Investments Chapter 19

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 problem. The stability of the country sometimes determines the nature of the investment--political, economic, and financial risks can be associated with unstable countries.

c) The fixed-income asset categories historically