Chapter 14 - International Investing - 6%

Question 1

What are the two important financial and capital market theories?

Answer 1

1. Capital Asset Pricing Model (CAPM)

2. Modern Portfolio Theory (MPT)

Question 2

What are the attributes that a passive benchmark must have?

Answer 2

1. The benchmark can be constructed in advance of analysis.
2. There is a well-defined methodology regarding individual security inclusion/exclusion rules and weighting.
3. It is entirely transaparent (regarding constituent compostion and weighting methodology)
4. Data is publicly available on a timely basis.
5. The benchmark is frequently valued (daily is the standard).
6. The benchmark has a long valuation history (preferable).
7. There are very few and infrequent changes in construction methodology.
8. The benchmark has investable constituents.

Question 3

What are the two most popular international equity market indices?

Answer 3

1. MSCI Inc.

2. S&P Dow Jones Indices

Question 4

What is MSCI EAFE?

Answer 4

MSCI’s Europe, Australasia and Far East (EAFE) equity market index is the most popular international equity market index by a substantial margin. It is designed to represent the performance of the equity markets in developed markets, excluding US and Canada.

The index is based on a selection of suitable stocks (ie., market capitalization, trading volume) from 21 countries.

EAFE is a free-float market capitalization index. This means that the weight of each company included in the index is based on the current number of shares outstanding, some of which might be in restricted hands. When constructing the index, MSCI first ranks the investable equities from largest market capitalization to smallest. This market capitalization is then used to populate their international equity market indices as follows:

• MSCI EAFE Large Cap Index: The top 70% of market capitalization
• MSCI EAFE Standard: The top 85% of market capitalization
• MSCI Investable Market Index (IMI): The top 99% of market capitalization

Question 5

What are S&P Dow Jones Indices?

Answer 5

S&P Dow Jones Indices publishes indices that pertain to global equity markets.

The S&P Global Broad Market Index (BMI) includes approx. 10,000 stocks from 26 developed markets and 20 emerging markets. The S&P Global BMI is a float-adjusted, market capitalization weighted index.

The S&P Global 1200 Index contain 1,200 stocks that comprise almost 70% of the world’s capital markets. The index has over a 50% weighting in US-based companies, which limits its ability to represent an international index for North American investors.

The S&P 1200 Global Index has some popularity with managers of global equity index products. It is often used as a basis for a number of structured investment products that provide global equity exposure.

Question 6

What are the primary advantages of International Investing?

Answer 6

There are 3 –

1. Diversification
2. Exposure to Emerging Markets
3. Exposure to Unique Companies

Question 7

What are the primary disadvantages and risks of international investing?

Answer 7

1. Expenses
2. Liquidity Risk
3. Legal and Accounting Bases
4. Shareholder Communications
5. Foreign Exchange Risk
6. Sovereign Risk

Question 8

Which type of foreign investment vehicle displays the most volatility?
A. American Depositary Share.
B. Actively traded mutual funds.
C. Individual country exchange-traded funds.
D. Private placement.

Answer 8

D. Private placement.

With generally smaller businesses and fewer shareholders, this is the most risky form of international investing.

Question 9

Which is the most widely used international equity market index?
A.	S&P Global 1200 index.		 	 
B.	S&P/TSX Composite Index.	 	 
C.	Dow Jones Industrial Average.		 	 
D.	MSCI EAFE index.

Answer 9

MSCI s Europe, Australia and Far East (EAFE) equity market index is the most popular international equity market index by a substantial margin. It is designed to represent the performance of the equity markets in developed markets, excluding the United States and Canada.

Question 10

What is true about American Depositary Shares (ADSs)?
A. They can be listed for any size international company.
B. They are U.S. and Canadian exchange listed.
C. They are growing as fast as the exchange-traded share market.
D. They hold a certain number of common shares of the issuer’s common stock.

Answer 10

D. They hold a certain number of common shares of the issuer’s common stock.

ADSs are exchange-listed shares of a trust, or special purpose company (SPC), whose sole purpose is to hold a certain number of common shares of the issuer’s common stock.

Question 11

What type of internationally themed exchange-traded fund would invest exclusively in foreign currency?
A.	Regional.		 	 
B.	Currency.
C.	Foreign Style.		 	 
D.	International Bond.

Answer 11

Only b) exclusively holds foreign currency.

Question 12

Which is a characteristic of an emerging market?
A. Less than efficient financial markets.
B. Full industrialization.
C. Similar regulatory coverage as developed nations.
D. Lower rates of economic growth.

