Presentation on

INTERNATIONAL PORTFOLIO INVESTMENT

INTERNTIONAL PORTFOLIO INVESTMENT

International Portfolio Investment is a grouping of financial assets such as stocks, bonds and cash equivalents, as well as their mutual, exchange-traded and closed-fund counterparts. A grouping of investment assets that focuses on securities from foreign markets rather than domestic ones. International Portfolio Investment is the investment preference where an investor seeks greater benefits in terms of returns and security. International Portfolio Investment is the managing of Investment in the international era as well as in domestic market. People seeks international investment opportunity to attain a better standard of investment plan and often invest internationally for diversification, to spread the investment risk among foreign companies and markets; and for growth, to take advantage of emerging markets

The International Dimensions of Portfolio Investment

The International Dimensions of Portfolio Investment

Principles of International Portfolio Investment

Principles of International Portfolio Investment

Individuals must allocate their income among:

Current consumption Productive Investment Financial investment

For IPI, local currency may not be exact for measuring purchasing power To analyze the pricing of securities, CAPM has been developed.

CAPM as a global extent moves to ICAPM ICAPM is comprised of some extended factors unlike

CAPM, risk premia in world market portfolio and risk premia in world currency exchange.

Problems arises when CAPM moves to ICAPM because

Mean-variance can not be measured automatically

Global market is not fully integrated

No common real risk free interest rate

Developing a global portfolio (by ICAPM) is difficult because:

Financial market is still segmented

Investors has different risk preference Expected risk and return change over time

Testing the ICAPM is difficult as:

Limited historical data on international capital market

An international benchmark portfolio is hard to specify

Its difficult to capture time variation of the security characteristics

 As CAPM has time variability constraints,

Autoregressive Conditional Heteroscedasticity (ARCH) model is developed. In ARCH, conditional variance for t+1 depends on information available at time t. As degree of market segmentation is constantly changing over time, conceptual problems exist for all approaches.

The Benefits from International Portfolio Investment

The attractions of IPI are based on

The participation in the growth of other market Hedging of investors consumption basket Abnormal Diversification returns due to effect market segmentation

The participation in the growth of other market

IPI allows investors to participate in the faster growth of

other countries. Risk in emerging market is higher than developed. So is a measurement of such risk. But it is not sufficient due to skewness and kurtosis. Two warnings have to be addressed: (a) Some growth may be discounted and added in security price. So security market may not reflect entire economy. (b) Investors may not be able to take participate in foreign markets due to takeover by local shareholders or some of them may not be correctly priced.

Hedging of investors consumption basket

Return on investment is related to consumption

pattern of investors. Realistically goods are not perfectly so deviations from PPP and Law of One Price (LOP) are possible. So, consumption pattern and investment position may stem risks for consumer-investor

Four cases
No foreign goods are consumed and no foreign asset is held
---The consumer-investor may face domestic inflation risk

No consumption of foreign goods, but foreign assets are held

---The consumer-investor may face domestic and foreign inflation risk

Foreign goods are consumed but no foreign asset is held

---The consumer-investor may face all three kinds of risks Consumption of foreign goods with investment in foreign asset ---No Exchange risk and the consumer-investor may face domestic and foreign inflation risk

International Portfolio Diversification

Benefits from International Portfolio Diversification
Empirical evidence of International Portfolio Diversification

Agenda

Benefits from International Portfolio Diversification

Low correlation between securities means lower portfolio

risk- Ceteris Paribus. So, diversification reduces risk Risk aversers will go for lowest correlation So, foreign securities give better opportunity as investors find a large market to diversify own portfolio On international portfolio, securities are partly affected by purely national events Industrial composition of national market varies across country. So, international diversification might stem from industrial diversification.So, this explains differences in volatility across markets, because some industries are more Ceteris Paribus than others.

Empirical evidence of International Portfolio Diversification

Two methods to demonstrate the effect of IPD

Benefits of IPD rely on low correlation

Regression of returns of individual stocks or national

market indices against a world market index

Limitation of methods
It does not take into account the unique cost and risk

of IPI which are likely to offset a large portion of the benefits represented by these models. The difficulties exist in choosing appropriate index for regression analysis

Market Segmentation

Benefits from Market Segmentation Agenda Empirical evidence of Market Segmentation

Benefits from Market Segmentation

Market segmentation is caused by barrier which are

difficult to overcome by investors. Segmentation leads to different risk-return tradeoffs and/or different benchmarks for measuring the riskiness of securities in different capital markets When market is segmented, IP will be based on selective basis, it may not include all international securities.

