Chapter 3
The Global Market Investment
Decision 
  Prepared By : DR. Wael Shams EL-Din
Why Investment Opportunities Increase
The Reasons behind the expansion of investment
opportunities are the following :-
Growth and development of foreign financial markets
Advances in telecommunications technology
Mergers of firms and security exchanges
Why Investors Construct Global Portfolio?
 Foreign Markets can significantly increase the
investment choices for any investor.
 The rates of return on European securities have higher
return compared with U.S. securities.
 The Low correlation between U.S. stock markets and
many foreign markets can help to reduce Portfolio
risk.
Size of World Financial Markets
1969 2010
Value of the securities Trillion 2.30 $ Trillion $113.60
Contribution of USA in Stocks & Bonds 65% 47%
 Overall value of the securities available in world capital market has
increased from $2.3 Trillion in 1969 to $113.6 Trillion in 2010 and the U.S.
portion has declined to less than half.
 The share of the U.S. in world stock and bond markets has dropped from
about 65 percent of the total in 1969 to about 47 percent in 2010.
Risk of Combined Country Investments
 Diversification with foreign securities can help to reduce portfolio risk
because foreign markets have low correlation with U.S. capital
markets.
 The correlation of returns between a two countries changes over time
because the factors influencing the correlation change over time.
 Diversified portfolios reduce variability of returns over time.

 Correlation coefficients measure diversification contribution.

(+1) Mean Perfect Positive correlation, move together in the same direction .
(-1) Mean Perfect Negative correlation, move in opposite direction
Risk of Global Bond Portfolio
 Macroeconomic factors such as International Trade patterns, economic
growth, Fiscal Policies, and Monetary Policies cause the correlation of
bond returns between the United States and foreign Markets

 For a U.S. investor, the average correlation between foreign bond return
and U.S. bond return in U.S. dollars is about 0.58 from 1986 to 2010. while
U.S.–Canada correlation is 0.75, whereas the U.S.–Japan correlation is
only 0.34.
 Adding non-correlated foreign bonds to a portfolio of U.S. bonds increases
the rate of return and reduces the risk of the portfolio.
Risk of Global Equity Portfolio
 U.S. stocks and foreign stocks have small positive correlations
 Adding foreign securities to a U.S. portfolio will reduces risk by more than
what a domestic diversification strategy can achieve. Therefore, investors can
reduce the overall risk of their stock portfolios by including foreign stocks.

 The correlation of world equity markets look like bonds; however, the
average correlation and foreign markets is about 0.65, lower than that for
bonds from 1988 to 2010. Again, the U.S.–Canada correlation is 0.76,
whereas the U.S.–Japan correlation is only 0.42.
Recap on Global Investing
 The relative size of the market for foreign bonds and stocks
has grown in size , importance and becoming too big.

 The rates of return for foreign bond and stocks investments

are often superior to those in the U.S. market.

 In order to achieve successful diversification, an investor

should combine investments with low correlation between
rates of return.
Global Investment Choices
1. Fixed-Income Investment
2. International Bond investment
3. Equity Investments
4. Special Equity Instrument
5. Futures Contracts Investment
6. Investment Companies
7. Real Estate Investment
8. Low Liquidity Investments
1. Fixed-Income Investment
Instrument Definition
Saving A/C usually no Minimum Balance or Required Term
Certificates of Instruments that require minimum deposits for specified terms, and pay higher
Deposit (CD)
rates of interest than savings accounts. Penalty imposed for early withdrawal
 Treasury Bills
 Treasury Notes Backed and full trust by the Government 100%
 Treasury Bonds
 Municipal Bonds Are issued by state and local governments usually to
.finance infrastructural projects
Bonds  Corporate Bonds Corporate bonds indicate that bond is issued by corporations

