How does international diversification enhance risk

reduction?  When might international diversification

results in sub-par   returns? What are political risk and
how do they affect international diversification?

 reasons to diversify
1. Not all types of investments perform well at the same time.
2. Different types of investments are affected differently by world events
and changes in economic factors such as interest rates, exchange rates and
inflation rates.
3. Diversification enables you to build a portfolio with generally less risk
than the combined risks of the individual securities.
4. If your portfolio is not diversified, it may carry unnecessary risk.

International diversification will result in risk reduction for a given return as long as the
correlation coefficient between the domestic and the foreign market is less than one (i.e., less
than 100 percent). Lower future correlation will provide deeper risk reduction.

International diversification results in subpar returns when the dollar value is appreciating in
relative to other currencies.Political risks are risks that are followed by a sudden change of
decision in foreign government where the investment ismade. They highly affect international
diversification since the investment can literally be seized by a government andcan harm
potential investments.

Political risk is a type of risk faced by investors, corporations, and governments that political
decisions, events, or conditions will significantly affect the profitability of a business actor or the
expected value of a given economic action. Political risk can be understood and managed with
reasoned foresight and investment.

The term political risk has had many different meanings over time.Broadly speaking, however,
political risk refers to the complications businesses and governments may face as a result of
what are commonly referred to as political decisions—or "any political change that alters the
expected outcome and value of a given economic action by changing the probability of
achieving business objectives". Political risk faced by firms can be defined as "the risk of a
strategic, financial, or personnel loss for a firm because of such nonmarket factors as
macroeconomic and social policies (fiscal, monetary, trade, investment, industrial, income,
labour, and developmental), or events related to political instability (terrorism, riots, coups, civil
war, and insurrection). Portfolio investors may face similar financial losses. Moreover,
governments may face complications in their ability to execute diplomatic, military or other
initiatives as a result of political risk. The field has historically focused on analyzing political risks
predominantly in emerging economies, but such risks also exist in developed economies and
liberal democracies as well, albeit in different manifestations.

A low level of political risk in a given country does not necessarily correspond to a high degree
of political freedom. Indeed, some of the more stable states are also the most authoritarian.
Long-term assessments of political risk must account for the danger that a politically oppressive
environment is only stable as long as top-down control is maintained and citizens prevented
from a free exchange of ideas and goods with the outside.

Political 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
lead to changes in inflation and interest rates, which in turn may affect stock prices. An act of
terrorism can also lead to a downturn in economic activity and a fall in stock prices. Many
developing countries do not have the same level of political and economic stability that the
United States does. This increases risk to a level that many investors don't feel they can
tolerate.