International Portfolio

1

• International Portfolio
• Investment
• (chapter 17 in Hirschey and Nofsinger)

2
Developed vs Emerging Markets

• Factors that are used to classify the worlds
  financial markets
• in developed and emerging markets
• the size and scope of the equity, fixed income
  and derivatives markets
• the sophistication of the local market
  professionals
• liquidity and transaction costs
• quality and quantity of financial information
• financial regulations, business laws, ethics,
  investor protection

3
Market Capitalization

• Almost 90 of the total market capitalization of
  the worlds equity markets is accounted for by
  the market capitalization of the developed world
• The other 10 is accounted for by the market
  capitalization of developing countries in
  emerging markets.
• Latin America
• Asia
• Eastern Europe
• Mideast/Africa

4
Risks of investing in international markets

• sovereign (political) risk
• Sovereign governments have the right to regulate
  the movement of goods, capital, and people
  across their borders
• in general, financial managers and investors
  incorporate a political risk premium when foreign
  activities are being evaluated
• Ex ethnic strife in Indonesia currency controls
  in Malayasia expropriation in Africa and Central
  America changes in taxes and regulations

5
Risks of investing in international markets

• liquidity risk refers to how quickly an asset
  can be sold without a major price concession
• - The equity markets of the developed world tend
  to be much more liquid than emerging markets
• - Emerging markets have limited investability

6
Risks of investing in international markets

• Information risk most investors prefer to invest
  in assets that
• are more familiar with
• foreign language
• limited access to information
• lack of disclosure
• unfamiliar accounting system

7
Risks of investing in international markets

• Foreign Exchange Risk
• - Foreign operations are conducted in foreign
  currencies.
• - When firms and individuals are engaged in
  cross-border transactions they are exposed to
  foreign exchange (FX) risk.
• - The foreign currency profits, costs, revenues
  in dollar terms depends on exchange rate
  movements.
• - FX risk affects the cost of capital and the
  capital structure of a MNC firm

8
International Correlation Structure and
Diversification

• Correlations between countries are not stable
  through time
• Security returns are much less correlated across
  countries than within a country.

9
The Optimal International Portfolio
OIP
1.53
JP
UK
FR
US
GM
CN
4.2
10
International Diversification through
International Mutual Funds

• A U.S. investor can easily achieve international
  diversification by investing in a U.S.-based
  international mutual fund.
• The advantages include
• Savings on transaction and information costs.
• Circumvention of legal and institutional barriers
  to direct portfolio investments abroad.
• Professional management and record keeping.

11
International Diversification through Country
Funds

• Recently, country funds have emerged as one of
  the most popular means of international
  investment.
• A country fund invests exclusively in the stocks
  of a single country. This allows investors to
• Speculate in a single foreign market with minimum
  cost.
• Construct their own personal international
  portfolios.
• Diversify into emerging markets that are
  otherwise practically inaccessible.

• ETFs (Exchange Traded Funds)/ World Equity
  Benchmark Shares (WEBS or iShares)
• Country-specific baskets of stocks designed to
  replicate the country indexes

12
Trading in International Equities

• During the 1980s world capital markets began a
  trend toward greater global integration
• Diversification, reduced regulation, improvements
  in computer and communications technology,
  increased demand from MNCs for global issuance.
• Cross-Listing refers to a firm having its equity
  shares listed on one or more foreign exchanges.
• Foreign stocks often trade on U.S. exchanges as
  ADRs.
• It is a receipt that represents the number of
  foreign shares that are deposited at a U.S. bank.
• The bank serves as a transfer agent for the ADRs

13
American Depository Receipts

• There are many advantages to trading ADRs as
  opposed to direct investment in the companys
  shares
• ADRs are denominated in U.S. dollars, trade on
  U.S. exchanges and can be bought through any
  broker.
• Dividends are paid in U.S. dollars.
• Most underlying stocks are bearer securities, the
  ADRs are registered.

14
Why Home Bias in Portfolio Holdings?

• Home bias refers to the extent to which portfolio
  investments are concentrated in domestic
  equities.
• Explanations for home bias

15
Learning outcomes

• discuss the characteristics that differentiate
  the developed from emerging markets
• discuss the following risks of investing in
  international markets sovereign, liquidity,
  foreign exchange , information
• what are the benefits and risks of investing
  internationally
• discuss how an investor can diversify
  internationally through mutual funds, ETFs,
  country funds and ADRs
• explain what is an ADR and why investors invest
  in them
• what is home bias and factors that affect it