International Investing

Summary :

Interational investing has some special risks. Here is what Securities and Exchange Commission has to say about these risk, which divides into seven different categories: Changes in the currency exchange rate, dramatic changes in market value, political, economic, and social events, lack of liquidity, less information, reliance on foreign legal remedies, and different market operations.

Calculation of Expected Return: rp  =  a rUS  +  ( 1 - a) rrw

where  rp = portfolio expected return   rUS = expected U.S. market return  rrw  = expected global return

Calculation of Expected Portfolio Risk = (sP )  sP =  [a 2sUS2 + (1-a)2 sr w2 + 2a(1-a)                                                                         sUSsrw sUS,rw]1/2

where  sUS,rw =the cross-market correlation, sUS2 =U.S. returns variance, sr w2 =World returns variance

Barriers to International Diversification: Segmented markets, Lack of liquidity, Exchange rate  controls, Less developed capital markets, Exchange rate risk, and Lack of information. Methods to Diversify: Trade in American Depository Receipts (ADRs), Trade in American shares, and Trade internationally diversified mutual funds (Global, International, and Single-country)

Measuring Total Returns Bonds: Dollar return  =  Foreign currency return x  Currency gain (loss)

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

Stocks (Calculating return) Formula:  1  +  R$=[ 1+ P(1) - P(0) + D  ](1+g)

                                                                                                P(0)

where: R$ =  dollar return, P(1)=  foreign currency stock price at time 1, D =  foreign currency annual dividend

Analyse

The recent surge in international portfolio investments reflects the globalization of financial markets. Specifically, many countries have liberalized and deregulated their capital and foreign exchange markets in recent years. In addition, commercial and investment banks have facilitated international investments by introducing such products as American Depository Receipts (ADRs) and country funds. Also, recent advancements in computer and telecommunication technologies led to a major reduction in transaction and information costs associated with international investments. In addition, investors might have become more aware of the potential gains from international investments.

Security returns are less correlated probably because countries are different from each other in terms of industry structure, resource endowments, macroeconomic policies, and have non-synchronous business cycles. Securities from a same country are subject to the same business cycle and macroeconomic policies, thus causing high correlations among their returns.

In an efficient market, the performance of emerging markets should be about in line with expectations. This means that the expected risk-adjusted return on emerging markets should be just about equal to that on developed country markets. Emerging markets can be expected to outperform developed country markets only if investors perceive the former markets to be riskier and thereby demand a risk premium (relative to developed country markets) for investing in them.