FBFN624: INVESTMENT AND RISK

ANALYSIS

INTERNATIONAL INVESTMENT AND

DIVERSIFICATION
INTERNATIONAL INVESTMENT
AND
DIVERSIFICATION
DR.DAUDI LWIZA- TUDARCo
drlwiza.dl@gmail.com
+255 653 539 483/+255 784 539 481

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 OVERVIEW OF THE TOPIC

 Meaning of international investment

 Types of international investment
 Factor affecting international investment
 Players in international investment
 International investment strategies
 Benefits of the international investment
 Risk involved in international investments
 Barriers to international investment
 International diversification
 Method of international diversification
 Modern portfolio theory
 Portfolio construction
 Barriers of international diversification

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International Investment
 International investment refers to the type of
investment in which individuals or institutional
investors’ channel or deploy their resources to projects
or portfolios in a foreign country with the aim of
achieving firms growth/owners wealth/higher
return/diversification

 Forms of International Investment

 Foreign Direct Investment (FDI)

 Foreign Portfolio Investment (FPI)

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Foreign Direct Investment(FDI)
 FDI refers to an investment made by a company or
entity based in one country, into a company or entity
based in another country.
 The investing company may make its overseas investment
in a number of ways - either by (i) setting up a subsidiary
or associate company in the foreign country, (ii) by
acquiring shares of an overseas company, or
(iii)through a merger or (iv) joint venture.
 An example of foreign direct investment would be an
American company taking a majority stake in a company in
China. Another example would be a Canadian company
setting up a joint venture to develop a mineral deposit in
Tanzania.

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 Types of Foreign Direct Investment
(FDI)
 Horizontal FDI arises when a firm duplicates its home country-
based activities at the same value chain stage in a host country
through FDI.
 Vertical FDI takes place when a firm through FDI moves
upstream or downstream in different value chains i.e., when
firms perform value-adding activities stage by stage in a vertical
fashion in a host country.
 Arguments for FDI
 Raising the Level of Investment
 Up gradation of Technology
 Improvement in Export Competitiveness
 Employment generation
 Benefits to Consumers
 Revenue to Government
 Mention other arguments for FDI
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Argument against FDI
 Foreign investment brings about the loss of political
and economic sovereignty.
 It controls key industries and export markets.
 It exploits local natural resources and unskilled
workers.
 It undermines indigenous cultures and societies by
imposing Western values and lifestyles on developing
countries.
 Add other arguments against FDI.

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Foreign Portfolio Investment
 Foreign Portfolio Investment refers to as 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 international
markets and provide diversification as well as allow
investors to further diversify their assets by moving away
from a domestic-only portfolio.
 Examples of Foreign Portfolio Investment includes; the
purchase of shares in a foreign company or the purchase of
bonds from another government.

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Factors Affecting International
Portfolio Investment
 Tax rate on interest or Dividend -Investors
normally prefer to invest in a country where the taxes
on interest or dividend income from investment are
relatively low.
 Interest rates -Money tends to flow to countries with
high interest rates, as long as the local currencies are
not expected to weaken.
 Exchange Rates

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Factors Affecting International
Investment
 The Foreign Investment Decision-Making Process: 11
steps/phases:
 The decision to search for foreign investment (internal and
external factors)
 The political climate
 The company’s overall strategy
 Cash flow analysis
 The cost of capital
 Economic evaluation
 Selection
 Risk analysis
 Implementation, Control, and Post-Audits Implementation
 Control
 Post audit
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Players in International Investment
 Multi- National Corporations
 Arbitragers
 Government as a regulatory authority
 Sovereign Wealth Funds, Mutual Funds, Hedge Funds
 Non government organizations (NGO’S)

