Multinational financial management 7th CH15

Multinational Financial
Management
Alan Shapiro
7th Edition
Power Points by
J.Wiley & Sons

Joseph F. Greco, Ph.D.
California State University, Fullerton
1


CHAPTER 15
INTERNATIONAL
PORTFOLIO
INVESTMENT
2


CHAPTER OVERVIEW:
I.

THE BENEFITS OF INTERNATIONAL EQUITY INVESTING

II.

INTERNATIONAL BOND INVESTING

III.OPTIMAL ASSET ALLOCATION
IV.

MEASURING THE TOTAL RETURN

V.
MEASURING EXCHANGE RISK ON
SECURITIES

FOREIGN

3


I. THE BENEFITS OF INTERNATIONAL
EQUITY INVESTING
I.

THE BENEFITS OF INTERNATIONAL
EQUITY INVESTING
A.

Advantages
1.

Offers more opportunities than
a domestic portfolio only

2.

Larger firms often are overseas

4

THE BENEFITS OF INTERNATIONAL
EQUITY INVESTING
B.

International Diversification

1.
greater

Risk-return tradeoff: may be
basic rulethe broader the diversification,
more stable the returns and

the more diffuse the risk.

5


THE BENEFITS OF INTERNATIONAL
EQUITY INVESTING
2. International diversification and
a.

systematic risk

Diversifying across nations with
different economic cycles

6


THE BENEFITS OF INTERNATIONAL
EQUITY INVESTING
b. While there is systematic risk
within a nation, it may be
nonsystematic and diversifiable
outside the country.

7


THE BENEFITS OF INTERNATIONAL
EQUITY INVESTING
3.

Recent History
a.

National stock markets have wide
differences in returns and risk.

b.

Emerging markets have higher
risk and return than developed
markets.

c.

Cross-market correlations have
been relatively low.

8


THE BENEFITS OF INTERNATIONAL
EQUITY INVESTING
C. Correlations and the Gains From

Diversification

1. Correlation of foreign market betas
Foreign
market =
beta

Correlation
Std dev
with U.S.
x for. mkt.
market

std dev
U.S. mkt.

9

THE BENEFITS OF INTERNATIONAL
EQUITY INVESTING
2.

Past empirical evidence suggests

international diversification reduces

portfolio risk.

10


THE BENEFITS OF INTERNATIONAL
EQUITY INVESTING
3.

Theoretical Conclusion
International diversification pushes out
the efficient frontier.

11


THE BENEFITS OF INTERNATIONAL
EQUITY INVESTING
4. Calculation of Expected Return:

r

where

p

= ar

US

+ ( 1 - a) r

rw

r = portfolio expected return
p
r
r

US
rw

= expected U.S. market return
= expected global return

12


THE BENEFITS OF INTERNATIONAL
EQUITY INVESTING
5. Calculation of Expected Portfolio Risk = (σ )
P

σ = [a 2σ 2 + (1-a)2 σ
2 + 2a(1-a)
P
US
rw
σ

σ
σ
]1/2
US rw US,rw

where σ

US,rw

=
σ

2
US
σ
2
rw

the cross-market
correlation
=

U.S. returns variance

=

World returns variance

13


THE BENEFITS OF INTERNATIONAL
EQUITY INVESTING
6.

Cross-market correlations

a.
Recent markets seem to be
most correlated when volatility
is greatest
b.

Result:
Efficient frontier retreats

14


THE BENEFITS OF INTERNATIONAL
EQUITY INVESTING
D.

Investing in Emerging Markets
a.

Offers highest risk and returns

b.

Low correlations with returns
elsewhere

c.

As impediments to capital market

mobility fall, correlations are
likely to increase in the future.

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THE BENEFITS OF INTERNATIONAL
EQUITY INVESTING
E. Barriers to International Diversification
1.

Segmented markets

2.

Lack of liquidity

3.

Exchange rate controls

4.

Less developed capital markets

5.

Exchange rate risk

6.

Lack of information
a.
readily accessible
b.
comparable

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THE BENEFITS OF INTERNATIONAL
EQUITY INVESTING
F.

Methods to Diversify
1.

Trade in American Depository
Receipts (ADRs)

2.

Trade in American shares

3.

Trade internationally diversified
mutual
a.
b.
c.

funds:
Global
International
Single-country

17


II. INTERNATIONAL BOND
INVESTING
II. INTERNATIONAL BOND INVESTING
-internationally diversified bond
portfolios offer superior performance

18


INTERNATIONAL BOND
INVESTING
A. Empirical Evidence
1.

Foreign bonds provide higher
returns

2.

Foreign portfolios outperform
purely domestic

19


III. OPTIMAL INTERNATIONAL ASSET
ALLOCATION
III. OPTIMAL INTERNATIONAL ASSET
ALLOCATION
-a diversified combination of stocks and
bonds
A.

Offered better risk-return tradeoff

B.

Weighting options flexible

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IV. MEASURING TOTAL RETURNS
FROM PORTFOLIO INVESTING
IV. MEASURING TOTAL RETURNS
A.

Bonds

Dollar = Foreign x
Currency
gain (loss)
return

return

currency

21


MEASURING TOTAL RETURNS
FROM PORTFOLIO INVESTING
Bond return formula:
1 + R
$

[1 +

=

B(1) - B(0) + C

]

(1+g)

B(0)
where R =
dollar return
$
B(1) = foreign currency bond price at time 1
C =

coupon income

g =

depreciation/appreciation
of foreign currency

22


MEASURING TOTAL RETURNS
FROM PORTFOLIO INVESTING

B.

Stocks (Calculating return)
Formula:

1 + R
where

$

[ 1+

=

P(1) - P(0) + D

]

(1+g)

P(0)
= dollar return

R
$
P(1)
= foreign currency stock
price at time 1
D
= foreign currency annual

dividend

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