CHAPTER 3 SELECTING INVESTMENTS IN A GLOBAL MARKET
1. Discuss three factors that cause U.S. investors to consider including global securities in their portfolios.
The three factors are: (1) Limiting oneself to the U.S. securities market would imply effectively ignoring more than 50% of the world securities market. While U.S. markets are still the largest single sector, foreign markets have been growing in absolute and relative size since 1969. (2) The rates of return available on non-U.S. securities often have substantially exceeded those of U.S. securities. (3) Diversification with foreign securities reduces portfolio risk.
2. Discuss why international diversification reduces portfolio risk. Specifically, why would you expect low correlation in the rates of return for domestic and foreign securities?
International diversification reduces portfolio risk because of the low correlation of returns among the securities from different countries. This is due to differing international trade patterns, economic growth, fiscal policies, and monetary policies among countries.
3. When you invest in Japanese or German bonds, what major additional risks must you consider besides yield changes within the country?
The major risks that an investor must consider when investing in any bond issue are business risk, financial risk and liquidity risk. Additional risk associated with foreign bonds, such as Japanese or German bonds, are exchange rate risk and country risk. Country risk is not a major concern for Japanese or German securities. Exchange rate risk is the uncertainty that arises from floating exchange rates between the U.S. dollar and the Japanese yen or...