International Investment Strategies

 Contract manufacturing
 Franchising agreements
 Licensing agreements
 Equity alliances
 The joint venture
 Mergers and acquisitions (external growth)
 Construction of new plants (internal growth)-Greenfield
Investments
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Benefits of International
Investment
Company Benefits
 MNCs invest their capital abroad to utilize their oligopoly-
created advantages. The use of such oligopolistic
advantages could enable an MNC to reduce its cost of
capital and to increase its profitability, thereby increasing
the value of the firm.
Host country benefits
 There are three basic forms of cross-border financial flows:
portfolio investment, FDI, and bank lending.
 FDI forms one of the most important links between
developing and industrial countries because it is stable.
Host-country benefits conti….
 Foreign investment induces the transfer of technology and skills that
are frequently in short supply.
 It increases both national employment and domestic wages.
 It provides local workers with an opportunity to learn managerial skills.
 It contributes to tax revenues and helps balance/improve the
international balance of payments

 Risks involved in international investment

 Political risks
 Operational restrictions
 Expropriation
 Foreign exchange risk
Risk of government nationalization
of investments (reasons)
 The government believes that it could run the
business more efficiently or/and is strategic to
national interest and security
 The government believes that the company is
concealing its profits.
 Left-wing governments, often times after being
elected, nationalize business firms.
 Wish to win popular support as they save jobs by
putting dying industries on a life support system.
 The government can control a company or industry by
pumping money into the company or industry.
 Barriers to International
Investment
 Excessive information and transaction costs;
 Double taxation of foreign investment profits;
 Foreign-exchange regulations and currency risk;
 Greater rate-of-return volatility;
 Unfamiliarity with operating procedures of foreign
stock exchanges;
 Unavailability of high-quality financial data for
foreign companies; and
 Significant delays of transactions and settlements
associated with foreign securities.
INTERNATIONAL DIVERSIFICATION
 Essentially the concept of International Diversification can
be explained as from the convincing bodies of literatures
holds the concept that: internationally diversified
portfolios are better than domestically diversified
portfolios on the essence that an international
diversified portfolio provides higher level of return
provided the market levels of risks.
 This is because the foreign investment tends to be less
closely correlated with domestic investments - thus
Investors will now be able to lower portfolio risk without
adversely affecting portfolio return under diversification
principle.

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International diversification Views;
 Financial View
 International diversification is an investment technique intended to
minimize risk by utilizing a wide variety of investments within a
portfolio.
 Political view
 The attempt of reducing risk by investing in more than one
nation. By diversifying across nations whose economic cycles are
not perfectly correlated, investors can typically reduce the
variability of their returns. This is done to reduce risk, often political
risk.
 International diversification basically lies on the spreading and pricing
of securities on an integrated world capital market.
 Economic view
 International diversification aims at spreading the investment risk
among different foreign companies and markets that are
different from that of the investor.
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Need of International Diversification
 Since it’s difficult to predict which market will be a top
performer in a given year, then it is eminent to hold a
portfolio that is diversified across a number of countries.
 Essentially also due to the movements of independent
global markets which react to factors such as different
domestic monetary and fiscal cycles and incentives
 Also when we diversify internationally in countries with
low cross-correlations. This is expected to result in an
increase of both return and reduction in volatility at
the total portfolio level over a long period of time. In
other words, it helps to improve the risk adjusted
performance of a portfolio.

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 Methods of Int. Diversification
 International diversification for FPI can be
done through one of the following
methods:
 Direct Purchases of Foreign Securities
 Depository Receipts (ADRs, GDRs, EDRs etc
 International Mutual Funds
 Hedge Funds
 Investment in Local Multinational Companies –operating
abroad
 Global investing

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MODERN PORTFOLIO THEORY

 The portfolio theory is concerned with risk reduction

when an investor switches from complete commitment
of one asset to diversified assets (optimal portfolio),
 For example shares in one company or one project, to
the position where resources are split between two or
more assets.
 But in the context of international diversification, the
portfolio theory is concerned with risk reduction when
an investor switches from complete commitment of
resources to one country to several countries.

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Assumptions of MPT
 Investors minimize one-period expected portfolio utility,
and their utility curves demonstrate diminishing marginal
utility of wealth.
 Investors estimate the risk of the portfolio on the basis of
the variability of expected returns. Thus, investors base
decisions solely on expected return and risk,
 For a given risk level, investors prefer higher returns
to lower returns.
 Similarly, for a given level of expected returns,
investors prefer less risk to more risk.
 All investors have the access to the same information at the
same time.
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Assumption cont……
 All investors are rational and risk averse. It does
not allow investors for “herd behaviour” or investors
who will accept lower return for high risk.
 Any investor can lend and borrow an unlimited
amount at the risk free rate of interest. In reality
every investor has a credit limit.
 NB: the fundamental point under the portfolio
theory is this despite the differences, each
investor will be able to invest in an efficient
portfolio, that is, one that gives the highest return
for a given level of risk.

