CH16sguide - 16 International PortfolioInvestment...

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Chapter Objectives 1. To determine the risk associated with investing in securities from different markets and denominated in various currencies. 2. To calculate the return associated with investing in securities from different countries and denominated in various currencies. 3. To explain how international diversification can allow investors to achieve a better risk-return trade-off than by investing solely in one-country securities, such as US securities. 4. To describe the various ways in which domestic investors, such as US investors can diversify into foreign securities. 5. To identify the barriers to international investment. Chapter Outline I. Key Diversification Terminologies A. Two conflicts from investment in assets are: i. Very few financial variables are known with certainty. ii. Investors are basically risk averters. B. Risk is variability in the return generated by investment in an asset. i. Risk may be measured by the dispersion of alternative returns around the average return. International Portfolio Investment      217 16 International  Portfolio Investment
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1. Standard deviation is a measure of dispersion and uses the formula: ( 29 1 2 - - = n R R σ where = standard deviation, R = monthly returns, and R = average monthly return. 2. A relative measure of dispersion is the coefficient of variation, i.e. that standard deviation divided by the average return. ii. The Capital Asset Pricing Model (CAPM) assumes that the total risk of a security consists of systematic (undiversifiable) risk and unsystematic (diversifiable) risk. 1. Systematic risk reflects overall market risk – risk that is common to all securities. 2. Unsystematic risk is unique to particular company. C. If a market is in equilibrium, the expected rate of return on an individual security (j) is states as: j f m f j R R R R β ) ( - + = where R j = expected rate of return on security j, R f = riskless rate of interest, R m = expected rate of return on the market portfolio, which is a group of risky securities such as Standard & Poor’s 500 stocks, and j = systematic risk of security j. his equation is known as the security market line. i. It is important to understand that beta - j - = [(R j – R f )/(R m – R f )] and this is an index of volatility in the excess return of one security relative to that of a market portfolio. ii. The whole market index is assigned a beta of 1. 1. Aggressive stocks are those with betas greater than 1. a. Their returns fluctuate more than the market. 2. Defensive stocks are those with betas less than 1. a. Their returns fluctuate less than the market. iii. The general decision rule for accepting a risky project (j) can be stated as: ( 29 j f m f j R R R R - + .
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This note was uploaded on 01/29/2012 for the course ECONOMICS 3400 taught by Professor Kroger during the Spring '11 term at Georgia State University, Atlanta.

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CH16sguide - 16 International PortfolioInvestment...

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