Transcript chpt25 - Banks and Markets

Bodie
Kane
INVESTMENTS
Marcus
Fourth Edition
Chapter 25
International
Diversification
Irwin/McGraw-Hill
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 The McGraw-Hill Companies, Inc., 1999
Bodie
Kane
INVESTMENTS
Marcus
Fourth Edition
Background
Global market
- US Market is 40% - 45% of all markets
- Improved access & technology
- New instruments
 Emphasis for our investigation
- Risk assessment
- Diversification

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 The McGraw-Hill Companies, Inc., 1999
Bodie
Kane
INVESTMENTS
Marcus
Fourth Edition
Issues
What 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?

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 The McGraw-Hill Companies, Inc., 1999
Bodie
Kane
INVESTMENTS
Marcus
Fourth Edition
Diversification Benefits
Evidence shows international diversification
is beneficial
 Possible to expand the efficient frontier
above domestic only frontier
 Possible to reduce the systematic risk level
below the domestic only level
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 The McGraw-Hill Companies, Inc., 1999
Bodie
Kane
INVESTMENTS
Marcus
Fourth Edition
Efficient Frontier with International
Diversification
Int’l
Return
** *
*
*
*
*
Dom
*
Risk
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 The McGraw-Hill Companies, Inc., 1999
Bodie
Kane
INVESTMENTS
Marcus
Fourth Edition
Systematic Risk Level with
International Diversification
Risk
Dom
Int’l
Securities
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Bodie
Kane
INVESTMENTS
Marcus
Fourth Edition
International Investment Choices
Direct stock purchases
 American depository receipts
 Mutual Funds
- Open-end funds
- Closed-end funds
- WEBS

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Kane
INVESTMENTS
Marcus
Fourth Edition
Risks in International Investing
Political Risks
 Expropriation of assets
 Restrictions on foreign exchange
 Political instability
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Bodie
Kane
INVESTMENTS
Marcus
Fourth Edition
Risks in International Investing
Foreign Exchange Risk
 Variation in return related to changes in the
relative value of the domestic and foreign
currency
 Total return = investment return & return on
foreign exchange
 Not possible to completely hedge a foreign
investment
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 The McGraw-Hill Companies, Inc., 1999
Bodie
Kane
INVESTMENTS
Marcus
Fourth Edition
Returns with FX

Return in US is a function of two factors
1. Return in the foreign market
2.Return on the foreign exchange
Irwin/McGraw-Hill
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 The McGraw-Hill Companies, Inc., 1999
Bodie
Kane
INVESTMENTS
Marcus
Fourth Edition
Returns with FX
(1 + rUS) = (1 + rFM) (1 + rFX)
rUS = return on the foreign investment in US
Dollars
rFM = return on the foreign market in local
currency
rFX = return on the foreign exchange
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 The McGraw-Hill Companies, Inc., 1999
Bodie
Kane
INVESTMENTS
Marcus
Fourth Edition
Return Example: Dollar Appreciates
Initial Investment : $100,000
Initial Exchange: $2.00/ Pound Sterling
Final Exchange:$2.10/ Pound Sterling
Return in British Security: 10%
Return in US Dollars
(1 + rUS) = (1.10) (1.05) = (1.155)
rUS = 15.5%
Irwin/McGraw-Hill
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 The McGraw-Hill Companies, Inc., 1999
Bodie
Kane
INVESTMENTS
Marcus
Fourth Edition
Return Example: Dollar Depreciates
Initial Investment : $100,000
Initial Exchange: $2/ Pound Sterling
Final Exchange: $1.85/ Pound Sterling
Return in British Security: 10%
Return in US Dollars
(1 + rUS) = (1.10) (.9250) = (1.0175)
rUS = 1.75%
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 The McGraw-Hill Companies, Inc., 1999
Bodie
Kane
INVESTMENTS
Marcus
Fourth Edition
Measuring Benchmark Returns
Indexes
 EAFE Index
 Issues in measuring performance
- Weighting
- Cross-Holdings
 Other possibilities
- Country and Region Funds

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 The McGraw-Hill Companies, Inc., 1999
Bodie
Kane
INVESTMENTS
Marcus
Fourth Edition
Performance Attribution with
International Investment
Extension to consider additional factors
 Currency selection
 Country selection
 Stock selection
 Cash and bond selection
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 The McGraw-Hill Companies, Inc., 1999
Bodie
Kane
INVESTMENTS
Marcus
Fourth Edition
Security Analysis with
International Investments
Accounting rules and conventions complicate
security analysis
 Depreciation
 Reserves
 Consolidation
 Taxes
 P/E ratios
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 The McGraw-Hill Companies, Inc., 1999