Topic 7 - Investment Portfolio Investment Flashcards
Security returns are found to be less correlated across countries than within a country. Why can this be?
Security returns are less correlated probably because countries are different from each other in terms of industry structure, resource endowments, macroeconomic policies, and have non-synchronous business cycles. Securities from a same country are subject to the same business cycle and macroeconomic policies, thus causing high correlations among their returns.
Explain the concept of the world beta of a security.
The world beta measures the sensitivity of returns to a security to returns to the world market portfolio. It is a measure of the systematic risk of the security in a global setting. Statistically, the world beta can be defined as: Cov(Ri, RM)/Var(RM), where Ri and RM are returns to the i-th security and the world market portfolio, respectively.
Explain how exchange rate fluctuations affect the return from a foreign market measured in dollar terms. Discuss the empirical evidence on the effect of exchange rate uncertainty on the risk of foreign investment.
It is useful to refer to Equations 15.4 and 15.5 of the text. Exchange rate fluctuations mostly contribute to the risk of foreign investment through its own volatility as well as its covariance with the local market returns. The covariance tends to be positive in most of the cases, implying that exchange rate changes tend to add to exchange risk, rather than offset it. Exchange risk is found to be much more significant in bond investments than in stock investments.
Evaluate a home country’s multinational corporations as a tool for international diversification.
Despite the fact that MNCs have operations worldwide, their stock prices behave very much like purely domestic firms. This is puzzling yet undeniable. As a result, MNCs are a poor substitute for direct foreign portfolio investments.
What are the advantages of investing via international mutual funds?
The advantages of investing via international mutual funds include: (1) save transaction/information costs, (2) circumvent legal/institutional barriers, and (3) benefit from the expertise of professional fund managers.
