Chapter 25: International Diversification Flashcards
Who has the higher equity market cap, USA or Canada?
USA, accounts for 42.87% of world portfolio, while Canada is at 2.67%.
Takeaway, invest in US stocks more!
Developing Equity markets does what for a country?
allowing citizens to own, trade, sell, and capitalize off of capital assets is an important requirement for economic advancement
- usually countries with larger cpaital markets tend to have a higher GDP per capita (how much does the one citizen produce?)
- with more companies and more people to invest in them, it’s not a mystery why these countries do well in terms of GDP
What is the MSCI classification Framework? (Used for identifying Developing, Emerging, Frontier countries)
- Economic Development - such as income per capita
- Size (market cap) and liquidity reqirements (only for individual secutities)
- Market accessibility criteria: aims to reflect international investor’s experience of investing in given market
- openesses to foreign ownership
- ease of capital inflows/outflows
What is the MSCI?
Morgan Stanley Capital International: MSCI Inc provides investment indices, risk tools, and analytics to investors and hedge funds. Its indices are also public.
- Indices are plural for index, have their own index(s)
The MSCI World Index Country Allocation, is based on only??
23 developed market countries, with USA being first and Japan second
What are Emerging countries? (not Developed)
- still undergoing industrialization
- transitioning from low income → to higher standard of living
- economies often is growing faster than developed countries (due to replicating technological advances of develped countries)
- higher political risk
Examples: China, Korea, India, Brazil,
Explain Frontier Markets
- they’re at the edge/boundary (frontier) from being classified as emerging
- countries are too small, and carry too much risk, and too illiquid
- political and economic risk
Example: Serbia, Croatia
What is Home Country Bias and what does it mean for investors?
Home Country Bias: invetsors tend to hold a large majority of their investments in thier home country
* ex. Canadian invetsors hold mostly Canadian invetsments
Usually due to lack of knowledge to international opportunities
What is an ADR?
American depositary receipt (ADR): is a certificate issued by a U.S. bank that represents shares in foreign stock. (often 1:1, could be 1:5)
- 1:1 means one ADR equals one share of the foreign stock.
- 1:5 means one ADR represents five shares of the foreign stock.
- ADRs are priced in US dollars, to avoid currency conversions
- follow US regulations
- allows for simplified access to foreign stocks
- are traded on US markets liek NASDAQ or NYSE
Goal: allows US citizens to have easy access to foreign stocks
Why it is called this: “American Depositary Receipt” means a certificate (or receipt) issued by a U.S. bank that represents ownership of foreign shares held on deposit.
What are some major risks to look into when your think about international investing?
Conduct a Qualititative Analysis
1. Political Risk (ex. China bans foreign tech, reducing prfits)
2. Exchange Risk (ex. euro weakens aganist the us dollar)
3. Economic Risk (country’s ability to pay off its debts, considers inflation and levels of productivity GDP)
4. Fiancial Risk (risk of defualt on bonds) and Transfer Risk (challenges to withdraw profits)
A foreign investment is simultaneously an investment in an overseas asset and in a ____ currency
foreign
what are some ways to hedge foreign currency
- Future Contracts
- Forward Contracts
- Borrow funds in Foreign Currency (Arbitrage)
What is the difference between Integration vs Segmentation, in terms of the relationship between foreign, domestic markets, and risk/return
Also include the factors affecting Segmentation
If assets in foreign marketes + doemstic markets = same risk/return. Then, the markets are **fully integrated **
If assets in foreign markets + domestic markets ≠ same risk/return. Then, the markets are segmentated
Factors causing segmentation include:
1. Legal barriers: limitation of foreign ownership
2. Indirect barriers: lack of access to credible financial information
Interntional Diversification reduces the amount of ___ of your portfolio, even lower than domestic ___.
risk, risk
What are the 3 rules of Thumb for Passive Diversification?
Include Country indexs in order of
1. Market capitalization (high to low)
2. Beta against Canada (from low to high) - want lower volatility
3. Country index standard deviation (from high to low) - Argue for low to high (lower risk and less dispersion from average return)
