Lecture 10.

INTERNATIONAL PORTFOLIO INVESTMENTS

Apalkova Viktoriia
PhD, Associate Professor, Department of International Economics
 Content
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 FOREIGN SECURITIES
VI. INTERNATIONAL STATISTICS

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International portfolio
• An international portfolio is a grouping
of investment assets that focuses on
securities from foreign markets rather
than domestic ones.
• An international portfolio is designed to
give the investor exposure to growth in
emerging and developed markets and
provide diversification.

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I. INTERNATIONAL STATISTICS

https://data.imf.org/?sk=B981B4E3-4E58-467E-9B90-9DE0C3367363

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I. THE BENEFITS OF INTERNATIONAL EQUITY INVESTING

A. Advantages

1. Offers more opportunities than a

domestic portfolio only
2. Larger firms often are overseas

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I. THE BENEFITS OF INTERNATIONAL EQUITY INVESTING

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.

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I. THE BENEFITS OF INTERNATIONAL EQUITY INVESTING

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.

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I. THE BENEFITS OF INTERNATIONAL EQUITY INVESTING

2. International diversification and systematic risk

Systematic risk refers to the risk

inherent to the entire market or
market segment.
Systematic risk, also known as
“undiversifiable risk,” “volatility” or
“market risk,” affects the overall
market, not just a particular stock or
industry.
This type of risk is both unpredictable
and impossible to completely avoid.

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I. THE BENEFITS OF INTERNATIONAL EQUITY INVESTING

2. International diversification and systematic risk

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.

Recent
statistics:https://data.worldbank.or
g/indicator/CM.MKT.LCAP.CD

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I. THE BENEFITS OF INTERNATIONAL EQUITY INVESTING

C. Correlations and the Gains From Diversification

1. Correlation of foreign market betas

Beta describes the activity of a security's returns responding to swings in

the market. A security's beta is calculated by dividing the product of the
covariance of the security's returns and the market's returns by the
variance of the market's returns over a specified period.

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I. THE BENEFITS OF INTERNATIONAL EQUITY INVESTING

C. Correlations and the Gains From Diversification

2. Past empirical evidence suggests

international diversification
reduces portfolio risk.

3. Theoretical Conclusion
International diversification pushes
out the efficient frontier.

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I. THE BENEFITS OF INTERNATIONAL EQUITY INVESTING

4. Calculation of Expected Return:

rp = a rdm + ( 1 - a) rrw
where
rp = portfolio expected return
rdm = expected domestic market return
rrw = expected global return

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I. THE BENEFITS OF INTERNATIONAL EQUITY INVESTING

5. Calculation of Expected Portfolio Risk = (P )

P = [a 2dm2 + (1-a)2 r w2 + 2a(1-a)

dmrw dm,rw]1/2

where dm,rw = the cross-market

correlation
dm2 = domestic returns
variance
r w2 = World returns variance
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I. 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

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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I. THE BENEFITS OF INTERNATIONAL EQUITY INVESTING

E. Barriers to International Diversification

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I. 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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II. INTERNATIONAL BOND INVESTING

II. INTERNATIONAL BOND INVESTING

-internationally diversified bond
portfolios offer superior performance

An international bond is a debt investment that is issued in a country

by a non-domestic entity. International bonds are issued in countries
outside of domestic country, in their native country's currency.

International bonds include Eurobonds, foreign bonds, and

global bonds.

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II. INTERNATIONAL BOND INVESTING

A. Empirical Evidence http://cbonds.com/

1. Foreign bonds provide higher returns

2. Foreign portfolios outperform purely domestic
Amounts Outstanding of International Bonds and Notes, Currency of Issue in Euro
(DISCONTINUED)

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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

IV. MEASURING TOTAL RETURNS

A. Bonds

Dollar = Foreign x Currency

return currency gain (loss)
return

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V. 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
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 List of related articles

Literature for reading

1. Nelson Camanho, Harald Hau, Hélène Rey “Global Portfolio
Rebalancing And Exchange Rates” Working Paper, 24320,
http://www.nber.org/papers/w24320
2. Luis M. Viceira, Zixuan (Kevin) Wang “Global Portfolio
Diversification for Long-Horizon Investors”,
https://www.nber.org/papers/w24646
3. Isha Agarwal, Grace Weishi Gu, Eswar S. Prasad“China's Impact on
Global Financial Markets” Working Paper,
https://www.nber.org/papers/w26311
4. Market capitalization of listed domestic companies (current US$)
https://data.worldbank.org/indicator/CM.MKT.LCAP.CD
5. https://www.theglobaleconomy.com/rankings/St
ock_market_return/
6. http://cbonds.com/
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Thank you for your attention!

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