OBJECTIVES
CURRENCY RISK MANAGEMENT
•Discuss the reasons that investors should consider constructing global
portfolios
•Discuss the changes in risk that occur when investors add international
securities to their portfolios and calculate the expected return and standard
deviation for a two–asset portfolio containing a domestic asset and a foreign
asset
•Demonstrate how changes in currency exchange rates can affect the returns
that investors earn on foreign security investments
•Explain the effect of international diversification on the efficient frontier by
comparing a frontier that includes foreign investments with one that does
not
Diversification
OBJECTIVES
CURRENCY RISK MANAGEMENT
•Discuss the factors that cause equity market correlations across countries to
be relatively low
•Discuss the factors that cause bond market correlations across countries to be
relatively low
•Discuss the reasons that currency risk may only slightly magnify the volatility
of foreign currency–denominated investments
•Explain the increasing correlation argument against international di–
versification and discuss the factors leading to increased correlations
•Discuss the barriers to international investing
Diversification
OBJECTIVES
CURRENCY RISK MANAGEMENT
•Discuss the potential benefits of investing in emerging markets
•Evaluate the historical performance of emerging equity markets
•Discuss the importance of currency issues in emerging–market investing
•Describe the concept of “investability” in emerging markets
•Discuss the segmentation versus integration characteristics of emerging
markets
Diversification
MOTIVATIONS FOR INTERNATIONAL INVESTMENTS
CURRENCY RISK MANAGEMENT
There are two motivations for international investments.
1. To reduce risk in your portfolios
2. To maximise the portfolios’ risk–adjusted returns.
But…international investments are not easily accomplished, there are many
barriers that may limit access to international diversification.
Our focus here is on a conceptual understanding of international portfolio
diversification. We will be introduced to the ”math” that underpins the benefits
of diversification (i.e. portfolio risk reduction).
Diversification
REDUCTION OF TOTAL RISK IN YOUR PORTFOLIO
CURRENCY RISK MANAGEMENT
•Risk diversification seeks to reduce the total risk of a portfolio
•Higher expected returns is a bonus
•You need to consider…
üRisks associated with investment in domestic assets
üRisk associated with investment in foreign assets
üCurrency risk
•As long as correlation between returns of domestic and foreign assets is not
high, risk reduction in the overall portfolio is possible.
Diversification
REDUCTION OF TOTAL RISK IN YOUR PORTFOLIO
CURRENCY RISK MANAGEMENT
Diversification
REDUCTION OF TOTAL RISK IN YOUR PORTFOLIO
Example
Assume that the domestic and foreign assets have standard deviations of 𝜎d=
Diversification
