Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 24-1 Chapter 24 Chapter 24 Managing an Managing an International International Investment Portfolio Investment Portfolio 24.1 Vehicles for Overcoming Capital Flow Barriers 24.2 Asset Allocation Policy and Managerial Style 24.3 Cross-Border Financial Statement Analysis 24.4 The Shifting Sands of Portfolio Analysis 24.5 Portfolio Hedging Strategies 24.6 Summary
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Chapter 24 Managing an International Investment Portfolio
Chapter 24 Managing an International Investment Portfolio. 24.1Vehicles for Overcoming Capital Flow Barriers 24.2Asset Allocation Policy and Managerial Style 24.3Cross-Border Financial Statement Analysis 24.4The Shifting Sands of Portfolio Analysis 24.5Portfolio Hedging Strategies - PowerPoint PPT Presentation
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Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 24-1
Chapter 24Chapter 24Managing an Managing an International Investment PortfolioInternational Investment Portfolio
24.1 Vehicles for Overcoming Capital Flow Barriers
24.2 Asset Allocation Policy and Managerial Style
24.3 Cross-Border Financial Statement Analysis
24.4 The Shifting Sands of Portfolio Analysis
24.5 Portfolio Hedging Strategies
24.6 Summary
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 24-2
Vehicles for overcoming capital flow barriersVehicles for overcoming capital flow barriers
Domestic-based MNCs Individual foreign securities
– Direct purchase in the foreign market
– Direct purchase in the domestic market
• Foreign shares (e.g. American shares in the U.S.)
• Depository receipts (e.g. ADRs in the U.S.)
– Mutual funds specializing in foreign securities
• Closed-end and open-end mutual funds
• Closed-end country funds
Hedge funds - private investment partnerships
Other international investment vehicles• Equity-linked Eurobonds
• Stock index futures, options, and swaps
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 24-3
Closed-end country fundsClosed-end country funds
Closed-end country funds invest in a single country’s stocks
CECFs trading on the NYSE include Brazil Germany Italy India
Korea Mexico Malaysia South Africa
Spain Switzerland Taiwan Thailand
United Kingdom
The CECFs of restricted markets can trade at substantial premiums or discounts to net asset value.
» classic portfolio maximization
» investor sentiment
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 24-4
Hedge fundsHedge funds
Hedge funds are private investment partnerships» a general manager and fewer than 100 limited partners
» unregulated (as long as each partner passes SEC accreditation)
Hedge fund strategies include– arbitrage
– emerging markets
– market-neutral
– opportunistic
– short-selling
– small-cap
– special situations
– value
– yield-curve arbitrage
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 24-5
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 24-9
Portfolio analysisPortfolio analysis
Inputs to portfolio analysis
» E[RP] = i Xi E[Ri]
» Var(RP) = i Xi2 i
2 + i j Xi Xjij
ij
The shifting sands of portfolio analysis
» Time-varying expected returns
» Time-varying risk premiums
» Time-varying volatilities
» Time-varying correlations
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 24-10
60-month rolling correlations60-month rolling correlationswith the U.S. stock marketwith the U.S. stock market
0.0
0.2
0.4
0.6
0.8
1.0
Dec-75 Dec-80 Dec-85 Dec-90 Dec-95
Canada
U.K.Germany
Japan
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 24-11
National markets during the international National markets during the international stock market crash of October 1987stock market crash of October 1987
0
20
40
60
80
100
120
9/30
/87
10/1
/87
10/2
/87
10/5
/87
10/6
/87
10/7
/87
10/8
/87
10/9
/87
10/1
2/87
10/1
3/87
10/1
4/87
10/1
5/87
10/1
6/87
10/1
9/87
10/2
0/87
10/2
1/87
10/2
2/87
10/2
3/87
10/2
6/87
10/2
7/87
10/2
8/87
10/2
9/87
10/3
0/87
Japan
U.K.
U.S.
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 24-12
Are Cross-Country Correlations Constant?Are Cross-Country Correlations Constant?
Longin & Solnik estimated national stock market correlations during periods of high and low market volatility assuming constant correlations i,us between index i and the U.S. market.*
* Francois Longin and Bruno Solnik, “Is the Correlation in International
Equity Returns Constant?” Journal of International Money and Finance,
No. 1, 1995.
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 24-13
Are Cross-Country Correlations Constant?Are Cross-Country Correlations Constant?
National stock market returns were modeled with autoregressive variances:
i,t2 = ai + bi i,t-1
2 + ci si,t-12
where
i,t-12 = conditional variance from previous period
si,t-12 = square of return during previous period
ai, bi, and ci are constants for stock market index i
Conditional covariance is i,us:t = i,usi,tus,t
given conditional variances i,t2 and us,t
2
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 24-14
Are Cross-Country Correlations Constant?Are Cross-Country Correlations Constant?
Correlation with U.S. market
Calm Volatile Unconditional
Country periods periods correlation
Canada 0.729 0.753 0.723
France 0.331 0.525 0.407
Germany 0.327 0.461 0.353
Japan 0.265 0.366 0.297
Switzerland 0.458 0.650 0.508
U.K. 0.468 0.525 0.469
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 2e 24-15
The benefits of currency risk hedgingThe benefits of currency risk hedging
8%
10%
12%
14%
16%
18%
20%
22%
24%
4% 6% 8% 10% 12% 14% 16% 18% 20%
Standard deviation of annual return
Mean annual return
Adapted from “Asset Allocation with Hedged and Unhedged Foreign Stocks and Bonds” byPhillipe Jorion, Journal of Portfolio Management Summer 1989, p. 49-54. Reprinted with permission.