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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

CHAPTER TWENTY-FIVE

INTERNATIONAL INVESTING

the total investable interntational capital market portfolio
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
the total investable interntational capital market portfolio3
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%
the total investable interntational capital market portfolio4
THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL MARKET PORTFOLIO
  • GLOBAL EQUITY INDICES
    • MOST CLOSELY WATCHED:
      • FTSE100
      • NIKKEI225
      • TSE 300
the total investable interntational capital market portfolio5
THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL MARKET PORTFOLIO
  • INTERNATIONAL
    • EAFE (Morgan Stanley)
    • IFC (International Finance Corporation)
the total investable interntational capital market portfolio6
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
the total investable interntational capital market portfolio7
THE TOTAL INVESTABLE INTERNTATIONAL CAPITAL MARKET PORTFOLIO
  • EMERGING MARKET INDICES
    • Morgan Stanley
    • IFC: Emerging Market Index, national
risk and return from foreign investing
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
risk and return from foreign investing9
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
risk and return from foreign investing10
RISK AND RETURN FROM FOREIGN INVESTING
  • MANAGING EXCHANGE RATE RISK
    • involves using hedge instruments such as
      • currency forward contracts
      • currency options
      • currency futures
risk and return from foreign investing11
RISK AND RETURN FROM FOREIGN INVESTING
  • MANAGING EXCHANGE RATE RISK
    • TWO APPROACHES:
      • passive currency management
risk and return from foreign investing12
RISK AND RETURN FROM FOREIGN INVESTING
  • MANAGING EXCHANGE RATE RISK
    • TWO APPROACHES:
      • active currency management
risk and return from foreign investing13
RISK AND RETURN FROM FOREIGN INVESTING
  • passive currency management
    • involves a strategy of permanently controlling a portfolio’s exposure to risk
risk and return from foreign investing14
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
foreign and domestic returns
FOREIGN AND DOMESTIC RETURNS
  • THE DOMESTIC RETURN
    • FORMULA
foreign and domestic returns16
FOREIGN AND DOMESTIC RETURNS
  • THE FOREIGN RETURN
    • FORMULA
foreign and domestic returns17
FOREIGN AND DOMESTIC RETURNS
  • FOREIGN INVESTMENT
    • Two Parts:
      • the investment in the country’s firm(s)
      • the currency exposure
foreign and domestic returns18
FOREIGN AND DOMESTIC RETURNS
  • Calculating the return on foreign currency
foreign and domestic returns20
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
expected returns
EXPECTED RETURNS
  • ON A FOREIGN SECURITY
    • FORMULA
    • If expected return differential exists, interest rate parity equates the two rates
expected returns22
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

foreign and domestic risk
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

foreign and domestic risk24
FOREIGN AND DOMESTIC RISK
  • PORTFOLIO RISK
    • the smaller the value of the correlation coefficient, the lower the foreign portfolio risk