Unique Risk of International Portfolio Investment

Potential Risk Currency Risk Country Risk

Currency Risk

Unexpected changes in exchange rate can be additional

risk to the investor, but also can reduce risk for the investor.
The net effect depends on how volatility is measured;

Whether measured on

Real terms against index of goods Nominal terms against units of a base currency

The effect ultimately depends on

The specifics of portfolio consumption Volatility of exchange rates Correlations of return of securities & exchange rates Correlation between currencies

Currency Risk
Exchange risk contributes significantly to the

total volatility of security This risk can be diversified by investing in securities denominated in many different currencies, with offsetting correlation Exchange rate and stock market move same direction for major currencies for shorter time period. So, currency reinforces the effect of stock market movements

Currency Risk
Hedging is another way for reducing such risk. But

this solution is contradictory. Some says it reduces risk if completely hedged and some state that its just a short term solution, because in long term it increases the return variance if fully hedged It is difficult because there is no optimal hedge ratio Countries with proper money discipline shows positive correlation which is good to avoid such risk

Currency Risk
As no country stay at same position for mony discipline,

optimal hedge ratio become difficult. Universal hedge ratio appears appealing theoretically but it relies on too restrictive assumption So, more convenient way to find hedge ratio are approaches that derive the optimal hedge ratio by minimizing the portfolio variance or maximizing the portfolios risk adjusted return

Country Risk

Country Risk
Exchange control, expropriation of asset, tax policy are

important factors Country risk are local government policies that lower actual return on the foreign investment or make the repatriation of dividend, interest, principle more difficult Published information may not be adequate & difficult to interpret which is called information barrier Many investors are reluctant to invest in politically unstable country as it improves risk-return combination of portfolio

Institutional constraints for International Portfolio Investment

Taxation

Foreign exchange controls

Capital market regulation

Transaction Cost

Familiarity with foreign market

Taxation
Tax is both an obstacle and an incentive

This issue is complex as individual government

decide tax policy Tax on various portfolio return vary from country to country Almost all countries has some tax exempted income which are lucrative for investors Almost all countries tax their resident whether he invest home or abroad- The worldwide income concept

Taxation Tax Heavens

There are many countries e.g. UK, Singapore that

impose tax only when the income is repatriated to home country So, this promote a pattern to invest in countries with favorable jurisdiction for foreign investors, which is called Tax Heavens Such tax heaven countries make themselves more attractive by adopting secrecy laws; hiding identity of investors

Tax Heavens
Misusing this advantage, people are also transferring

black-money via tax heavens To prevent this two major step is taken
A system of reporting about foreign investment return to home country; agreed by EU members US initiated qualifying foreign financial intermediaries which make foreign bank responsible for tax collection from potential investors

Withholding tax
Barriers to IPI is primarily created by withholding

tax. This type of tax is applied instead of income tax of payers home country Such tax should be credited against home country income tax of investor-but for delays and other factors, the ghost of double taxation is ever present. Tax treaties play a crucial role in this point

Foreign exchange controls

While countries are quite ready to restrict undesired

flow of capital, they also seem reluctant when situation is no longer same Countries often take drastic measures by requiring resident to sell off all or part of securities for domestic funds Capital inflow constraint limit the fraction of a domestic fund equity that may be held by foreign investors

Foreign exchange controls

Outflow constraint limit the amount of capital

invested in foreign asset So, as premium have to pay to acquire foreign asset, investor may invest in near-substitute domestic product Sometimes, effect of capital constraint may not be visible due to opposing effect of inflow and outflow capital

Capital market regulation

To ensure fair and competitiveness, and protection

of buyer, regulatory body as SEC is formed Capital market control manifest themselves by restricting on the issuance of foreign securities and limiting the amount of foreign investment Institutional investors face much difficulty in this regard than private investors

Transaction Cost
Trading in foreign market causes extra cost for:

Intermediaries
Information cost Market movement

Technical equipment

Transaction Cost

Time difference can be a costly headache

This barrier can be mitigated by characteristics of

liquidity providing depth, breadth and resilience of certain capital market. Example: US and British markets

Familiarity with foreign market

Cultural differences

Time zone
Trading procedure Reporting customs Language difference

Psychological barrier

Channels for International Portfolio Investment

Purchase of foreign securities in foreign markets
Purchase of foreign securities in domestic markets

Direct foreign portfolio investment

Channels

Equity linked eurobonds

Indirect foreign portfolio investment

Purchase of shares of multinational companies

International Mutual fund

Purchase of foreign securities in foreign markets

Foreign investors could place order through banks

or brokers either in foreign or domestic country For purchasing secondary shares usually it has to be in issuers market Problems arise regarding this;

Delivery of certificates Expense of making timely payment in foreign funds Securing good information Collecting dividend and interest

So, practically investment account is best

Purchase of foreign securities in domestic markets

Issues
Global equity issues Computerized Broker-dealer accounting role Complication regarding transaction Role of DR (Depository Receipt)

Equity linked Eurobonds

Equity linked Eurobonds are basically eurobond with

warrant and convertible eurobond Due to the equity component of eurobond the value of these instrument is not only dependent on the movement of interest rates but also changes with the development of the underlying security

Purchase of shares of multinational companies

Because barrier to foreign investment exist,

segmented capital market could be a source of important advantages for MNCs In comparison to MNC and UNC portfolio, betas of MNC portfolios are more stable and significantly lower. Through CML, one can easily determine the changes occurred by MNC

Conclusion
Although investing globally was more than difficult

at a time, but revolutionary changes in security instrument, portfolio management, assessing and overcoming risks made it possible now a days All the constraints now either eliminated or reduced through technology and policy which is providing an investor better options in international arena then ever