 Mortgage Bonds is a bond secured by a mortgage or pool of mortgages, These

bonds are typically backed by real property
 Convertible Bonds Convertible bonds are convertible into shares of common stock, at
.a fixed price, at the option of the bondholder
 Zero Coupon Bonds Offered at a deep discount from the face value. No interest
payment during the life of the bond
Preferred Hybrid security with some features of both bonds and stocks
Stock
Saving Accounts & CDs
 Savings Accounts
o Fixed earnings
o Convenient
o Liquid and low risk
o Low rates
 Certificates of Deposit (CDs)
o Money Market Certificates
o Compete against Treasury bills (T-bills)
o Minimum amount required ( e.g. $10,000 in USA )
o Redeemable only at issuing bank
o Penalty if withdrawn before maturity but with six months
Treasury Securities
 Highly liquid Instruments, issued by the Treasury and Sold by
government agencies.
 Treasury Securities referred to government Instruments since it’s
issued by the U.S. federal government. It is reasonable to assume that
the federal government will make good on its promised payments, so
these Securities have no default risk ( it is known as RFR)
 Treasury Securities is guaranteed by federal government but Value of
the bonds itself May be decline when interest rates rise in the market.
 Type of Treasury Securities depend on the maturity:-
o T. Bills with a maturity less than 1 year
o T. Notes with a maturity in 1 - 10 years
o T. Bonds with a maturity over 10 years
Municipal Bonds (Munis)
 Municipal bonds are issued by state and local governments.
Like corporate bonds, have default risk. However, (Munis)
offer one major advantage over all other bonds: the interest
earned on most municipal bonds is exempt from federal
taxes and also from state taxes if the holder is a resident of
the issuing State.
 Consequently, municipal bonds carry interest rates that are
considerably lower than those on corporate bonds with the
same default risk.
Corporate Bonds
 Corporate bonds indicate that bond is issued by corporations but
corporate bonds are exposed to default risk (Credit Risk) if the issuing
company gets into trouble or Bankruptcy, it may be unable to make the
promised interest and principal payments.
 Different corporate bonds have different levels of default risk,
depending on the issuing company’s characteristics and the terms of the
specific bond. the larger the default or credit risk, the higher the interest
rate the issuer must pay

Risk Rating for Bonds

Investment Grade Junk Bonds

Moody’s Aaa Aa A Baa Ba B Caa C

S&P AAA AA A BBB BB B CCC D

Risk Rating
Long-Term Bonds Interest Spread
U.S. Treasury 5.25% Zero
AAA 6.25% 1.00%
AA 6.42% 1.17%
A 6.54% 1.29%
BBB 6.60% 1.35%
BB 7.80% 2.55%
B 8.42% 3.17%
CCC 10.53% 5.28%
Other Bonds –USA Market
 Mortgage Bonds : Secured by liens on specific assets

 Collateral trust Bonds: Secured by

o Financial Assets
o Equipment Trust Certificates
o Transportation Equipment
 Convertible Bonds
o Offer the upside potential of common stock and the downside protection of a bond
o Usually have lower interest rates
 Bonds with Warrants
o Allows bondholder to purchase the firm’s common stock at a fixed price for a given
time period
o Interest rates usually lower on bonds with warrants attached
 Zero Coupon Bond
o Offered at a deep discount from the face value
o No interest during the life of the bond, only the principal payment at maturity
Preferred Stock
 Preferred dividends are specified by contract, but they may
be omitted without placing the Firm in default.
 Most preferred stocks prohibit the firm from paying
common dividends when the preferred is in arrears.
  Preferred stock has no voting rights.

Advantages Disadvantages
Dividend obligation will not lead the Preferred dividends not tax deductible, so
company to bankruptcy. typically costs more than debt.

Avoids dilution of common stock , that Increases Financial Risk since preferred
occur when common stock sold ( such as dividends is considered as fixed cost.
Merge)

Avoids Large Repayment of Principal

(since there is no maturity.
2. International Bond Investing
Issuer Nationality Currency Sold in
Australian Company USD Japan
Eurobond
An international bond denominated in a currency other than the country where it is
issued. For example, Australian company issues a bond denominated in U.S. dollars
sold in Japan , The Australian company in this example could issue the Eurodollar bond
in any country other than the U.S.
Issuer Nationality Currency Sold in