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 Portfolio Construction
 A portfolio refers to a collection of investment vehicles
such as stocks, bonds, units in mutual funds and so on
depending on an investor income, budget and
convenient time frame.
 Top-down managers will normally come to a decision
as to which portfolio to hold only after the country
allocations have been decided. This may be followed
by asset allocation and currency allocation
decisions
 In a international portfolio construction major focus
is on geographical mix;

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 From a modern portifolio Theory we learn that the assets
allocation decision accounts for 60%-80% of the variability
of total portifolio returns,with stock selection accounting
for the reminder.As a result,greater emphasis is placed on
asset allocation decisions
 Major considerations for selecting countries in which
to invest includes:
 Valuation criteria

 Volatility of returns

 Correlation of country returns

 Economic conditions

 Imposed constraints (internally)

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Portifolio Management Strategy

 One can define a portfolio management as the act of

selecting the right investment policy for the individual
in term of maximum return in a given time.

 In managing a portifolio containing international

assets,three factors have to be considered:
 Asset allocation
 Weighting of the international versus domestic assets
 Location of the international asset management group

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 Currency Management of an
International Asset Portfolio
 Currency management has become an integral part of
in recent years of international portfolio management.
 Currency management can be viewed as overlay
management, where you superimpose your currency
view over the existing assets and establish the desired
currency exposures
 Research has shown that currency movements have
played a significant part in the determination of a
manager’s total return and the volatility of those
returns. Active management of currency positions
may give the highest return

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Currency Management (cont…)
 When investing in overseas assets a portfolio
manager has three choices in currency
management
 No hedging

 Totally hedged

 Active currency management (using both

internal and external currency risk
management methods) – (Assignment:
Explain them briefly).
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Barriers of International Diversification
 Legal barriers
 Informational barriers
 Economic impediments
 Currency control barriers
 Political instability
 Specific tax regulation
 Exchange risk
 Lack of readily accessible comparable information on
potential foreign security acquisitions

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The status of international investment in Tanzania
The World Investment Report 2015 which was officially launched
on 24th June 2015 has indicated that FDI rose by 14.5% into the
United Republic of Tanzania. The FDI inflows into Tanzania
represented its highest level in 2014 given that it attracted slightly
over $ 2,142 million compared to its last peak of $ 2,131 million in
2013. This amount is significantly higher than the very low level of
$ 640 million that flowed into the country between 2005-2007 (pre-
crisis). This achievement is primarily due to gas discoveries in the
United Republic of Tanzania.
Currently Tanzania as a developing country has a very limited ability
to invest in other countries in terms capital market, physical
investment like industries or plants, also investments in terms of
service providing companies. Many of the international investment
activities are conducted by developed nations through MNC’s that
are investing in developing nations like Tanzania example Barclays
Bank, and Vodacom Telecommunication Company (Mention and
discuss
11/15/2012 other examples in Tanzania). 28
 Thank you for your attentive
listening and active
participation

04/02/2016
29
REFERENCES
Bhalla, V.K (2010) Investment Management: Security analysis and Portifolio
management, 16TH edition, New Delhi; S. Chand & Company LTD

Singh, Preeti (SP): Investment Management, 2nd edition Bombay; Himalaya

Publishing House.

Alexander, G.J, Sharpe, W.F, and Bailey, J.V (ASBa) (2006) Fundamentals of
Investments 3rd Edition, Pearson Education.

Baisi M.D (2006) Fundamentals of Financial Management, University of Dar es

Salaam Business School.

February 4, 2016 from http://en.wikipedia.org/wiki/Foreign_direct_investment (14:30pm

February 3, 2016 http//www.investopedia.com/terms/i/internationalportfolio.asp

(14:57pm)

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