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 =$25 Total World Portfolio= 49.1 Fixed Income securities= 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 FTSE100 4 NIKKEI225 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  F = the risk of the foreign portfolio  D = the risk of the foreign stock  C = the risk of the foreign currency  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