International portfolio investment
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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.

Chapter 15 - Portfolio Investment


Correlation

Correlation

  • 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 -

Chapter 15 - Portfolio Investment


Portfolio risk

Portfolio Risk

Chapter 15 - Portfolio Investment


Two asset portfolio

Two-asset Portfolio

Preferred Portfolio

Ep

Efficient Set

Opportunity Set

Risk preferences

SDP

Chapter 15 - Portfolio Investment


Implications of correlation statistics

Implications of Correlation Statistics

  • 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

Ep

High positive

Correlation

Low positive

Correlation

SDP

Chapter 15 - Portfolio Investment


Assets with high positive correlation

Assets with high positive correlation

r

T

Chapter 15 - Portfolio Investment


Assets with low positive correlation

Assets with low positive correlation

r

T

Chapter 15 - Portfolio Investment


Four asset portfolio

Four-asset Portfolio

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

Chapter 15 - Portfolio Investment


Multiple asset portfolios calculating portfolio values

Multiple-asset portfolios - calculating portfolio values

Chapter 15 - Portfolio Investment


Multiple asset portfolio

Multiple-asset Portfolio

Ep

SDP

Chapter 15 - Portfolio Investment


Systematic risk

Systematic Risk

SDp

All Canadian

equity portfolio

SDC

SDW

International

Portfolio

N

Chapter 15 - Portfolio Investment


International diversification

International Diversification

World Equities

Efficient Frontier

Ep

Canadian Equities

Efficient Frontier

SDP

Chapter 15 - Portfolio Investment


Systematic risk1

Systematic Risk

  • 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

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

  • 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

  • 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

  • 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

rM

=1

Chapter 15 - Portfolio Investment


Security market line change in rate of inflation

Security Market Line - Change in rate of inflation

rM

rM

Inflation adjustment

=1

Chapter 15 - Portfolio Investment


Security market line change in risk premium

Security Market Line -Change in Risk Premium

rM

rM

Slope change

reflecting increased

Systematic Risk

=1

Chapter 15 - Portfolio Investment


Country markets

Country Markets

  • 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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