Selecting Investments in a Global Market

1. Selecting Investments in a Global Market Innovative Financial Instruments Dr. A. DeMaskey Chapter 3

2. The Case for Global Investments • Growth and development of foreign financial markets • Advances in telecommunications • Mergers of firms and security exchanges • Reasons for global investing • More investment opportunities • Better rates of returns • Greater potential for diversification

3. Relative Size ofU.S. Financial Markets • Prior to 1970, U.S. stock and bond market made up about 65% of all securities traded worldwide. • By 1998, U.S. securities accounted for only 47% of the world total. • Overall value has increased from $2.3 Trillion to $58.2 Trillion. • This trend is likely to continue, and not investing in foreign markets is to ignore 53% of the available securities

4. Rates of Return on U.S. and Foreign Securities • Many non-U.S. securities provide superior rates of return. • Total domestic return • Total return in U.S. dollar terms

5. Risk of Combined Country Investments • Diversified portfolios reduce variability of returns over time • Correlation coefficients measure diversification contribution • Compare correlation of return among U.S. bonds and stocks with returns on foreign bonds and stocks

6. Global Bond Portfolio Risk • Low positive correlation • Opportunities for U.S. investors to reduce risk • Correlation changes over time • Adding non-correlated foreign bonds to a portfolio of U.S. bonds increases the rate of return and reduces the risk of the portfolio

7. Global Equity Portfolio Risk • Low positive correlation • Opportunities to reduce risk of stock portfolio by including foreign stocks

8. Summary on Global Investing • Absolute and relative sizes of U.S. and foreign markets for stocks and bonds • Rates of return available on non-U.S. securities often exceed U.S. securities • Diversification with foreign securities can help reduce portfolio risk because of their low correlation with U.S. securities

9. Global Investment Choices • Fixed-income investments • Equity investments • Special equity instruments • Forward and Futures contracts • Investment companies • Real assets • Low-liquidity investments

10. Savings Accounts Passbook savings account Certificate of deposit Money market certificate Capital Market Instruments U.S. Treasury securities U.S. government agency securities Municipal bonds Corporate bonds Preferred Stock International Bond Investing Eurobond Yankee bond Foreign access to domestic bonds Fixed-Income Investments

11. Equity Instruments • Common stock • Foreign equities • American Depository Receipts (ADRs) • American shares • Foreign shares • Foreign shares listed on U.S. exchanges • International or global mutual funds

12. Special Equity Instruments • Warrant • Call option • Put option

13. Futures Instruments • Futures Contracts • Commodity futures • Financial futures • Index futures • Forward Contracts

14. Investment Companies • Money Market Funds • Bond Funds • Common Stock Funds • Balanced Funds

15. Real Estate • Real Estate Investment Trust (REIT) • Direct Real Estate Investment • Home ownership • Raw land • Land development • Rental property

16. Low-Liquidity Investments • Antiques • Art • Coins • Stamps • Diamonds

17. Historical Risk/Returns on Alternative Investments • Returns on Stocks, Bonds and T-bills • World Portfolio Performance • Art and Antiques • Real Estate

18. Returns of Stocks, Bonds, and T-Bills • Ibbotson and Sinquefield (I&S) examined nominal and real rates of return for seven major classes of assets in the U.S. for the period 1926-1998 • They computed geometric and arithmetic mean rates of return • They derived four return premiums • Risk premium • Small-stock premium • Horizon premium • Default premium

19. Returns of Stocks, Bonds, and T-Bills • They adjusted the returns of the series for inflation • The study tends to confirm the idea that: • Returns and risk increase together • Rates of return are generally consistent with the uncertainty of returns

20. World Portfolio Performance • Reilly studied world portfolios for the period 1980-1997 • Asset return and risk relationship is confirmed • Coefficients of variation ranged widely, showing benefits of global diversification • Correlations between asset returns varied by global regions

21. Art and Antiques • Market data is limited • Reilly studies the return series on art and antiques for the period 1976-1991 • Results vary widely, and change over time, making generalization impossible, but showing a reasonably consistent relationship between risk and return • Correlation coefficients vary widely, allowing for great diversification potential • Liquidity is still a concern

22. Real Estate • Returns are difficult to derive due to lack of consistent data • Study by Goetzman and Ibbotson found: • Residential real estate had lower risk and return than commercial real estate • During some short time periods, REITs had higher returns than stocks with lower risk measures • Long term returns for real estate are lower than for stocks, and have lower risk • Potential for diversification exists due to: • Negative correlation between residential and farm real estate and stocks • Low positive correlation between commercial real estate and stocks

23. The Internet:Investments Online www.wiso.gwdg.de/ifbg/finance.html www.global-investor.com www.nfsn.com www.emgmkts.com www.datastream.com www.www.euro.net/innovation/Finance_Base/Fin_ency.html www.sothebys.com