International Portfolio Investing
Abstract
In recent years, portfolio investments by individuals and institutional investors that include an allocation to international securities have grown rapidly because of risk reduction without sacrificing returns. This paper will explain why and how investing some overseas is better than investing all in domestic securities. Although the investors can benefit a great deal from international diversification, the foreign investments expose them to additional risks such as political risks and currency exchange rate fluctuations. The paper will examine these risks in detail including how to manage them.
1. Introduction
The globalization of financial markets has reflected in the rapid growth of international investing. It arose from deregulation of foreign exchange and capital markets together with recent advance in telecommunication that facilitate cross-border transactions. The value invested in foreign equities by U.S. investors has steadily grown from a rather negligible level in early 1980 to $2,400 billion in 2004. In the mean time, Japanese are investing heavily in U.S. and other countries to recycle their enormous trade surplus.
The first section of the paper will explain motives behind investing abroad and benefits of risk reduction from international diversification. The second part will discuss home bias and barriers to international investing. The third section will show how to determine an appropriate mix of assets to get an effective diversified portfolio. Finally, the paper will give details of risk exposure associated with international portfolio such as country risk and foreign currency exchange rate risk including various hedging strategies.
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