CHP 19

Question 1

1. Reasons for overseas investment

Answer 1

3 main reasons for investing in foreign assets:

1. Match liabilities in the foreign currency
2. Increase expected return
3. Reduce risk by increasing the level of diversification

Question 2

1.2. Increasing expected returns - overseas invts

Answer 2

Returns in overseas markets could be higher than domestic market returns either:
• Because they are fair compensation for higher risk
• Inefficiencies in the global market allow fund managers to find countries whose markets are undervalued.

Question 3

1.3. Diversification - overseas invts

Answer 3

Investing in a number of different markets or economies with low correlation helps to reduce overall risk.
Also could invest in industries that are not available in the domestic market, this gives a larger number of companies from which to construct a diversified portfolio.

Question 4

2. Problems of overseas investment

2. 1. Adverse currency movements

Answer 4

Investing in an overseas market, an investor with domestic liabilities is accepting a mismatch.
Currency movements also add volatility to returns.
These problems can be fully (or partly) overcome by hedging

Question 5

2. Problems of overseas investment

2. 2. Taxation

Answer 5

Taxation varies in different countries, it may not be possible to recover withholding taxes imposed on overseas investments.

Question 6

2. Problems of overseas investment

2. 3. Expenses and expertise

Answer 6

Further cost of increased expertise required.
It is also necessary to appoint an overseas custodian to deal with settlement, voting rights issues, receipt of dividends, holding of stock certificates etc.
Costs in recruiting additional staff and set up new admin procedures to deal with accounting for foreign currency and repatriation of funds.

Question 7

2. Problems of overseas investment

2. 4. Further problems

Answer 7

• Different accounting systems
• Less information may be available than in the home market
• Language problems (many of the larger overseas companies publish in English)
• Time delays
• Poorer market regulation in some countries.
• Risk of adverse political developments
• Liquidity
• Restriction on ownership of certain shares

Question 8

3. Investment and risk characteristics of overseas investments
   Describing characteristics of overseas markets can be seen as a 3 stage process:

Answer 8

1. Consider the characteristics of the equivalent domestic market – the fundamental characteristics of an overseas investment are essentially the same as those of the equivalent domestic market.
2. Consider any specific differences – for a particular investment there may be specific differences that need to be considered, e.g. risk of default, taxation and volatility of market values.
3. Allow for exchange rate movements – this is in addition to all other differences.

Question 9

4. Indirect overseas investment

Answer 9

In general, indirect investment is particularly suitable for small funds, although large funds could also benefit from investing in specialist areas outside of what they have.

1. Investment in multinational companies in the domestic market
2. Investment in domestic companies with substantial export trade.
3. Investment in collective investment vehicles specializing in overseas investment
4. Investment in derivative based overseas assets.

Question 10

1. Investment in multinational companies in the domestic market
   The advantages:

Answer 10

• Easy to deal in the familiar home market
• Companies have expertise and will tend to conduct business in the most profitable areas overseas, including areas where direct investment may be difficult.

Question 11

1. Investment in multinational companies in the domestic market
   Disadvantages:

Answer 11

• These company’s earnings will be diluted by domestic earnings
• The investor will have no control over where the company conducts business.

Question 12

5. Emerging markets

Answer 12

These offer high expected returns due to rapid industrialization and are very risky.

Question 13

5.1. Attractions of investments in emerging markets

Answer 13

With the prospects of high growth rates and possible market inefficiencies, opportunities exist for profitable investment, but with a corresponding higher level of risk.
Rapid economic growth
Better diversification – economies and markets of many smaller countries are less interdependent than major powers.
Inefficient markets – buy cheaply.
Perceived to be risky – buy cheaply

Question 14

5.2. Drawbacks of investment in emerging markets

Answer 14

• Easier said than done
• Regulation of the stock market
• Volatility – these markets can be affected by large flows of money due to changes in sentiment.
• Less friendly towards foreigners
• Repatriation problems

Question 15

5.3. Factors to consider before investing in emerging markets

Answer 15

• Current market valuation
• Possibility of high economic growth rate
• Currency stability and strength
• Level of marketability
• Degree of political stability
• Market regulation
• Restrictions on foreign investment
• Range of companies available
• Communication problems availability and quality of information