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International Portfolio Investment. Chapter Twenty Two Eiteman, Stonehill, & Moffett. Relevant statistics for a return distributions for a single asset. Expected return use the mean of historical returns to estimate Standard deviation

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International portfolio investment

International PortfolioInvestment

Chapter Twenty Two

Eiteman, Stonehill, & Moffett

Chapter 15 - Portfolio Investment


Relevant statistics for a return distributions for a single asset
Relevant statistics for a return distributions for a single asset

  • Expected return

    • use the mean of historical returns to estimate

  • Standard deviation

    • use the standard deviation from historical returns to estimate

  • Covariance

    • use covariance with other return distributions to estimate correlation and asset betas

Chapter 15 - Portfolio Investment


Statistics
Statistics. asset

Chapter 15 - Portfolio Investment


Correlation
Correlation asset

  • Correlation normalizes covariance

    • value of +1 means perfect positive correlation

    • value of 0 means independence

    • value of -1 means perfect negative correlation

Chapter 15 - Portfolio Investment


Relevant statistics for a portfolio of many assets
Relevant statistics for a portfolio of many assets - asset

Chapter 15 - Portfolio Investment


Portfolio risk
Portfolio Risk asset

Chapter 15 - Portfolio Investment


Two asset portfolio
Two-asset Portfolio asset

Preferred Portfolio

Ep

Efficient Set

Opportunity Set

Risk preferences

SDP

Chapter 15 - Portfolio Investment


Implications of correlation statistics
Implications of Correlation Statistics asset

  • The lower the pairwise correlation of two assets, the greater the diversification benefit of adding those assets to your portfolio

  • Adding assets which have low pairwise correlation with each other to your portfolio reduces overall portfolio risk

Chapter 15 - Portfolio Investment


Affects of correlation
Affects of Correlation asset

Ep

High positive

Correlation

Low positive

Correlation

SDP

Chapter 15 - Portfolio Investment


Assets with high positive correlation
Assets with high positive correlation asset

r

T

Chapter 15 - Portfolio Investment


Assets with low positive correlation
Assets with low positive correlation asset

r

T

Chapter 15 - Portfolio Investment


Four asset portfolio
Four-asset Portfolio asset

Portfolios with

assets A , B, C & D

Ep

Portfolios with

assets C & D

Portfolios with

assets A & B

SDP

Chapter 15 - Portfolio Investment


Calculating portfolio values four asset portfolio
Calculating Portfolio values - four asset portfolio asset

Chapter 15 - Portfolio Investment


Multiple asset portfolios calculating portfolio values
Multiple-asset portfolios - calculating portfolio values asset

Chapter 15 - Portfolio Investment


Multiple asset portfolio
Multiple-asset Portfolio asset

Ep

SDP

Chapter 15 - Portfolio Investment


Systematic risk
Systematic Risk asset

SDp

All Canadian

equity portfolio

SDC

SDW

International

Portfolio

N

Chapter 15 - Portfolio Investment


International diversification
International Diversification asset

World Equities

Efficient Frontier

Ep

Canadian Equities

Efficient Frontier

SDP

Chapter 15 - Portfolio Investment


Systematic risk1
Systematic Risk asset

  • As you diversify your portfolio by adding assets, your portfolio standard deviation decreases

  • When you are fully diversified, your risk is the risk of the market portfolio

  • By changing portfolio proportions you can modify risk to suit your preferences

Chapter 15 - Portfolio Investment


Optimal portfolio
Optimal Portfolio asset

U2

U1

Capital

Market

Line

Less risk averse

EM

More

risk

averse

SDM

Chapter 15 - Portfolio Investment


Relevant statistic for a fully diversified portfolio beta
Relevant statistic for a fully diversified portfolio - Beta asset

  • Beta measures only the systematic risk of an assets

  • Beta is also a covariance that is normalized by something, the variance of the market

Chapter 15 - Portfolio Investment


The risk free asset
The Risk-free Asset asset

  • The risk-free asset does not exist except as a theoretical concept

  • The least risky asset is the T-bill

    • Low default risk - government backing

    • Low interest rate risk - very short-term security

Chapter 15 - Portfolio Investment


Capital asset pricing model
Capital Asset Pricing Model asset

  • Prices the risk of asset relative to its systematic risk

  • gives the required rate of return relative to its systematic risk

Chapter 15 - Portfolio Investment


Security market line
Security Market Line asset

rM

=1

Chapter 15 - Portfolio Investment


Security market line change in rate of inflation
Security Market Line - assetChange in rate of inflation

rM

rM

Inflation adjustment

=1

Chapter 15 - Portfolio Investment


Security market line change in risk premium
Security Market Line - assetChange in Risk Premium

rM

rM

Slope change

reflecting increased

Systematic Risk

=1

Chapter 15 - Portfolio Investment


Country markets
Country Markets asset

  • Are the efficient

    • perfect information

      • few market reporting requirements

    • price takers

      • few buyers, few sellers

    • no transactions costs

      • capital controls

      • foreign content rules

Chapter 15 - Portfolio Investment


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