Yankee Foreign Co ./ GOV. USD USA

Bonds
A bond that Sold in USA and denominated is Dollars, but issued by foreign
corporations or governments. This bond eliminates exchange risk to U.S. investors.
For example Japanese company/Government issue this bond in Dollars and sell it
within USA market. Issuer Nationality Currency Sold in
International Domestic Bonds Japanese Company JPY Japan

A bond that Sold by Issuer within its own country in that country’s currency. For
example a Japanese company issued a bond within Japan market denominated in
Japanese yen. While a U.S. investor enter Japan market to acquire this bond in
order to maximize diversification but he/she will incur the credit risk of the
company and exchange rate risk of the Japanese currency.
3.Equity Investments
 Common Stock
◦ Represents ownership of a firm
◦ Investor’s return depend on the performance of the management of the
corporate and may result in loss or gain
 Common Stock Classifications
 Industrial : Manufacturers of automobiles, machinery, chemicals, beverages
 Utilities: electrical power companies, gas suppliers, water industry
 Transportation: Airlines, truck lines, railroads
 Financial: Banks, insurance companies , credit unions
Acquiring Foreign Equities
 American Depository Receipts (ADRs)
o Easiest way to directly acquire foreign shares and may represent multiple shares
o Certificates of ownership issued by a U.S. bank that represents indirect ownership of a
certain number of shares of a specific foreign firm on deposit in a U.S. bank.
Instruments Currency Place of Trading
o Buy and sell in U.S. dollars GDR USD Outside America
o Dividends in U.S. dollars ADR USD Inside America
o Listed on U.S. exchanges EDR EURO Outside America
o Very popular, 361 out of 474 foreign companies on NYSE at the end of 2010

 Purchase of American Shares

o Issued in the United States by transfer fund to agent on behalf of a foreign firm
o Highly expenses
o Limited availability
Acquiring Foreign Equities
 Direct Purchase of Foreign Shares
◦ Direct buying of the foreign shares form firm’s own country but already
Listed on a stock exchange outside the home country (e.g., French firms on
London Stock Exchange.

 Global Mutual Funds or Exchange traded fund (ETFs)

◦ Global funds: Invest in both U.S. and foreign stocks
◦ International funds: Invest mostly outside the U.S.
◦ Funds can specialize
 Diversification across many countries
 Concentrate in a segment of the world
 Concentrate in a specific country
 Concentrate in types of markets
4.Special Equity Instruments
These are equity-derivative securities which have a claim on the
common stock of a firm.
Options
Option is a contract between 2 parties buyer and seller , this
contract give the buyer the right but not obligation to buy or sell
an underlying asset sometime in the future at price know today
and for this right the buyer has to pay premium.
Call Option : The Right to buy
Put Option : The Right to sell
Warrants
A warrant is a certificate issued by a company that gives the
holder the right to buy a stated number of shares of the
company’s stock at a specified price for specific time.
Generally warrant is issued with debt.
5. Futures Contracts
 A “Future Contract” is a commitment to deliver or receive a standardized quantity and
quality of a commodity (Cotton, Sugar, Orange juice or Gold ) or a Financial Instrument
at a specified future date.
 Futures Contracts is used as a hedge tool, in case the farmer believes that the price of a
particular commodity will be lower in the future. A cotton farmer wants to lock in a price
for an anticipated future sale (selling a still un-harvested crop) can sell his crop in the
Future market.
Characteristic of Future Contract
 Future contract is Always traded in organized exchange.
 Highly standardized contract Terms
 Future contract is guaranteed by clearinghouse which mean that clearinghouse guarantees
that all of the traders in the futures market will honor their obligations.(financial integrity
to all traders)
 Trader require to deposit a margin (10%) in order to trade the future contract to cover in
fluctuation in the prices .
 Regulated by government agency
Financial Futures
 Recently there are a future contracts on financial instruments such as T-bills,
Treasury bonds, Eurobonds, Various stock, and market index S&P 500.
6.Investment Companies
 Instead of buy individual securities directly from the issuer investor can
acquire shares/units in an investment company
 Investment companies sell its shares and uses proceeds to buy securities
from the market.
 By this way Investors can own a part of the portfolio of investment
company
Type of Portfolios
1. Money Market Funds
2. Bond Funds
3. Common Stock Funds
4. Balanced Funds
5. Index Funds
6. Exchange-Traded Funds (ETFs)
Money Market Funds
 Acquire high-quality, short-term investments
 Profits are higher than normal bank CDs
 Typical minimum investment is $1,000
 No sales commission charges
 Withdrawal is by check with no penalty
 Investments usually are not insured
 The total value of these funds reached almost $4 trillion in 2011

