Transcript Asset Management - Universidade Nova de Lisboa

Asset Management
Lecture 16
Outline for today

International Diversification
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Emphasis for our investigation
 Risk assessment
 Diversification
3rd Case
The question set will be posted On April 22,
Wednesday.
 The report is due on May 1, Friday.

Market Capitalization of Stock Exchanges in
Developed Countries
Global Equity Market 2008
American SE
Bermuda SE
BM &FBOVESPA
Buenos Aires SE
Colombia SE
Lima SE
M exican Exchange
NASDAQ OM X
NYSE Euronext (US)
Santiago SE
TSX Group
Australian SE
Bombay SE
Bursa M alaysia
Colombo SE
Hong Kong Exchanges
Indonesia SE
Jasdaq
Korea Exchange
National Stock Exchange India
New Zealand Exchange
Osaka SE
Philippine SE
Shanghai SE
Shenzhen SE
Singapore Exchange
Taiwan SE Corp.
Thailand SE
Tokyo SE Group
Amman SE
Athens Exchange
BM E Spanish Exchanges
Borsa Italiana
Budapest SE
Cyprus SE
Deutsche Börse
Egyptian Exchange
Irish SE
Istanbul SE
Johannesburg SE
Ljubljana SE
London SE
Luxembourg SE
M alta SE
M auritius SE
NASDAQ OM X Nordic Exchange
NYSE Euronext (Europe)
Oslo Børs
SIX Swiss Exchange
Tehran SE
Tel Aviv SE
Warsaw SE
Wiener Börse
Table 25.2 Market Capitalization of Stock
Exchanges in Emerging Markets
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?
Foreign Exchange Risk
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Example:
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British T-bill pays 10% per year
The exchange rate is $2 per pound
The U.S. investor invests $20,000
What is the payoff in one year’s time?
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If the exchange rate does not change
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£10,000*1.1=£11,000=$22,000
If the pound depreciate to $1.8 by the end of the year
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£10,000*1.1=£11,000=$19,800
Returns with Foreign Exchange
E1
1  r (US )  1  rf (UK ) 
E0
Return in the foreign market
2. Return on the foreign exchange
In our example, when E0=$2/£, E1=$1.8/£
1+r(US)=1.1*1.8/2=0.99
r(US)=-1%
1.
Stock Market Returns in U.S. Dollars and
Local Currencies for 2005
Rates of Change in the U.S. Dollar Against
World Currencies, 2001 – 2005
Partly
diversifiable
exchange rate
risk
Hedging Exchange Rate Risk
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The use of futures or forward contracts
In our example:
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The U.S. investor can lock in a riskless
dollar-denominated return
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either by investing in UK bills and hedging
exchange rate risk
or by investing riskless U.S. assets
Hedging Exchange Rate Risk
F0
1  rf (UK ) 
 1  rf (US )
E0
rearranged:
F0 1  rf (US )

E0 1  rf (UK )
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Interest rate parity, covered interest arbitrage
E.g. The forward exchange rate F0=$1.93/£
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(1+0.1)*1.93/2=1.0615
The hedge would only be perfect if foreign
return is risk-free
Country Specific Risk
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Political Risk Services Group Ratings
Rank countries with respect to
political risk
 financial risk
 economic risk
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Composite Risk Rating for country risk
Popular support,
legislative
strength
Unemployment,
consumer
confidence,
Payment
delays,
poverty
contract viability
Civil war, terrorism
Judicial system,
law enforcement
Political Risk Points by Component
Composite Risk Rating for country risk
Table 25.6 Current Risk Ratings and
Composite Risk Forecasts
International Diversification
Benefits of international diversification
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expand the efficient frontier
reduce the systematic risk level
Risk and Return Across the Globe,
Investment
in emerging
markets are
riskier
Higher
average
returns
also?
But the
systematic
risk to a
U.S.
investor is
not
necessarily
higher.
Correlation for Asset Returns: Unhedged and
Diversification
Hedged Currencies
possibilities?
Limited benefit of
global diversification?
Diversification by Market Capitalization:
National Markets versus Regional Funds
Home bias
Home bias
 Preference for domestic securities
 Consumption in domestic currencies
 Information asymmetry
 Other explanations?
International Performance Attribution
Extension to consider additional factors
 Currency selection
 Country selection
 Stock selection
 Cash and bond selection