Investments Chapter 19 homework
11) Including international equities as an additional asset for a pension fund:
a) Investing part of the pension fund in international equities can increase expected return and will create a more active portfolio as well as help diversify risk among different currencies.
Pros:
Higher growth, unique?diversification?less risk, business cycles, foreign exchange, different interest rates
? The correlation coefficients between a stock index of one country and bond portfolios of another are very low?a portfolio balanced between stocks and bonds would greatly benefit from international diversification.
? International diversification can reduce the standard deviation of a domestic portfolio by almost 50%.
? Investing in emerging markets results in higher average returns, so a portfolio balanced between emerging markets and developed countries may be a way to lessen risk but also maintain a higher return.
b) Investing in international equities increases the risk of the portfolio.
Barriers:
Regulations?institutional, political barriers, costs, imperfect information, language
? Exchange rate risk?changes in exchange rates with a particular country can result in a negative return for an investment in that country.
? Imperfect exchange rate risk hedging?the hedging opportunity offered by foreign exchange forward contracts are imperfect because you do not know the risky return earned in the foreign currency.
? Country-specific risk?financial markets of some countries are less transparent that others and false or misleading information is also a proble ...