Tài chính doanh nghiệp - Chapter 25: International diversification

Chapter 25International DiversificationGlobal market US Market is 40% - 49% of all marketsImproved access & technologyNew instrumentsEmphasis for our investigationRisk assessmentDiversificationBackgroundWhat are the risks involved in investment in foreign securities?How do you measure benchmark returns on foreign investments?Are there benefits to diversification in foreign securities?IssuesForeign Exchange RiskVariation in return related to changes in the relative value of the domestic and foreign currency.Total return = investment return & return on foreign exchangeIt’s not possible to completely hedge a foreign investment.Foreign Exchange RiskReturn in US is a function of two factors:1. Return in the foreign market2. Return on the foreign exchangeReturns with Foreign ExchangeCondition: U.S. Investor invests $10,000 in the British MarketInitial Conditions:Initial Investment : $20,000Initial Exchange: $2.00/ Pound SterlingInitial Investment in Pound Sterling: 10,000Risk Free Rate in U.K.: 10%Future Value in Pound Sterling: 11,000Returns with Foreign Exchange: ExamplePound Depreciates to $1.80 11,000 * 1.8 = $19,800 Return in US$ (-200 / 20,000) = -1%Pound Remains at $2.00 11,000 * 2.0 = $22,000 Return in US$ (2,000 / 20,000) = 10%Pound Appreciates to $2.20 11,000 * 2.20 = $24,200 Return in US$ ( 4,200 / 20,000) = 21% Returns with Foreign ExchangeReturns with Foreign ExchangeMovements in foreign exchange can have a major influenceFrom Figure 25.2New Zealand nearly 50% of return is from foreign exchangeAustralia virtually all of the return in from foreign exchangeReturns from U.K. and Switzerland are mostly from returns in local currencyBoth factors must be considered in international investingPolitical Risk Services Group RatingsRank countries with respect to political risk, financial risk and economic riskAssign composite rating from very high risk to very low risk based on the above elements of riskCountry Specific RiskPSR Risk VariablesPolitical Risk VariablesGovernment stability, corruption etcFinancial Risk VariablesForeign debt (%GDP), Exchange rate stability etcEconomic Risk VariablesGDP per capita, annual inflation etcEvidence shows international diversification is beneficial.It’s possible to expand the efficient frontier above domestic only frontier.It’s possible to reduce the systematic risk level below the domestic only level.Diversification BenefitsGains From International DiversificationReturnRisk********DomInt’lSystematic Risk Level with InternationalRiskSecuritiesInt’lDomDirect stock purchasesAmerican depository receiptsMutual FundsOpen-end fundsClosed-end fundsWEBSInternational Investment ChoicesIndexesEAFE IndexIssues in measuring performanceWeightingCross-HoldingsOther possibilitiesCountry and Region FundsMeasuring Benchmark ReturnsPerformance Attribution with InternationalExtension to consider additional factorsCurrency selectionCountry selectionStock selectionCash and bond selection