Bond Funds
Invest in long-term government, corporate, or municipal bonds
Bond funds vary in bond quality from the risk-free government bonds to
the high-yield or junk bonds
Expected returns also differ reflecting the risk level of bonds in the fund
Common Stock Funds
 Different funds with different investment objectives
 Aggressive growth income and valuable international stocks
 Offer diversification to smaller investors
 Sector funds concentrate in specific industry
 International funds invest outside the United States
 Global funds invest in the United States and other countries

Balanced Funds
Invest in a combination of stocks and bonds depending on their stated
objectives
Index Funds
These are funds created to track the performance of a market index like
the S&P 500
Appeal to passive investors who want to simply experience returns equal
to some market index
Many bond index funds have been created

Exchange-Traded Funds (ETFs)

These are depository receipts for a portfolio of securities deposited at a
financial institution in a unit trust that issues a certificate of ownership for
the portfolio of stocks
The stocks in a portfolio are those in an index like S&P 500 and many
other indexes
ETFscan be bought and sold continuously on an exchange market like
common stock
7.Real Estate
Real Estate Investment Trusts (REITs)
Investment

Development

Mortgage

Equity
fund that invests in a variety of real estate properties, similar to a stock or bond mutual fund
trusts provide builders with construction financing
trusts provide long-term financing for properties
trusts own various income-producing properties
Direct Real Estate Investment
A. Purchase of a home
B. Purchase of raw land
◦ Intention of selling in future for a profit
◦ Ownership provides a negative cash flow due to mortgage payments, taxes, and
property maintenance
C. Land Development
◦ Divide the land into individual lots
◦ Build houses or a shopping mall on it
◦ Requires capital, time, and expertise
D. Rental Property
◦ Acquire apartment buildings or houses with low down payments
◦ Create enough income from the rents to pay the expenses of the structure,
including the mortgage payments, and generate a good return
◦ Rental property provides a cash flow and an opportunity to profit from the sale of
the property
8. Low-Liquidity Investments

 Basic Concepts
◦ Some investments don’t trade on securities markets
◦ Lack of liquidity keeps many investors away
◦ Auction sales create wide fluctuations in prices
◦ Without notional markets, dealers incur high transaction costs
◦ Some may consider them more as hobbies than investments
8. Low-Liquidity Investments
Antiques
Some Individuals buying a few
pieces to decorate their home and
may have financial difficulty later.
Serious collectors are buying
these pieces at lower price and sell
them at higher price to make a good
returns.
Art
 Investor requires wide knowledge
art world, while acquiring good
work from a well-known artist
needs large amount of capital.
 The transaction cost is very high
while investor is facing great
uncertainty and extreme liquidity
risk.
8. Low-Liquidity Investments
Coins and Stamps Diamonds
Enjoyed by many peoples as hobby as well as Can be liquidated
investment Class can determines the value
Market is more liquid than art and antiques
Diamonds require large amount of funds
market
No positive cash flow until sold
Price lists are published weekly and monthly
Wide Costs of insurance and storage is very
spread between bid and ask prices
High
Risk & Returns on Art and Antiques
 Market data is very limited
 Results vary widely, and change over time
 We can’t generalize the results of the market , but there is a
reasonably relationship between risk and return
 Correlation is differ widely and allowing for great diversification
 Liquidity is still a big concern
Risk & Returns on Real Estate Investments
 Returns are difficult to derive due to lack of data
 Residential shows lower risk and return than commercial real estate
 Real Estate Investment Trusts (REITs) have shown:-
o higher returns with lower risk vs. stock in short-term
o but lower return with lower risk vs. stock in long-term
 Negative correlation between residential and stocks
 Low positive correlation between commercial real estate and stocks
 Potential for diversification
Thank You