Question

Describe the major risks of international diversification in parapgraph form.

Answer 1

There are always questions on the benefits of International diversification, mainly the question is about the increased cost of investing in international market worth the benefits? Well, it is important to know about the types of risks faced by investor while doing international diversification.

1. Transaction cost- It is one of the biggest barrier in investing in foreign market. Even after globalization and connected world, transportation and transaction cost still incur high losses to the company. Apart from that brokerage, clearing and duty fess will add on to the transaction cost.
2. Currency volatility- When you are investing in the foreign market, you have to exchange your currency with the foreign currency. Exchange rate fluctuations in the international market possess serious concerns to the businesses while purchasing foreign stock. It is highly uncertain to predict the foreign exchange rate which restricts many investors for investing in international markets. The only solution to this currency risk is Hedging through currency future options and forwards.
3. Liquidity risk- The liquidity risk is very important to analyse especially in emerging markets where business is highly uncertain. Investors are always in fear to their investments, to become illiquid at the time they close their positions in the foreign market.