Question

4) Describe the importance of knowing and applying the concept of the Foreign Market Beta (FMP). As part of your answer be sure to provide the actual formula and describe the main uses of the FMB for a foreign corporate (institutional) investor.

Answer 1

Foreign market beta is a measure of foreign market/systematic risk and is derived from the Capital Asset Pricing Model. Knowing the FMP of a country where we see huge growth opportunities will help us in making more effective investments.

As per CAPM, Required return= Risk free rate + (Market return- Risk free rate) *Beta

where, Risk free rate includes rate on Govt bonds of the foreign country; Market return (foreign market); Beta of the investment stock

A foreign institutional investor is an investor who invests funds in a country outside of the one in which it is registered. FIIs include investment banks, mutual fund companies, hedge funds etc. FIIs have a great contribution in uplifting an Economy, although most countries place limits on the value of assets that can be owned by an FII or the number of shares that can be purchased in a company.

For example, if an investment bank sees good invetsment opportunities in the Indian stock market, then it will invest in an Indian listed Company by purchasing the shares in the stock market. In doing this investement analysis, the Bank will assess the required returns from the particular stock, taking into account the Foreign Market Beta of that stock (Indian market/systematic risk)

FIIs must take into account the FMB of a stock before investing to know how much systematic risk it will be taking on by investing in the stock. This will enable it in estimating the expected return and in conducting a thorough risk-reward analysis of the investment.