INTERNATIONAL DIVERSIFICATION
AND PORTFOLIO MANAGEMENT
DIVERSIFICATION
DIVERSIFICATION
Domestic Diversification
Why international diversification?
INTERNATIONAL DIVERSIFICATION
The attempt to reduce 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.
INTERNATIONAL PORTFOLIO INVESTMENT-
BENEFITS
International Portfolio allows investors to further diversify
their assets by moving away from a domestic portfolio
only.
Reduce Systematic Risk
Designed to give the investor exposure to growth in
emerging & international markets and provide
diversification.
Better risk-return trade off
FDI VS. FPI
FDI versus FPI comparison chart
FDI FPI
Management Projects are efficiently managed Projects are less efficiently managed
Involvement - direct Direct Indirect
or indirect
Sell off It is more difficult to sell off or It is fairly easy to sell securities and pull out
pull out. because they are liquid.
Comes from Tends to be undertaken by Comes from more diverse sources.
Multinational organisations
What is invested Involves the transfer of non- Only investment of financial assets.
financial assets e.g.technology
and intellectual capital, in
addition to financial assets.
Stands for Foreign Direct Investment Foreign Portfolio Investment
MODES OF INTERNATIONAL PORTFOLIO
INVESTMENT
1. Buying foreign securities or depository receipts directly from the domestic stock
exchange if securities are listed there.
2. Investing in International Mutual Funds
3. Investing in Closed- end country funds.
4. Buying directly from the securities of domestic companies having global
operations.
MODE1: BUYING FOREIGN SECURITIES OR DEPOSITORY
RECEIPTS FROM DOMESTIC STOCK EXCHANGE
Here investor can buy the foreign securities or depository receipts from
domestic stock exchange provided the securities are listed thereon.
Usually the companies prefer to get their securities listed on different
countries’ stock exchange to diversify risk. Investors can buy such shares or
can also buy ADR/GDR from depositories.
MODE 2: BUYING INTERNATIONAL MUTUAL FUNDS
• There are many open-ended mutual funds that trade in
international securities. Such MFs prefer liquidity and allocate
portfolio in proportion of market capitalization of important
stock exchanges.
• Investors can buy the units of international diversified mutual
funds.
MODE3: BUYING CLOSE-ENDED COUNTRY FUNDS
The close-ended funds first make investment in international
securities and issue shares against the portfolio.
Such funds try to avoid any change in their investment portfolio
depending upon the changes in response of investors.
MODE 4: BUYING SECURITIES OF DOMESTIC COMPANIES
HAVING GLOBAL OPERATIONS
Investors buy shares of domestic company that operates
internationally.
Indirect way of participating in global economy.
EXPECTED RETURN FROM
INTERNATIONAL INVESTMENT
Note: In case of international investment, the changes in exchange rate are also
considered while estimating expected returns.
Formula
1+ RHC = 1+ (S1-S0+ I)/S0
1+e
Where,
S0= Host-country currency value during t0
S1= Host-country currency value during t1
I= Income from dividend/ interest
e= exchange rate changes
EXAMPLE
Suppose the present value of a security in terms of host-country currency is $200 and it
goes up to $202 after one year. The interest during the year is $8. Dollar appreciates by
3%. Calculate the return in terms of home-country currency.
Ans- 8.15%
If host country currency Appreciates – Return will be higher
If host country currency depreciates – Return will be lower
PORTFOLIO RETURN
It is the weighted average of the expected return from different securities existing in the
portfolio.
Rp= RAWA + RBWB
Where,
R= return
W= relative share of investment
A& B= two securities
INTERNATIONAL FINANCIAL
INSTRUMENTS
GLOBAL EQUITY MARKET
Cross-listing is the listing
of a company's common
shares on a different
exchange than its primary
and original stock
exchange.
CROSS LISTINGS OF BENEFITS A COMPANY IN THE
FOLLOWING WAYS:
Expansion of investor base and hence higher stock prices and lower capital cost
Open secondary markets of company’s equity shares and hence creates liquidity
for existing stocks and room for issuing follow on equity in foreign markets.
Create visibility for the company and at the same enhance corporate governance
and public disclosures.
FOREIGN LISTINGS OF STOCK CARRY COSTS FOR THE COMPANY IN
THE FOLLOWING MANNER
High disclosures norms of regulatory bodies.
Higher cost of market volatility and it may negatively affect
the company’s domestic operations.
Foreign ownership may influence the domestic decisions.
DEPOSITORY RECEIPTS
.A depositary receipt (DR) is a negotiable certificate representing shares in a foreign company traded on a local
stock exchange.
Depositary receipts allow investors to hold equity shares of foreign companies without the need to trade
directly on a foreign market.
Depositary receipts allow investors to diversify their portfolios by purchasing shares of companies in different
markets and economies.
Depositary receipts are more convenient and less expensive than purchasing stocks directly in foreign markets.
SPONSORED DEPOSITORY RECEIPT
Banks issue sponsored ADRs on behalf of a foreign company whose
equity serves as the underlying asset.
A sponsored ADR is a legal relationship between the ADR and the
foreign company whereby the foreign company is responsible for the
cost of issuing the security.
UNSPONSERD DEPOSITORY RECEIPT
An unsponsored DR is a depositary receipt issued by a depositary bank
without the involvement, participation, or consent of the foreign
company.
These securities trade on the over-the-counter market rather than stock
exchanges.
Unlike regular DRs and stock, shareholder benefits and voting rights
may not be extended to investors who hold unsponsored DRs.
EURO BONDS
A Eurobond is a debt
instrument that's
denominated in a
currency other than the
home currency of the
country or market in
which it is issued.
FOREIGN BONDS
A foreign bond is a bond issued in a domestic
market by a foreign entity in the domestic
market's currency as a means of raising capital.
For foreign firms doing a large amount of business
in the domestic market.
EXAMPLES OF FOREIGN BONDS
Yankee Bonds Foreign Bonds sold in U.S.
Samurai Bonds Foreign Bonds sold in Japan.
Bulldog Bonds Foreign Bonds sold in U.K.
Rembrandt Bond Foreign Bonds sold in Netherland.
Matador Bond Foreign Bonds sold in Spain.
INTERNATIONAL CAPITAL ASSET PRICING &
COST OF CAPITAL
Cost of equity capital is the return expected by the equity holders. Capital Assets Pricing Model
provides us some indication to estimate the cost of equity capital.
Ri= Rf + βi (RM – Rf)
Where βi = Cov(Ri ,RM)
Var(RM)
Ri :Expected Return from the capital market
Rf :Risk-free Return
βi :Systematic Risk
(RM – Rf): Market Risk Premium
Ri = Rf + βiW (RW– Rf) : World level
INTEGRATION & SEGMENTATION
Financial integration or segmentation at the international level plays major role
for determining the cost of capital.
Cost of capital differs in different countries. When markets are imperfect, that is
when free mobility of capital is restricted, international financing can lower the
firm’s cost of capital. One way to achieve this to internationalize the firm’s
ownership structure.
Cross border listings of stocks have become quite popular among major
corporations. The largest contingents of foreign stocks are listed on the London
Stock Exchange, US exchanges attracted the largest contingent of foreign stocks.
