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I. THE BENEFITS OF INTERNATIONAL EQUITY INVESTING

I. THE BENEFITS OF INTERNATIONAL EQUITY INVESTING

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THE BENEFITS OF INTERNATIONAL

EQUITY INVESTING

B.



International Diversification



1.

greater



Risk-return tradeoff: may be

basic rulethe broader the diversification,

more stable the returns and



the more diffuse the risk.



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THE BENEFITS OF INTERNATIONAL

EQUITY INVESTING

2. International diversification and

a.



systematic risk



Diversifying across nations with

different economic cycles



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THE BENEFITS OF INTERNATIONAL

EQUITY INVESTING

b. While there is systematic risk

within a nation, it may be

nonsystematic and diversifiable

outside the country.



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THE BENEFITS OF INTERNATIONAL

EQUITY INVESTING

3.



Recent History

a.



National stock markets have wide

differences in returns and risk.



b.



Emerging markets have higher

risk and return than developed

markets.



c.



Cross-market correlations have

been relatively low.



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THE BENEFITS OF INTERNATIONAL

EQUITY INVESTING

C. Correlations and the Gains From



Diversification



1. Correlation of foreign market betas

Foreign

market =

beta



Correlation

Std dev

with U.S.

x for. mkt.

market



std dev

U.S. mkt.



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THE BENEFITS OF INTERNATIONAL

EQUITY INVESTING

2.



Past empirical evidence suggests



international diversification reduces



portfolio risk.



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THE BENEFITS OF INTERNATIONAL

EQUITY INVESTING

3.



Theoretical Conclusion

International diversification pushes out

the efficient frontier.



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THE BENEFITS OF INTERNATIONAL

EQUITY INVESTING

4. Calculation of Expected Return:



r



where



p



= ar



US



+ ( 1 - a) r



rw



r = portfolio expected return

p

r

r



US

rw



= expected U.S. market return

= expected global return



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THE BENEFITS OF INTERNATIONAL

EQUITY INVESTING

5. Calculation of Expected Portfolio Risk = (σ )

P

σ = [a 2σ 2 + (1-a)2 σ

2 + 2a(1-a)

P

US

rw

σ



σ

σ

]1/2

US rw US,rw



where σ



US,rw



=

σ



2

US

σ

2

rw



the cross-market

correlation

=



U.S. returns variance



=



World returns variance



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THE BENEFITS OF INTERNATIONAL

EQUITY INVESTING

6.



Cross-market correlations



a.

Recent markets seem to be

most correlated when volatility

is greatest

b.



Result:

Efficient frontier retreats



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THE BENEFITS OF INTERNATIONAL

EQUITY INVESTING

D.



Investing in Emerging Markets

a.



Offers highest risk and returns



b.



Low correlations with returns

elsewhere



c.



As impediments to capital market



mobility fall, correlations are

likely to increase in the future.



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