Multinational Finance

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Multinational Finance

• Multinational Portfolio Management
• Dr. George Ogum

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OUTLINE

• Key Terminologies
• Investment Setting
• International Risks
• Diversification
• Benefits of International Diversification
• Methods of International Diversification
• Effects of changes in Exchange Rates
• Foreign Exchange Risk Management

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KEY TERMINOLOGIES

• Modern Portfolio Theory
• MPT involves two factors
• Diversification
• Attitudes of investors toward risk
• MPT assumes that investors are concerned only
  with
• Expected return and
• Standard deviation

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KEY TERMINOLOGIES

• PORTFOLIO vs. SINGLE SECURITY
• RISK ANALYSIS
• Stand Alone Risk (Standard Deviation)
• Portfolio Return and Risk
• Optimal Portfolio
• CAPITAL ASSET PRICING MODEL (CAPM)
• Assumes total risk consists of
• systematic (undiversifiable) risk
• unsystematic (diversifiable) risk
• CAPM is expresses as Rj Rf Bj (RmRf)

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CAPITAL ASSET PRICING MODEL (CAPM)

• Rj Rf Bj (RmRf)
• Where
• Rj expected rate of return on security j
• Rf riskless rate of interest
• Rm expected rate of return on market
  portfolio
• Bj is the Beta or systematic risk of
  security j
• Bj (RmRf) risk premium

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INVESTMENT SETTING

• GOAL OF INVESTMENT
• Wealth creation
• Process of Investment
• GAMBLING, SPECULATION AND INVESTMENT
• INVESTORS
• Cannot control RETURN
• Can control the RISKS
• TIME VALUE OF MONEY
• NATIONAL vs. GLOBAL MARKET

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INTERNATIONAL RISKS

• FOREIGN EXCHANGE RISK
• Interest Rate Differential
• Inflation Rate Differential
• Income Level Differential
• Expectations
• SOVEREIGN (COUNTRY) RISK
• INTERNATIONAL LIQUIDITY RISK
• INTERNATIONAL INFORMATION RISK

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DIVERSIFICATION

• The holding of many securities to lessen risk
• INTERNATIONAL ASSET PRICING
• Based on efficient markets theory
• International market efficiency is viewed in
  terms of international market integration or
  segmentation
• Capital Asset Pricing Model (CAPM) extended to
  international Model (IAPM) is the building block
  to asset pricing

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BENEFITS OF INTERNATIONAL DIVERSIFICATION

• HIGHER STABLE RETURN
• INCREASED RETURN
• LOWER RISK
• SUPERIOR HEDGED PORTFOLIOS

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BARRIERS TO INTERNATIONAL DIVERSIFICATION

• Segmented markets
• Lack of liquidity
• Exchange rate controls
• Less developed capital markets
• Exchange rate risk
• Lack of information
• Readily accessible
• comparable

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METHODS OF INTERNATIONAL DIVERSIFICATION

• PURCHASE INTERNATIONAL MUTUAL FUNDS
• Global funds
• International funds
• Regional funds
• Country funds
• PURCHASE AMERICAN DEPOSITORY RECEIPTS (ADRs)
• DIRECT PURCHASE OF FOREIGN SECURITIES
• INVESTMENT IN MULTINATIONAL COMPANIES (MNCs)

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EFFECT OF EXCHANGE RATE RISK (EXCHANGE
RATE EXPOSURE)

• Translation Exposure (Accounting Exposure)
• The impact of changes in exchange rates on the
  financial statements
• Transaction Exposure
• Potential gain or losses on the future settlement
  of outstanding obligations denominated in foreign
  currency
• Economic Exposure
• Potential for change in the present value of
  future cash flows due to unexpected change in
  exchange rates

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FOREIGN EXCHANGE RISK MANAGEMENT

• Balance Sheet Hedge
• Forward Market Hedge
• Money Market Hedge
• Swap Transaction
• Options Market Hedge

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SUMMARY

• Empirical Evidence Suggest
• That foreign bonds provide higher returns
• Foreign portfolios outperform purely domestic
  portfolios
• Internationally diversified bond portfolios offer
  superior performance

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SUMMARY

• Investing in Emerging Markets
• Offers highest risk and returns
• Has low correlations with returns elsewhere
• As impediments to capital market mobility fall,
  correlations are likely to increase in the future.