Download Chapter 13

CHAPTER THIRTEEN
INVESTING INTERNATIONALLY
© 2001 South-Western College Publishing
Outline

Motivation for International Investing
Diversification
 Market Efficiency
 Growth


Methods of Investing
American Depository Receipts
 Country Funds
 Individual Securities
 Unit Investment Trusts
 International Mutual Funds

2
Outline

Emerging Markets
Characteristics
 Rationale
 Investment Considerations


Special Risks
Country Risk
 Trading Costs
 Market Pressure
 Lack of Financial Information

3
Motivation for International Investing

Diversification: Portfolio risk reduction was
the original motivation for international
investing. Now however, evidence indicates
that this alleged advantage may be
overstated.

Market efficiency: Free lunches may exist in
underdeveloped markets.

Growth: Many markets are less efficient than
those in the United States.
4
Methods of Investing: ADRs

An American depository receipt (ADR) is a
marketable receipt showing ownership of a
foreign security.

Large commercial banks issue ADRs as a
convenience to would-be investors in foreign
securities.

A sponsored ADR is issued in coordination
with the underlying company.
5
Methods of Investing: GDRs

Global depository receipts (GDRs) are issued
in the Euromarket and are backed by the
Euromarket depositories rather than by a
specific bank.

ADRs and GDRs improve a firm’s access to
U.S. investment capital.
6
Methods of Investing

A country fund is a closed-end investment
company whose portfolio is comprised
almost entirely of securities issued within a
particular foreign country.

Individual securities: Investors may also
purchase shares directly on a foreign
exchange, especially if the exchange is welldeveloped.
7
Methods of Investing

A unit investment trust is a professionally
selected, but unmanaged, portfolio of
securities designed to meet some stated
investment objective.

International mutual funds are portfolios of
securities too. They provide immediate
diversification, professional management,
and ease of entry and exit from the market.
8
Emerging Markets: Characteristics

An emerging market is characterized by a low
per capita gross national product.

History: Today’s developed markets were
once emerging markets too.

Culture: Significant differences exist among
emerging markets, but as a group, they
share one primary similarity - change.

The stock market of an emerging country can
be particularly volatile, especially by U.S.
standards.
9
Emerging Markets: Rationale

Adding value: Inefficiencies in developing
markets provide opportunities for money to
be made.

Reducing risk: While correlations among the
developed markets are increasing, emerging
markets show little correlation with
developed markets or with one another.

Getting on the bandwagon: Current industry
practice is another reason for the popularity
of international investing.
10
Emerging Markets: Investment Considerations

Accounting information: Reliable accounting
information is especially scarce in emerging
markets.

Foreign currency risk: Hedging foreign
exchange risk is complicated in emerging
markets due to the less availability of
hedging vehicles.
11
Emerging Markets: Investment Considerations

Fraud: Emerging markets carry a genuine
risk of fraud, ranging from accounting
misstatements to counterfeit securities or
bucket shops.

Liquidity risk: Residents of a developing
country typically have little money of their
own to invest.
12
Special Risks: Country Risk

Country risk refers to a country’s ability and
willingness to meet its foreign exchange
obligations.

The two components to country risk are
political risk and economic risk.

Political risk is a measure of a country’s
willingness to honor its foreign obligations.

Economic risk is a measure of the country’s
ability to pay. It is largely a function of the
income statement rather than of the
balance sheet.
13
Special Risks

Foreign market investing is likely to involve
trading costs at least one percent higher
than investing domestically.

Market pressure can be an important trading
cost in international markets.

Lack of financial information: Some particular
problems with financial information sources
are inherent in emerging markets. Often,
accounting standards differ too.
14
Review

Motivation for International Investing
Diversification
 Market Efficiency
 Growth


Methods of Investing
American Depository Receipts
 Country Funds
 Individual Securities
 Unit Investment Trusts
 International Mutual Funds

15
Review

Emerging Markets
Characteristics
 Rationale
 Investment Considerations


Special Risks
Country Risk
 Trading Costs
 Market Pressure
 Lack of Financial Information

16