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CHAPTER TWENTY-FIVE. INTERNATIONAL INVESTING. THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL MARKET PORTFOLIO. 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.

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CHAPTER TWENTY-FIVE

INTERNATIONAL INVESTING


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THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL MARKET PORTFOLIO

  • 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


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THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL MARKET PORTFOLIO

  • 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%


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THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL MARKET PORTFOLIO

  • GLOBAL EQUITY INDICES

    • MOST CLOSELY WATCHED:

      • FTSE100

      • NIKKEI225

      • TSE 300


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THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL MARKET PORTFOLIO

  • INTERNATIONAL

    • EAFE (Morgan Stanley)

    • IFC (International Finance Corporation)


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THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL MARKET PORTFOLIO

  • EMERGING MARKETS

    • COMMON FEATURES:

      • securities improved political and economic stability

      • available to foreign ownership

      • convertible currency

      • relatively low level of per capita GDP


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THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL MARKET PORTFOLIO

  • EMERGING MARKET INDICES

    • Morgan Stanley

    • IFC: Emerging Market Index, national


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RISK AND RETURN FROM FOREIGN INVESTING

  • THE ADDITIONAL RISKS

    • POLITICAL RISK

      • DEFINITION:refers to the uncertainty about the ability of an investor to convert foreign currency into local


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RISK AND RETURN FROM FOREIGN INVESTING

  • THE ADDITIONAL RISKS

    • EXCHANGE RATE RISK

      • DEFINITION:refers to uncertainty about the rate at which a foreign currency can be exchanged for the investor’s local currency in the future


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RISK AND RETURN FROM FOREIGN INVESTING

  • MANAGING EXCHANGE RATE RISK

    • involves using hedge instruments such as

      • currency forward contracts

      • currency options

      • currency futures


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RISK AND RETURN FROM FOREIGN INVESTING

  • MANAGING EXCHANGE RATE RISK

    • TWO APPROACHES:

      • passive currency management


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RISK AND RETURN FROM FOREIGN INVESTING

  • MANAGING EXCHANGE RATE RISK

    • TWO APPROACHES:

      • active currency management


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RISK AND RETURN FROM FOREIGN INVESTING

  • passive currency management

    • involves a strategy of permanently controlling a portfolio’s exposure to risk


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RISK AND RETURN FROM FOREIGN INVESTING

  • active currency management

    • involves a strategy of frequently changing currency exposures to take advantage of perceived short-run mispricings


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FOREIGN AND DOMESTIC RETURNS

  • THE DOMESTIC RETURN

    • FORMULA


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FOREIGN AND DOMESTIC RETURNS

  • THE FOREIGN RETURN

    • FORMULA


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FOREIGN AND DOMESTIC RETURNS

  • FOREIGN INVESTMENT

    • Two Parts:

      • the investment in the country’s firm(s)

      • the currency exposure


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FOREIGN AND DOMESTIC RETURNS

  • Calculating the return on foreign currency



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FOREIGN AND DOMESTIC RETURNS

  • Calculating the return on foreign currency

    • the return on a foreign security ( rF ) can be estimated by summing the domestic with the currency returns


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EXPECTED RETURNS

  • ON A FOREIGN SECURITY

    • FORMULA

    • If expected return differential exists, interest rate parity equates the two rates


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EXPECTED RETURNS

  • 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


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FOREIGN AND DOMESTIC RISK

  • Calculating Portfolio Risk

    • Formula:

      where

      sF= the risk of the foreign portfolio

      sD = the risk of the foreign stock

      sC = the risk of the foreign currency

      rDC= the correlation between the currency change and the asset returns


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FOREIGN AND DOMESTIC RISK

  • PORTFOLIO RISK

    • the smaller the value of the correlation coefficient, the lower the foreign portfolio risk



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