International portfolio investment

Trimis la data: 2010-06-26
Materia: Economie
Nivel: Facultate
Pagini: 22
Nota: 10.00 / 10
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Autor: Alexandru_M
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Individuals must allocate their income among current consumption, productive investment, and financial investment. Simplifying these choices by assuming that consumption and productive investment decisions have already been made and thereby omitting potential feedback effects leaves the portfolio decision narrowly defined: how to allocate the remaining wealth to financial and/or real assets so as to maximize the most desirable return, i.e. consumption in the future.

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Despite this simplification, there is still a bewildering array of forms in which wealth can be held, ranging from non-liquid holdings of real estate,through gold coins and commodity futures, all the way to stocks, bonds, savings accounts, money market securities, and cash equivalents. Investment theory, then, comprises the principles that help investors to rationally allocate their wealth between the different investment alternatives.

In the context of IPI, which involves investment not only in domestic, but also in foreign securities, the established investment concepts of portfolio theory and capital market theory must be modified and extended to take into account the international dimension. Whereas the basic principles also mostly apply on an international scale, additional considerations become necessary. An important issue that arises if portfolios are composed of securities from different countries is the choice of a numeraire for measuring risk and expected return.

As a matter of tradition and/or due to regulation, local currency is used in most cases to calculate these security characteristics, which means that return and variance values for foreign securities need to be adjusted for currency gains or losses. It has to be noted, however, that foreign goods and services represent a significant proportion of the consumption basket in many countries. Therefore, if purchasing power were to be maintained, the maximization of local currency returns may not be optimal in this regard.

The Capital Asset Pricing Model (CAPM) has been developed with respect to major capital markets in the world. It is well accepted and widely used by professional portfolio managers to analyze the pricing of securities in national financial markets. However, since the scope of securities under consideration is enlarged to incorporate equities of all markets around the globe,

and since the cost of obtaining information and restrictions are generally eliminated, it may be argued that capital markets have become increasingly "integrated", and securities' prices might actually be determined by internationally integrated, as opposed to segmented, financial markets. With integrated capital markets, optimal diversification is realized by forming a global market portfolio, and the riskiness of all securities in the world is measured according to their contribution to the risk of this portfolio.
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