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Foundations of Multinational Financial Management Alan Shapiro John Wiley & Sons

Foundations of Multinational Financial Management Alan Shapiro John Wiley & Sons. Power Points by Joseph F. Greco, Ph.D. California State University, Fullerton. International Portfolio Investment. Chapter 15. THE BENEFITS OF INTERNATIONAL EQUITY INVESTING. I. THE BENEFITS OF INTERNATIONAL

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Foundations of Multinational Financial Management Alan Shapiro John Wiley & Sons

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  1. Foundations of Multinational Financial ManagementAlan ShapiroJohn Wiley & Sons Power Points by Joseph F. Greco, Ph.D. California State University, Fullerton

  2. International Portfolio Investment Chapter 15

  3. 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. INTERNATIONAL DIVERSIFICATION • B. International Diversification • 1. Risk-return tradeoff: • may be greater • basic rule- • the broader the diversification, • more stable the returns and the more diffuse the risk.

  5. INTERNATIONAL DIVERSIFICATION • 2. International diversification and systematic risk • a. Diversifying across nations with • different economic cycles • b. While there is systematic risk • within a nation, it may be • nonsystematic and diversifiable • outside the country.

  6. INTERNATIONAL PORTFOLIOINVESTMENT • 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.

  7. INTERNATIONAL PORTFOLIOINVESTMENT • C. Correlations and the Gains From Diversification • 1. Correlation of foreign market betas • Foreign Correlation Std dev • market = with U.S. x for mkt. • beta market std dev • U.S mkt. • Past empirical evidence suggests inter- • national diversification reduces portfolio • risk.

  8. INTERNATIONAL PORTFOLIOINVESTMENT • 3. Theoretical Conclusion • International diversification pushes out • the efficient frontier. • 4. 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

  9. INTERNATIONAL PORTFOLIOINVESTMENT • Calculation of Expected Portfolio Risk • P = [a 2US2 + (1-a)2 r w2 + 2a(1-a) USrw US,rw]1/2 • where US,rw = the cross-market • correlation • US2 = U.S. returns variance • r w2 = World returns variance

  10. CROSS-MARKET CORRELAITONS • 6. Cross-market correlations • a. Recent markets seem to be most correlated when volatility is greatest • b. Result: • Efficient frontier retreats

  11. Investing in Emerging Markets • 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.

  12. Barriers to International Diversification • 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

  13. Methods to Diversify • F. Methods to Diversify • 1. Trade in American Depository • Receipts (ADRs) • 2. Trade in American shares • 3. Trade internationally diversified • mutual funds: • a. Global • b. International • c. Single-country

  14. BOND INVESTING • II. INTERNATIONAL BOND INVESTING • internationally diversified bond • portfolios offer superior performance • A. Empirical Evidence • 1. Foreign bonds provide higher • returns • 2. Foreign portfolios outperform • purely domestic

  15. OPTIMAL INTERNATIONAL ASSETALLOCATION • III. OPTIMAL INTERNATIONAL ASSET • ALLOCATION • -a diversified combination of stocks and bonds • A. Offered better risk-return tradeoff • B. Weighting options flexible

  16. INTERNATIONAL PORTFOLIOINVESTMENT • IV. MEASURING TOTAL RETURNS • FROM FOREIGN PORTFOLIOS • A. Bonds • Dollar = Foreign x Currency return currency gain (loss) • return

  17. INTERNATIONAL PORTFOLIOINVESTMENT • Bond return formula: • where R$ = dollar return • B(1) = foreign currency bond price at time 1 • C = coupon income • g = currency depreciation or appreciation

  18. INTERNATIONAL PORTFOLIOINVESTMENT • B. Stocks (Calculating return) • Formula: • where R$ = dollar return • P(1) = foreign currency stock price at time 1 • D = foreign currency annual • dividend

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