Question

Explain how international investment can lead to an increase in the return per unit of risk. Use diagrams or formulae to support your answer as appropriate.

Answer 1

The decision to invest overseas should begin with determining the risk of the investment climate in country under consideration.

Ex- 1.Country Risk- It refers to the economic, political and business risks that are unique and specific to a country and that could be in result of unexpected investment losses.

2. Economic Risk - It refers to a country's ability to pay back its debts. A country with stable finance and stronger economy should provide more reliable investment than a country with weaker finance economy.

3. Political Risk - It refers to the political decisions made within country that might result into unexpected losses.

4. Sovereign Risk. It is a risk that a foreign central bank will alter its foreign exchange regulation so reducing and nullifying the value of its foreign exchange contract.

Measurement of risk per unit-

1. Treynor Ratio (MR-RF)/B - For computation purpose we need some info as under with example.

Return-: Country - A 10% and Country B- 12%

Beta-: Country 0.75 (Risk Factor)

Risk free rate of return country A- 3%

Now assume an investor in country A want to invest in country B with assuming other thing remain constant.

so applying formula with MR= Market Return, RF- Risk free return and B- Beta

Sol.- Country A- (10%-3%)/.75 = 0.0933

Country B- (12%-3%)/.75 =0.12

Conclusion - Here the unit return per in country B is higher so investor can invest as well in country B provided other things remain constant such Exchange rate and Interest Rate.