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Chapter 24 Managing an International Investment Portfolio

Chapter 24 Managing an International Investment Portfolio. 24.1 Vehicles for Overcoming Capital Flow Barriers 24.2 Asset Allocation Policy and Managerial Style 24.3 Cross-Border Financial Statement Analysis 24.4 The Shifting Sands of Portfolio Analysis 24.5 Portfolio Hedging Strategies

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Chapter 24 Managing an International Investment Portfolio

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  1. Chapter 24Managing an International Investment Portfolio 24.1 Vehicles for Overcoming Capital Flow Barriers 24.2 Asset Allocation Policy and Managerial Style 24.3 Cross-Border Financial Statement Analysis 24.4 The Shifting Sands of Portfolio Analysis 24.5 Portfolio Hedging Strategies 24.6 Summary

  2. Vehicles for overcoming capital flow barriers • Domestic-based MNCs • Individual foreign securities • Direct purchase in the foreign market • Direct purchase in the domestic market • Foreign shares (e.g. American shares in the U.S.) • Depository receipts (e.g. ADRs in the U.S.) • Mutual funds specializing in foreign securities • Closed-end and open-end mutual funds • Closed-end country funds • Hedge funds - private investment partnerships • Other international investment vehicles • Equity-linked Eurobonds • Stock index futures, options, and swaps

  3. Closed-end country funds • Closed-end country funds invest in a single country’s stocks • CECFs trading on the NYSE include Brazil Germany Italy India Korea Mexico Malaysia South Africa Spain Switzerland Taiwan Thailand United Kingdom • The CECFs of restricted markets can trade at substantial premiums or discounts to net asset value. • classic portfolio maximization • investor sentiment

  4. Hedge funds • Hedge funds are private investment partnerships • a general manager and fewer than 100 limited partners • unregulated (as long as each partner passes SEC accreditation) • Hedge fund strategies include • arbitrage • emerging markets • market-neutral • opportunistic • short-selling • small-cap • special situations • value • yield-curve arbitrage

  5. Portfolio management styles • Asset allocation policy • target weights on asset classes • Investment philosophy • Passive fund management • often benchmarked to an index • Active fund management • active asset allocation • active security selection

  6. Cross-border financial statement analysis • Accounting systems influence statement analysis • Legalistic accounting systems • Emphasis is on the legal entity • Used in “code law” countries such as France and Germany • Accounting rules consist of “thou shalts” • Nonlegalistic accounting systems • Emphasis is on the economic entity • Used in “common law” countries such as the United Kingdom and the United States • Accounting rules consist of a list of “thou shalt nots”

  7. Cross-border financial statement analysis • Differences in financial accounting measure are particularly prominent in accounting for • Goodwill • Discretionary reserves • Pension liabilities • Inflation accounting

  8. Cross-border financial statement analysis:International financial disclosure • Responses to the need for financial information • Do nothing • Prepare convenience translations • Restate selected items • Prepare financial statements using another country’s accounting principles • There are notable international differences in financial disclosure requirements

  9. Portfolio analysis • Inputs to portfolio analysis • E[RP] = Si Xi E[Ri] • Var(RP) = Si Xi2si2 + SiSj Xi Xj sij i¹j • The shifting sands of portfolio analysis • Time-varying expected returns • Time-varying risk premiums • Time-varying volatilities • Time-varying correlations

  10. 60-month rolling correlationswith the U.S. stock market

  11. National markets during the international stock market crash of October 1987

  12. Are Cross-Country Correlations Constant? Longin & Solnik estimated national stock market correlations during periods of high and low market volatility assuming constant correlations ri,us between index i and the U.S. market.* * Francois Longin and Bruno Solnik, “Is the Correlation in International Equity Returns Constant?” Journal of International Money and Finance, No. 1, 1995.

  13. Are Cross-Country Correlations Constant? National stock market returns were modeled with autoregressive variances: si,t2 = ai + bisi,t-12 + ci si,t-12 where si,t-12 = conditional variance from previous period si,t-12 = square of return during previous period ai, bi, and ci are constants for stock market index i Conditional covariance is si,us:t = ri,ussi,tsus,t given conditional variances si,t2 and sus,t2

  14. Are Cross-Country Correlations Constant? Correlation with U.S. market Calm Volatile Unconditional Country periods periods correlation Canada 0.729 0.753 0.723 France 0.331 0.525 0.407 Germany 0.327 0.461 0.353 Japan 0.265 0.366 0.297 Switzerland 0.458 0.650 0.508 U.K. 0.468 0.525 0.469

  15. The benefits of currency risk hedging

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