Question

Foreign financial markets

1. How should an investor whose investment portfolio consists solely of domestic investments expect the risk of the portfolio to change if the investor adds foreign investments to the portfolio? Explain.

2. Name two ways a US investors can include foreign investments in their investment portfolios without the need to buy or sell investments in foreign securities markets.

Answer 1

Foreign investments diversify the original portfolio, but it will bring in multiple risk factors alongside-

1. Currency volatility- The investor needs to exchange domestic currency into foreign currency at the current exchange rate in order to buy the stocks. Later on at the time of selling the same stocks, the foreign currency will have to be converted back into domestic current at the prevailing rate. A fall in exchange rate is always a concern for the investors.
2. Liquidity problem- Liquidity risk arises when an investor could not sell his foreign investment securities quickly enough due to absence of any potential buyer.
3. Sovereign risk- Foreign investors also face the risk that a foreign central bank an change it's current monetary policy against their favor.

Ways to invest in foreign market without actually buying then in foreign securities market-

1. American depository receipt (ADR)

2. Exchange trade funds(ETF)

3. Mutual funds registered in US having foreign funds within