Session8 - Notes Session 8 > Chapter 13 Direct Foreign...

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Notes - Session 8 >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> Chapter 13: Direct Foreign Investment Chapter 14: Multinational Capital Budgeting >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> DIRECT FOREIGN INVESTMENT Direct foreign investment (DFI), which is also termed foreign direct investment (FDI), refers to investment in real assets (such as land, buildings or factories in foreign countries. The word is used in contrast to the term foreign portfolio investment, which refers to purchase of stock, bonds and other financial instruments overseas. Over the last two decades, there has been a dramatic increase in global FDI. The average yearly outflow of FDI from the larger industrialized counties increased from about $47 billion per year in the early eighties to well over $200 billion currently. This growth in FDI has far outpaced the growth in world trade and world output. The U.S. is still the leading investor overseas, followed closely by Great Britain. The U.S. is also the leading destination for FDI, both because of its strong economy and also because of its perceived low political risk. The main purpose of Chapter 13 is to illustrate why MNCs often use DFI and to suggest the various factors involved in the DFI decision. The chapter suggests that each firm may benefit from DFI by capitalizing on some unique perceived advantages of the foreign market. Yet, all DFI decisions must conform to the MNC’s overall risk and return objectives. DFI decisions should be made in a strategic context. A decision to establish a foreign subsidiary may lower production costs. However, any cost advantage may be lost if competitors can match or better the savings from DFI. Portfolio theory teaches us that up to a point risk is reduced as the number of investments is increased. The same principle applies to DFI as a company's business is spread across several countries. Of course, the quality of the investments and the DFI investment environments also must be considered. Chapter 13 lists many of the reasons for FDI, and then gives examples of how to rate competing FDI projects using portfolio theory. If you need a review of the calculation methods for variance and standard deviation, please click on the link below. Notes on Standard Deviation MEASURING PORTFOLIO VARIANCE The following formula is given in your text as a way to measure the variance of a portfolio. (page 376). I have written it out in words as well below. Variance of a Portfolio (SD2P)
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(Code: VAR= Variance (this is the squared standard deviation) W= weight, CORR= correlation coefficient; P = portfolio) SD 2 P = {(W 2 A )(SD 2 A ) + (W 2 B )(SD 2 B) } + 2 (W A )(W B )(SD A )(SD A )(CORR AB ) Or to put it in words: Variance of a portfolio = {(squared weighting of Asset A)(Variance of A)} + {(squared weighting of Asset B)(Variance of B)} + 2(Weighting of Asset A)(Weighting of Asset B)(Standard Deviation of A)(Standard Deviation of B)(Correlation of A and B)
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Session8 - Notes Session 8 > Chapter 13 Direct Foreign...

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