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Topic – 11
International Diversification
–Tutorial
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Question 1
1. Discuss what are the advantages and
disadvantages of setting up a international
portfolio?

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Answer 1: International Portfolio Advantages
» May Reduce Risk: Having an international portfolio
can be used to reduce investment risk. If Malaysian
stocks underperform, gains in the investor’s
international holdings can smooth out returns.
» For example, an investor may split a portfolio evenly
between foreign and domestic holdings. The
domestic portfolio may decline by 10% while the
international portfolio could advance 20%, leaving
the investor with an overall net return of 10%. Risk
can be reduced further by holding a selection of
stocks from developed and emerging markets in the 3

international portfolio.
Answer 1: International Portfolio
Advantages
» Diversifies Currency Exposure: When investors
buy stocks for an international portfolio, they are
also effectively buying the currencies in which the
stocks are quoted.
» For example, if an investor purchases a stock that is
listed on the London Stock Exchange, the value of
that stock may rise and fall with the British pound.
If the domestic currency depreciates, the investor's
international portfolio helps to neutralize currency
fluctuations. 4
Answer 1: International Portfolio
Advantages
» Market Cycle Timing: An investor with an
international portfolio can take advantage of the
market cycles of different nations.
» For instance, an investor may believe that domestic
stocks and the domestic currency are overvalued
and may look for investment opportunities in in the
developing regions, such as Latin America and
Asia.

» Further readings of Market cycle timing 5

» https://www.investopedia.com/trading/market-cycles-key-maximum-returns/
Answer 1: International Portfolio Limitations
» Political and Economic Risk: Many developing countries
do not have the same level of political and economic
stability. This increases risk to a level that many investors
don't feel they can tolerate. For example, a political
revolution in a developing country may result in its stock
market declining by 40%.
» Increased Transaction Costs: Investors typically pay
more in commission and brokerage charges when they
buy and sell international stocks, which reduces their
overall returns. Taxes, stamp duties, levies, and exchange
fees may also need to be paid, which dilute gains further.
Many of these costs can be significantly reduced or 6

eliminated by gaining exposure to an international

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Answer 2
» Developed market – In investing, a developed
market is a country that is most developed in
terms of its economy and capital markets. Such
countries have high income, but also have
higher levels of openness to foreign ownership,
ease of capital movement, and efficiency of
market institutions.
» Examples: United States, Australia, Canada,
Sweden, Japan, Singapore, United Kingdom
etc. 8
Answer 2
» Emerging market – Emerging market is
recognized as an economy that experiences
considerable economic growth and possesses
some, but not all, characteristics of a
developed economy. Emerging markets are
countries that are transitioning from the
“developing” phase to the “developed” phase.
» Examples: Emerging-seven (China, Russia,
India, Brazil, Indonesia, Turkey, Mexico).
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Answer 2
» Frontier market – A frontier market is a term
used for a type of developing country's market
which is more developed than a least
developed country's, but too small, risky, or
illiquid to be generally classified as an
emerging market economy.
» Examples: Argentina, Ukraine, Romania,
Bahrain, Kuwait, Egypt, Qatar, etc.

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Question 3

Discuss what are the additional risks that

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Answer 3
Foreign investment risk – The risk of loss when
investing in foreign countries. When you buy foreign
investments (for example, the shares of companies in
emerging markets, frontier markets etc.) you face risks
that do not exist in domestic country. For example,
the risk of nationalization. It is considered as a primary
risk for companies doing business in foreign countries
due to the potential of having significant assets seized
without compensation. This risk is magnified in
countries with unstable leadership and stagnant or
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contracting economies.
Answer 3
Political risk – The risk of loss when there are
changes to the political leaders or policies in a
country. For example, if a new government comes
into power, it may decide to make new policies.
Sometimes these changes can be seen as good for
business, and sometimes not. They may also lead to
changes in inflation and interest rates, which in turn
may affect stock prices. Similarly, an act of terrorism
can also lead to a downturn in country’s stability
and causes a fall in stock prices. 13
Answer 3
Currency risk – The risk of losing money because of
a movement in the exchange rate. It significantly
affects individuals, businesses, and investors
engaged in international transactions or holding
assets denominated in foreign currencies.

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Answer 3
Interest Rate risk - Each country has its own central
bank. And each central bank has its own monetary
policy. Just because interest rates might be stable in
the home country doesn’t mean that the same thing
is happening in other countries. Fluctuating interest
rates can impact the value of a particular asset. Such
fluctuations could lead to a foreign asset’s value
decline.

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Answer 3
Liquidity Risk - Another risk inherent in foreign
markets, especially in emerging markets, is liquidity
risk. This is the risk of not being able to sell an
investment quickly at any time without risking
substantial losses.
Hedging tools are utilized to reduce the numerous
risks involved in foreign investment. Different
derivatives selection (Forward/future/swaps) can be
used to eliminate such risks to hold a position that
can benefit the expected future foreign risk 16
Thank you

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