risks involved in investment in foreign securities? • How do you measure benchmark returns on foreign investments? • Are there benefits to diversification in foreign securities? Fin 2802, Spring 08 - Tang Chapter 25: International Investing 6
Risks in International Investing: Foreign Exchange Rate Risk • Variation in return related to changes in the relative value of the domestic and foreign currency • Total Return = Investment return plus return on foreign exchange • Not possible to completely hedge a foreign investment Fin 2802, Spring 08 - Tang Chapter 25: International Investing 7
Returns with FX • Return in US is a function of two factors 1. Return in the foreign market 2. Return on the foreign exchange (1 + r. US) = (1 + r. FM) (1 + r. FX) r. US = return on the foreign investment in US Dollars r. FM = return on the foreign market in local currency r. FX = return on the foreign exchange Fin 2802, Spring 08 - Tang Chapter 25: International Investing 8
Return Example: Dollar Depreciates Relative to the Pound Initial Investment : $100, 000 Initial Exchange: $2. 00/ Pound Sterling Final Exchange: $2. 10/ Pound Sterling Return in British Security: 10% Return in US Dollars (1 + r. US) = (1. 10) (1. 05) = (1. 155) r. US = 15. 5% Fin 2802, Spring 08 - Tang Chapter 25: International Investing 9
Return Example: Dollar Appreciates Relative to the Pound Initial Investment : $100, 000 Initial Exchange: $2/ Pound Sterling Final Exchange: $1. 85/ Pound Sterling Return in British Security: 10% Return in US Dollars (1 + r. US) = (1. 10) (. 9250) = (1. 0175) r. US = 1. 75% Fin 2802, Spring 08 - Tang Chapter 25: International Investing 10
Figure 25. 2 Stock Market Returns in U. S. Dollars and Local Currencies for 2005 Fin 2802, Spring 08 - Tang Chapter 25: International Investing 11
Table 25. 3 Rates of Change in the U. S. Dollar against Major World Currencies, 2001 – 2005 (monthly data) Fin 2802, Spring 08 - Tang Chapter 25: International Investing 12
Other Risks in International Investing Country - Specific • Composition – Political – Financial – Economic • Composite Ratings Fin 2802, Spring 08 - Tang Chapter 25: International Investing 13
Table 25. 4 Composite Risk Ratings for October 2004 and November 2003 Fin 2802, Spring 08 - Tang Chapter 25: International Investing 14
Table 25. 5 Variables Used in PRS’s Political Risk Score Fin 2802, Spring 08 - Tang Chapter 25: International Investing 15
Table 25. 6 Current Risk Ratings and Composite Risk Forecasts Fin 2802, Spring 08 - Tang Chapter 25: International Investing 16
Table 25. 7 Composite and Political Risk Forecasts Fin 2802, Spring 08 - Tang Chapter 25: International Investing 17
Table 25. 8 Political Risk Points by Component, October 2004 Fin 2802, Spring 08 - Tang Chapter 25: International Investing 18
Int’l Investment Choices • Direct Stock Purchases • Mutual Funds – Open End – Closed End – WEBS Fin 2802, Spring 08 - Tang Chapter 25: International Investing 19
Questions on Assessing Performance in US Dollars in Foreign Markets • Are emerging markets riskier? • Is exchange rate risk important in international portfolios? • Are there diversification benefits to international investing? Fin 2802, Spring 08 - Tang Chapter 25: International Investing 20
Table 25. 9 Risk and Return across the Globe, 2001 – 2005 (Developed Countries) Fin 2802, Spring 08 - Tang Chapter 25: International Investing 21
Table 25. 9 Risk and Return across the Globe, 2001 – 2005 (Emerging Markets) Fin 2802, Spring 08 - Tang Chapter 25: International Investing 22
Figure 25. 3 Annualized Standard Deviation of Investments across the Globe ($ returns 2001 – 2005) Fin 2802, Spring 08 - Tang Chapter 25: International Investing 23
Figure 25. 4 Beta on U. S. Stocks across the Globe, 2001 – 2005 Fin 2802, Spring 08 - Tang Chapter 25: International Investing 24
Figure 25. 3 Annualized Average $ Return of Investments across the Globe 2001 – 2005 Fin 2802, Spring 08 - Tang Chapter 25: International Investing 25
Figure 25. 6 Standard Deviation of Investments across the Globe in U. S. Dollars versus Local Currency, 2001 – 2005 Fin 2802, Spring 08 - Tang Chapter 25: International Investing 26
Diversification Benefits Evidence shows international diversification is beneficial • Possible to expand the efficient frontier above domestic only frontier • Possible to reduce the systematic risk level below the domestic only level Fin 2802, Spring 08 - Tang Chapter 25: International Investing 27
Table 25. 11 Correlation of U. S. Equity Returns with Country Equity Returns Fin 2802, Spring 08 - Tang Chapter 25: International Investing 28
Figure 25. 7 International Diversification Fin 2802, Spring 08 - Tang Chapter 25: International Investing 29
Figure 25. 8 Ex Post Efficient Frontier of Country Portfolios, 2001 – 2005 Fin 2802, Spring 08 - Tang Chapter 25: International Investing 30
Figure 25. 9 Efficient Frontier of Country Portfolios (world expected excess return =. 6% per month) Fin 2802, Spring 08 - Tang Chapter 25: International Investing 31
Figure 25. 10 Regional Indexes around the Crash, October 14 – October 26, 1987 Fin 2802, Spring 08 - Tang Chapter 25: International Investing 32
Figure 25. 11 Efficient Diversification by Various Methods Fin 2802, Spring 08 - Tang Chapter 25: International Investing 33
Figure 25. 12 Diversification by Market Capitalization: National Markets versus Regional Funds Fin 2802, Spring 08 - Tang Chapter 25: International Investing 34
Figure 25. 13 Diversification Benefits over Time Fin 2802, Spring 08 - Tang Chapter 25: International Investing 35
Table 25. 12 Weighting Schemes for EAFE Countries Fin 2802, Spring 08 - Tang Chapter 25: International Investing 36
Performance Attribution with International Extension to consider additional factors • Currency selection • Country selection • Stock selection • Cash and bond selection Fin 2802, Spring 08 - Tang Chapter 25: International Investing 37
Table 25. 13 Example of Performance Attribution: International Fin 2802, Spring 08 - Tang Chapter 25: International Investing 38
Summary • • World financial markets Risks in international investing International diversification Next class: Behavioral Finance Fin 2802, Spring 08 - Tang Chapter 25: International Investing 39
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