Chapter 3: Selecting Investments in a Global Market

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CHAPTER 3

SELECTING INVESTMENTS IN A GLOBAL MARKET

The Case For Global Investments

Relative Size of U.S. Financial Markets

Rates of Return on U.S. and Foreign Securities
Global Bond Market Returns
Global Equity Market Returns

Risk Diversification
Individual Country Risk and Return
Risk of Combined Country Investments
Global Bond Portfolio Risk
Global Equity Portfolio Risk
Global Competition
Summary on Global Investing

Global Investment Choices

Fixed Income Investments.

Capital Market Instruments.
U.S. Treasury securities
U.S. Government Agency Securities
Municipal Bonds
Corporate Bonds
Indenture Provisions
Preferred Stock

International Bond Investing
Eurobond
Yankee Bonds
International Domestic Bonds

Bond Ratings

Equity Instruments
American Depository Receipts (ADR)
Direct purchase
International Mutual Funds

Derivatives

Managed Investments
Investment Companies
Hedge Funds
Venture Capital Pools
REITS

Historical Risk/Returns on Alternative Investments

Stocks, Bonds, and T-Bills (Ibbotson-Sinquefield Study)

World Portfolio Performance.
CHAPTER 3

Answers to Questions

1. The major advantage of investing in common stocks is that generally an investor would earn a higher rate of return than on corporate bonds. Also, while the return on bonds is pre-specified and fixed, the return on common stocks can be substantially higher if the investor can pick a "winner" --i.e., if the company's performance turns out to be better than current market expectations. The main disadvantage of common stock ownership is the higher risk. While the income on bonds is certain (except in the extreme case of bankruptcy), the return on stocks will vary depending upon the future performance of the company and could well be negative.

2. The four factors are: (1) Limiting oneself to the U.S. securities market would imply effectively ignoring approximately 50% of the world securities market. While the U.S. bond market is still the dominant sector, foreign bond markets have been growing in absolute and relative size since 1969. (2) The rates of return available on non-U.S. securities often have substantially exceeded those of U.S. securities. (3) Diversification with foreign securities reduces portfolio risk. (4) Firms are no longer restricted to their home markets, thus attractive opportunities may be found in firms that are no based in the investors home country.

3. International diversification reduces portfolio risk because of the low correlation of returns among the securities from different countries. This is due to differing international trade patterns, economic growth, fiscal policies, and monetary policies among countries.

4. There are different correlation of returns between securities from the U.S. and alternate countries because there are substantial differences in the economies of the various countries (at a given time) in terms of inflation, international trade, monetary and fiscal policies and economic growth.

5. The correlations between U.S. stocks and stocks for different countries should change over time because each country has a fairly independent set of economic policies. Factors influencing the correlations include international trade, economic growth, fiscal policy and monetary policy. A change in any of these variables will cause a change in how the economies are related. For example, the correlation between U.S. and Japanese stock will change as the balance of trade shifts between the two countries.

6. Growing international trade will increase correlations between stock markets in different countries. For example Canada and the U.S have extensive trade links and the stock markets have relatively high correlation of 0.47. Japan and the U.S have relatively low levels of trade and the stock markets...
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