CHAPTER THIRTEEN INVESTING INTERNATIONALLY © 2001 South-Western College Publishing

2 Outline  Motivation for International Investing  Diversification  Market Efficiency  Growth  Methods of Investing  American Depository Receipts  Country Funds  Individual Securities  Unit Investment Trusts  International Mutual Funds

3 Outline  Emerging Markets  Characteristics  Rationale  Investment Considerations  Special Risks  Country Risk  Trading Costs  Market Pressure  Lack of Financial Information

4 Motivation for International Investing  Diversification: Portfolio risk reduction was the original motivation for international investing. Now however, evidence indicates that this alleged advantage may be overstated.  Market efficiency: Free lunches may exist in underdeveloped markets.  Growth: Many markets are less efficient than those in the United States.

5 Methods of Investing: ADRs  An American depository receipt (ADR) is a marketable receipt showing ownership of a foreign security.  Large commercial banks issue ADRs as a convenience to would-be investors in foreign securities.  A sponsored ADR is issued in coordination with the underlying company.

6 Methods of Investing: GDRs  Global depository receipts (GDRs) are issued in the Euromarket and are backed by the Euromarket depositories rather than by a specific bank.  ADRs and GDRs improve a firm’s access to U.S. investment capital.

7 Methods of Investing  A country fund is a closed-end investment company whose portfolio is comprised almost entirely of securities issued within a particular foreign country.  Individual securities: Investors may also purchase shares directly on a foreign exchange, especially if the exchange is well- developed.

8 Methods of Investing  A unit investment trust is a professionally selected, but unmanaged, portfolio of securities designed to meet some stated investment objective.  International mutual funds are portfolios of securities too. They provide immediate diversification, professional management, and ease of entry and exit from the market.

9 Emerging Markets: Characteristics  An emerging market is characterized by a low per capita gross national product.  History: Today’s developed markets were once emerging markets too.  Culture: Significant differences exist among emerging markets, but as a group, they share one primary similarity - change.  The stock market of an emerging country can be particularly volatile, especially by U.S. standards.

10 Emerging Markets: Rationale  Adding value: Inefficiencies in developing markets provide opportunities for money to be made.  Reducing risk: While correlations among the developed markets are increasing, emerging markets show little correlation with developed markets or with one another.  Getting on the bandwagon: Current industry practice is another reason for the popularity of international investing.

11 Emerging Markets: Investment Considerations  Accounting information: Reliable accounting information is especially scarce in emerging markets.  Foreign currency risk: Hedging foreign exchange risk is complicated in emerging markets due to the less availability of hedging vehicles.

12  Fraud: Emerging markets carry a genuine risk of fraud, ranging from accounting misstatements to counterfeit securities or bucket shops.  Liquidity risk: Residents of a developing country typically have little money of their own to invest. Emerging Markets: Investment Considerations

13  Country risk refers to a country’s ability and willingness to meet its foreign exchange obligations.  The two components to country risk are political risk and economic risk.  Political risk is a measure of a country’s willingness to honor its foreign obligations.  Economic risk is a measure of the country’s ability to pay. It is largely a function of the income statement rather than of the balance sheet. Special Risks: Country Risk

14  Foreign market investing is likely to involve trading costs at least one percent higher than investing domestically.  Market pressure can be an important trading cost in international markets.  Lack of financial information: Some particular problems with financial information sources are inherent in emerging markets. Often, accounting standards differ too. Special Risks

15 Review  Motivation for International Investing  Diversification  Market Efficiency  Growth  Methods of Investing  American Depository Receipts  Country Funds  Individual Securities  Unit Investment Trusts  International Mutual Funds

16 Review  Emerging Markets  Characteristics  Rationale  Investment Considerations  Special Risks  Country Risk  Trading Costs  Market Pressure  Lack of Financial Information