1. International Portfolio Investment
Chapter 15

2. Why Invest Internationally?
What are the advantages of international investment?

3. THE BENEFITS OF INTERNATIONAL EQUITY INVESTING
I. THE BENEFITS OF INTERNATIONAL
EQUITY INVESTING
A. Advantages
1. Offers more opportunities than
a purely domestic portfolio
2. Attractive investments overseas
3. Impact on efficient portfolio with diversification benefits

4. Basic Portfolio Theory:
What is the efficient frontier?
It represents the most efficient combinations of all possible risky assets.

5. The Efficient FrontierA B

6. Basic Portfolio Theory:
The broader the diversification, the more stable the returns and the more diffuse the risk.

7. INTERNATIONAL DIVERSIFICATION
B. International Diversification
1. Risk-return tradeoff:
may be greater

8. Basic Portfolio Theory:
Total Risk of a Security’s Returns may be segmented into
Systematic Risk
can not be eliminated
Non-systematic Risk
can be eliminated by diversification

9. The Benefits of Int’l Diversification

10. INTERNATIONAL DIVERSIFICATION
2. International diversification and systematic risk
a. Diversify across nations with
different economic cycles
b. While there is systematic risk
within a nation, outside the country it may be nonsystematic and diversifiable

11. INTERNATIONAL PORTFOLIO INVESTMENT
3. Recent History
a. National stock markets have wide
differences in returns and risk.
b. Emerging markets have higher
risk and return than developed
markets.
c. Cross-market correlations have
been relatively low.

12. INTERNATIONAL PORTFOLIO INVESTMENT
3. Theoretical Conclusion
International diversification pushes out the efficient frontier.

13. The New Efficient FrontierA B

14. CROSS-MARKET CORRELATIONS
a. Recent markets seem to be most correlated when volatility is greatest
b. Result:
Efficient frontier retreats

15. The Frontier During Global Crises

16. Investing in Emerging Markets
D. Investing in Emerging Markets
a. Offers highest risk and returns
b. Low correlations with returns
elsewhere
c. As impediments to capital market mobility fall, correlations are likely to increase in the future.

17. Barriers to International Diversification
E. Barriers to International Diversification
1. Segmented markets
2. Lack of liquidity
3. Exchange rate controls
4. Underdeveloped capital markets
5. Exchange rate risk
6. Lack of information
a. not readily accessible
b. data is not comparable

18. Other Methods to Diversify
F. Diversify by a
1. Trade in American Depository
Receipts (ADRs)
2. Trade in American shares
3. Trade internationally diversified
mutual funds:
a. Global (all types)
b. International (no home country securities)
c. Single-country

19. INTERNATIONAL PORTFOLIO INVESTMENT
4. Calculation of Expected Portfolio Return:
rp = a rUS + ( 1 - a) rrw
where
rp = portfolio expected return
rUS = expected U.S. market return
rrw = expected global return

20. Portfolio Return Sample Problem
What is the expected return of a portfolio with 35% invested in Japan returning 10% and 65% in the U.S. returning 5%?
rp = a rUS + ( 1 - a) rrw
= (.05) + .35(.10) =
= 6.75%

21. INTERNATIONAL PORTFOLIO INVESTMENT
Calculation of Expected Portfolio Risk
where = the cross-market
correlation
US2 = U.S. returns variance
r w2 = World returns variance

22. Portfolio Risk
What is the risk of a portfolio with 35% invested in Japan with a standard deviation of 6% and a standard deviation of 8% in the U.S. and a correlation coefficient of .7?
= [(.65)2 (.08) 2 + (.35) 2(.06) (.65)(.35)(.08)(.06)(.7)] 1/2
= 6.8%

23. INTERNATIONAL PORTFOLIO INVESTMENT
IV. MEASURING TOTAL RETURNS
FROM FOREIGN PORTFOLIOS
A. To compute dollar return of a foreign security: or

24. Flash Back!
For currency appreciation:
For currency depreciation:

25. INTERNATIONAL PORTFOLIO INVESTMENT
Bond (calculating return) formula:
where R$ = dollar return
B(1) = foreign currency bond price at time 1 (present)
C = coupon income during period
g = currency depreciation or appreciation

26. INTERNATIONAL PORTFOLIO INVESTMENT
B. Stocks (Calculating return)
Formula:
where R$ = dollar return
P(1) = foreign currency stock price at time 1
D = foreign currency annual
dividend

27. U.S. $ Stock Returns: Sample Problem
Suppose the beginning stock price if FF50 and the ending price is FF48. Dividend income was FF1. The franc depreciates from FF 20 /$ to FF21.05 /$ during the year against the dollar.
What is the stock’s US$ return for the year?

28. U.S. $ Stock Returns: Sample Solution