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CHAPTER 25

CHAPTER 25. International Diversification. Global market US market is 39.2% of all markets in 2005 US market share is down from 47% in 2000 Improved access & technology New instruments Emphasis for our investigation Risk assessment Diversification. Background.

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CHAPTER 25

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  1. CHAPTER 25 International Diversification

  2. Global market US market is 39.2% of all markets in 2005 US market share is down from 47% in 2000 Improved access & technology New instruments Emphasis for our investigation Risk assessment Diversification Background

  3. Table 25.1 Market Capitalization of Stock Exchanges in Developed Countries

  4. Table 25.2 Market Capitalization of Stock Exchanges in Emerging Markets

  5. Figure 25.1 Per Capita GDP and Market Capitalization as Percentage of GDP (log scale)

  6. What are the risks involved in investment in foreign securities? How do you measure benchmark returns on foreign investments? Are there benefits to diversification in foreign securities? Issues

  7. Foreign Exchange Risk Variation in return related to changes in the relative value of the domestic and foreign currency Total return = investment return & return on foreign exchange It’s not possible to completely hedge a foreign investment Foreign Exchange Risk

  8. Return in US is a function of two factors: 1. Return in the foreign market 2. Return on the foreign exchange Returns with Foreign Exchange

  9. Figure 25.2 Stock Market Returns in U.S. Dollars and Local Currencies for 2005

  10. Table 25.3 Rates of Change in the U.S. Dollar Against Major World Currencies, 2001 – 2005 (Annualized from monthly data)

  11. Hedging Exchange Rate Risk Futures or forward markets are used to eliminate the risk of holding another asset The U.S. investor can lock in a riskless dollar-denominated return either by investing in UK bills and hedging exchange rate risk or by investing riskless U.S. assets

  12. Political Risk Services Group Ratings Rank countries with respect to political risk, financial risk and economic risk Assign composite rating from very high risk to very low risk based on the above elements of risk Country Specific Risk

  13. Table 25.4 Composite Risk Ratings for October 2004 and November 2003

  14. Table 25.5 The Three Ratings that Comprise ICRG’s Composite Risk Rating

  15. Table 25.6 Current Risk Ratings and Composite Risk Forecasts

  16. Table 25.7 Composite and Political Risk Forecasts

  17. Table 25.8 Political Risk Points by Component, October 2004

  18. Evidence shows international diversification is beneficial It’s possible to expand the efficient frontier above domestic only frontier It’s possible to reduce the systematic risk level below the domestic only level Diversification Benefits

  19. Table 25.9 Risk and Return Across the Globe, 2001 – 2005 (Developed Countries and Emerging Markets)

  20. Figure 25.3 Annualized Standard Deviation of Investments Across the Globe ($ returns, 2001 – 2005)

  21. Figure 25.4 Beta on U.S. Stocks Across the Globe, 2001–2005

  22. Figure 25.5 Annualized Average $ Return of Investments Across the Globe, 2001 – 2005

  23. Figure 25.6 Standard Deviation of Investments Across the Globe in U.S. Dollars versus Local Currency, 2001 – 2005

  24. Table 25.10 Correlation for Asset Returns: Unhedged and Hedged Currencies

  25. Table 25.11 Correlation of U.S. Equity Returns with Country Equity Returns

  26. Figure 25.7 International Diversification

  27. Figure 25.8 Ex Post Efficient Frontier of Country Portfolios, 2001 – 2005

  28. Figure 25.9 Efficient Frontier of Country Portfolios (world expected excess return = .6% per month)

  29. Figure 25.10 Regional Indexes around the Crash, October 14–October 26, 1987

  30. Figure 25.11 Efficient Diversification by Various Methods

  31. Figure 25.12 Diversification by Market Capitalization: National Markets versus Regional Funds

  32. Figure 25.13 Diversification Benefits over Time

  33. Table 25.12 Weighting Schemes for EAFE Countries

  34. Performance Attribution with International Extension to consider additional factors Currency selection Country selection Stock selection Cash and bond selection

  35. Table 25.13 Example of Performance Attribution: International

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