Answer 12

A.

Emerging markets are less efficient.

Question 13

Why might an advisor ignore a model asset allocation of 65% in foreign equity?
A. Foreign markets are more volatile than domestic markets.
B. Overseas exchanges have longer settlement conventions.
C. Trading internationally is more expensive than trading domestically.
D. The foreign markets return data used in the model may have been very limited.

Answer 13

D.

Limited return data may skew asset allocation weight models.

Question 14

Which investment factor(s) might be used to sustain the usefulness of mean variance optimization in modelling portfolios that have international securities?

I. Country.
II. Asset class.
III. Industry.
IV. Company.

Answer 14

III and IV.

Industry and company factors may be more important than country or asset class factors in international investing.

Question 15

What type of ETF would only invest in companies that produce gold?
A.	Foreign dividend ETF.		 	 
B.	Commodity themed ETF.
C.	Foreign currency ETF.		 	 
D.	Regional ETF.

Answer 15

Generally, commodity themed ETFs invest directly or indirectly in commodities themselves or in the companies that produce commodities.

Question 16

Which of the following statements regarding exchange traded funds (ETFs) is true?
A. Institutional investors can invest in an ETF.
B. Most ETFs have active investment management styles.
C. Regional ETFs provide exposure to a specific region within a country.
D. The most popular ETFs tend to be individual country ETFs.

Answer 16

A. Institutional investors can invest in an ETF.

ETFs are investment options available to investors – both individual and institutional. Virtually all ETFs offered have passive investment management styles tracking the performance of popular international equity market indices. Broad-based international ETFs are designed to passively track widely used international equity indices, such as the EAFE, and are the most popular international ETFs. Regional ETFs provide exposure to a specific region or group of international equity markets. One popular regional ETF theme covers the BRIC group (Brazil, Russia, India and China).

Question 17

Which is an argument against international diversification?

A. Correlations between foreign equity markets are decreasing with time.
B. Correlations between foreign equity markets have not changed significantly over the past decade.
C. Correlations between foreign equity markets are increasing with time.
D. Returns on foreign equity markets have been decreasing with time.

Answer 17

C. Correlations between foreign equity markets are increasing with time.

In times of unstable North American capital markets, the volatility in various international markets increases. This recent phenomenon is creating situations where, in times of heightened U.S. market volatility, a client’s diversified portfolio that includes an international equity allocation actually declines in value more than the U.S. or Canadian stock market. This occurs because the foreign equity markets become more positively correlated. In these instances, most clients feel that diversification into international markets hurts, more than helps. Higher correlation among the world’s equity markets, during periods of both low and heightened volatility, might be one of the negative consequences of the ongoing capital market and economic globalization process.

Question 18

Which is/are true when comparing international investing to domestic investing for a Canadian investor?

I. Transaction costs tend to be higher in the domestic market than the international markets.
II. In times of crises, liquidity decreases faster in international markets than in domestic markets.
III. The bid-ask spreads are smaller for international issuers than for domestic issuers.

Answer 18

A. II only.

Almost all types of investment related fees are generally higher in international markets than those associated with domestic equity investments. In times of market stress, liquidity disappears more quickly in international markets than in domestic equity markets. Concurrent with less liquidity, the bid-ask spreads tend to be larger for international issuers as compared to their domestic counterpart. This essentially translates into higher costs in these markets.

Question 19

What is the share basis of a free-float market-capitalization index?
A.	Shares available in the market.
B.	Shares outstanding.	 	 
C.	Restricted shares.		 	 
D.	Treasury shares.

Answer 19

A. Shares available in the market.

These are shares readily available in the market.

Question 20

The recent behaviour of which statistical measure has placed into question the theoretical underpinning of international investing?
A.	R-squared.		 	 
B.	Correlation.	  	 
C.	Volatility.		 	 
D.	T-stat.

Answer 20

B. Correlation

Correlation has been strongly positive.

Question 21

What is an advantage to investing in international markets?
A. Getting timely information on foreign firms.
B. Similar costs to domestic investing.
C. Better liquidity than domestic markets.
D. Exposure to firms with no North American peer.

Answer 21

D. Exposure to firms with no North American peer.

There are some foreign firms with no North American counterpart.

Question 22

Where could a foreign company get exposed to sovereign risk?
A. The capital markets in which it borrows.
B. The stock exchange where its shares are listed.
C. The national markets into which it sells its products.
D. The country of origin of its employees.

Answer 22

C. The national markets into which it sells its products.

Sovereign risk also applies to the countries in which a firm does business.