Practice investment management pim3 ch15

South-Western / Thomson Learning © 2004 15 - 6Motivation for International Investing  Market efficiency: Free lunches may exist in underdeveloped markets.. South-Western / Thomson Learn

INVESTING INTERNATIONALLY

CHAPTER FIFTEEN

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Outline

 Motivation for International Investing

 Diversification

 Market Efficiency

 Growth

 Methods of Investing

 American Depository Receipts

 Country Funds

 Individual Securities

 Unit Investment Trusts

 International Mutual Funds

 Emerging Markets

 Characteristics

 Rationale

 Investment Considerations

 Special Risks

 Country Risk

 Trading Costs

 Market Pressure

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Introduction

Insert Figure 15-1 here.

Motivation for International Investing

 Diversification: Portfolio risk reduction was

the original motivation for international

investing Now however, evidence indicates that this alleged advantage may be

overstated.

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Motivation for International Investing

 Market efficiency: Free lunches may exist in

underdeveloped markets.

 Growth: Many markets are less efficient than

those in the United States.

Methods of Investing: ADRs

 An American depository receipt (ADR) is a

marketable receipt showing ownership of a foreign security

 Large commercial banks issue ADRs as a

convenience to would-be investors in foreign securities.

 A sponsored ADR is issued in coordination

with the underlying company.

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Methods of Investing: GDRs

 Global depository receipts (GDRs) are issued

in the Euromarket and are backed by the

Euromarket depositories rather than by a

specific bank.

 In practice, the terms ADR, GDR, and DR are interchangeable They all improve a firm’s

access to U.S investment capital.

Methods of Investing

 A country fund is a closed-end investment company whose portfolio is comprised

almost entirely of securities issued within a particular foreign country

 The fund may contain some short-term

domestic securities for holding temporary funds awaiting reinvestment.

 Closed-end fund shares typically sell at a

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Methods of Investing

 Individual securities: Individual and

institutional investors may also purchase

shares directly on a foreign exchange,

especially if the exchange is well-developed.

 A unit investment trust is a professionally selected, but unmanaged, portfolio of

securities designed to meet some stated

investment objective.

Methods of Investing

 International mutual funds are portfolios of securities too They provide immediate

diversification, professional management, and ease of entry and exit from the market.

 An important consideration in selecting a

mutual fund is the fee charged by the fund manager.

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Emerging Markets: Characteristics

 An emerging market is characterized by a low

per capita gross national product.

 History: Today’s developed markets were

once emerging markets too.

 Culture: Significant differences exist among

emerging markets, but as a group, they

share one primary similarity - change.

 The stock market of an emerging country can

be particularly volatile, especially by U.S

standards.

Emerging Markets: Characteristics

Insert Figure 15-2 (Emerging Market Volatility) here.

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Emerging Markets: Rationale

 Adding value: Inefficiencies in developing

markets provide opportunities for money to

be made.

 Reducing risk: While correlations among the

developed markets are increasing, emerging markets show little correlation with

developed markets or with one another.

 Getting on the bandwagon: Current industry

practice is another reason for the popularity

of international investing.

Emerging Markets: Investment Considerations

 Accounting information: Reliable accounting

information is especially scarce in emerging markets.

 Foreign currency risk: Hedging foreign

exchange risk is complicated in emerging

markets due to the less availability of

hedging vehicles.

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 Fraud: Emerging markets carry a genuine

risk of fraud, ranging from accounting

misstatements to counterfeit securities or bucket shops.

 Liquidity risk: Residents of a developing

country typically have little money of their own to invest.

Emerging Markets: Investment Considerations

 Country risk refers to a country’s ability and

willingness to meet its foreign exchange

obligations.

 The two components to country risk are

political risk and economic risk.

 Political risk is a measure of a country’s

willingness to honor its foreign obligations.

 Economic risk is a measure of the country’s

ability to pay It is largely a function of the

Special Risks: Country Risk

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 Foreign market investing is likely to involve

trading costs at least one percent higher

than investing domestically.

 Market pressure can be an important trading

cost in international markets, especially with small-capitalization stocks.

 Lack of financial information: Some particular

problems with financial information sources are inherent in emerging markets Often,

accounting standards differ too.

Special Risks

 Motivation for International Investing

 Diversification

 Market Efficiency

 Growth

 Methods of Investing

 American Depository Receipts

 Country Funds

 Individual Securities

 Unit Investment Trusts

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Review

 Emerging Markets

 Characteristics

 Rationale

 Investment Considerations

 Special Risks

 Country Risk

 Trading Costs

 Market Pressure

 Lack of Financial Information