Primeasia University

Assignment on
Diversification Analysis of International Project

Course Code: FIN402

Course Title: International Finance

Submitted to:

Mohammad Nazrul Islam

Assistant Professor
School of business
Primeasia University

Submitted By:

Maria Akter
ID:173008045
Primeasia University

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 Table of content

SN Content Page No
1. Introduction 2
2. Measure of diversification 2
3. The Effects of International Diversification on Portfolio Risk 2
4. Impact of diversification and internationalization on company 3
performance
5. Multinational Business Diversification on the Financial 4
Sustainability
6. Conclusion 5

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Introduction
With the ever growing global economy, understanding international stock market
correlations has become a vital instrument for investors wishing to diversify their
portfolios on a global basis. Therefore, for investors to have effective international
portfolio diversification, it is important to determine the countries whose stock prices
move together, those whose stock prices move in opposite directions and those whose
stock prices are unrelated all together. Countries whose stock prices move in the same
direction (comovements) are considered positively correlated while countries whose
stocks move in opposite directions are negatively correlated. According to the principle
of diversification, a portfolio containing mainly positively correlated assets holds the
portfolio at a higher risk than a portfolio with stock prices that are negatively correlated.

In addition, investors wishing to diversify a risky investment, such as stocks in an

emerging market, through international diversification, would have more success in
countries found to be negatively correlated as well. The lack of accurate determination of
stock market price movements holds any portfolio at a higher risk level than necessary
due to the presence of the diversifiable risk.

Measure of diversification

Various measures of firm diversification have been developed over the past decades. The
current study uses entropy measure as shown in eq. [1] to calculate the levels of
diversification, which is called diversify index (DI).

The Effects of International Diversification on Portfolio Risk

With an increasing global economy, understanding international stock market movements
in order to diversify a portfolio is very important for effective allocation of investment
funds. In the first exercise in this study, we showed that a portfolio containing the two
European (DAX and CAC) indices had the highest risk of all portfolios. As hypothesized,
the German and French markets were found to be highly correlated from the regression.
Combining these two indices into a portfolio did little to reduce risk as confirmed by the
theory that perfectly positively correlated indices would not reduce risk. Since these
markets were not perfectly positively correlated, the risk level on the portfolio was less
than the German index alone, however it was still higher than the French.

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As seen in this study and other past studies, a strong interconnectivity is being formed
among stock markets. The U.S. market was found to have a strong positive correlation
with the German index. However, since the correlation was still significantly less than the
correlation of the French market, when the U.S. index is added to the European portfolio,
the risk level is decrease dramatically. This shows that diversification ofless correlated
indices will allow further risk reduction as theory had predicted.Lastly, risk was further
reduced when a market found to have no correlation to the

German index was added to the portfolio. Even with the extraordinarily high standard
deviation ofthe Chinese index alone, when added to a portfolio that contains uncorrelated
markets, risk can significantly be reduced. What does remain from the Chinese index,
however is part of its high rate ofreturn.

Since the risk level of the U.S. index and the portfolio with all four indices are similar,
any risk-adverse investor would be indifferent to either option. Because of the other
higher rates ofretum that are combined into the portfolio, the U.S. index would appear to
be a less attractive investment. Thus, a rational investor would chose to diversify across
all four markets.

Unfortunately, the macro variables selected did not predict well. Market movements must
be, to some extent, independent ofthese macro shocks to the economy. This suggests that
predicting movements in these global, competitive and local shocks may not be good
guides for allocation purposes. Future research can look for better ways to predict these
movements, probably using different variables than those selected here.

Impact of diversification and internationalization on

company performance
Prior to analyzing the impact of diversification and internationalization on the financial
performance of construction companies, multicollinearity between the variables of the
bootstrap truncated regression model was tested. One common metric to evaluate
multicollinearity is the variance inflation factor (VIF) (see Gujarati 2002). A value of VIF
greater than 10 suggests that multicollinearity may cause problems with the estimations.
The VIF values for the regressors (independent and control variables) included in the
bootstrap truncated regression models ranged between 1.02 and 9.11, meaning that
multicollinearity is not problematic.

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To analyze the effect of diversification and internationalization on the financial
performance of construction companies, two bootstrap truncated regressions were
estimated separately for Portugal and Spain. The bootstrap truncated regression models
include the bias-corrected within country performance as dependent variable,
diversification and internationalization as independent variables, and company age, size
and year as control variables.

The total number of observations included in the bootstrap truncated regression model for

Portugal was 28808 and for Spain it was 62067, which corresponds to all observations
analyzed in all years (see data in Table 1). The bootstrap truncated regression models are
statistically significant (χ2 test with p-value < 0.0001). Table 4 reports the results of the
estimation of the bootstrap truncated regression models, i.e. the coefficients and the
standard errors.

Multinational Business Diversification on the Financial

Sustainability

Recently, the construction business has experienced challenges due to the recession in
real estate business. The recession in the domestic residential construction business,
which occupies a high proportion of the business portfolio of construction firms,
contributes to the deteriorating financial stability of construction firms. To resolve this
situation, additional sources of profit should be

secured by expanding to various markets based on the existing business sector. From this
perspective, expansion to overseas markets by construction firms can be considered
reasonable in terms of multinational diversification. However, as noted in previous
studies, a diversification strategy can be linked to poor corporate performance.
Accordingly, in this study, empirical analysis was performed using the VEC model to
determine whether this business strategy of construction firms affects the financial
sustainability of construction firms.

However, construction firms’ overseas construction expansion is blamed unconditionally

based on the relevant results, which is problematic. Expansion to overseas markets is
essential for construction firms’ survival because of the limitations of the domestic

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construction market. Actually, previous research mentioned that even if there is not profit
directly, it is important to secure business opportunities consistently [44]. Accordingly,
multinational diversification of construction firms through expansion of the overseas
construction market could be considered a rational decision.

Overall, multinational business diversification is advisable in terms of enhancement of

business opportunities. However, for succeeding with this strategy, it is necessary to
secure the capability to execute overseas construction business stably. In other words,
because overseas construction business is more at risk than domestic construction
business, construction firms have to prepare accurate feasibility examinations and
systematic risk management strategies for overseas construction projects.

For that, construction firms need to establish diverse local business network for not only
securing technical skills but planning business strategies effectively.

Conclusion:

Pattern of diversification, through which issues of business diversification for the

international contractors can be investigated. Our findings suggest that large firms with
rich resources may do well in diversification. The rule for diversification is not “the
more, the better”, and it may not even be the best strategy to compete. The international
contractors could follow the suggested proper diversification level but decide their own
diversification level accordingly.

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