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Investment Analysis and Portfolio Management: Frank K. Reilly & Keith C. Brown
Investment Analysis and Portfolio Management: Frank K. Reilly & Keith C. Brown
Investment Analysis and Portfolio Management: Frank K. Reilly & Keith C. Brown
to accompany
Chapter 3
Chapter 3 - Selecting
Investments in a Global
Market
Questions to be answered:
• Why should investors have a global
perspective regarding their investments?
Chapter 3 - Selecting
Investments in a Global
Market
Questions to be answered:
• What has happened to the relative size of
U.S. and foreign stock and bond
markets?
Chapter 3 - Selecting
Investments in a Global
Market
Questions to be answered:
• What are the differences in the rates of
return on U.S. and foreign securities
markets?
Chapter 3 - Selecting
Investments in a Global
Market
Questions to be answered:
• How can changes in currency exchange
rates affect the returns that U.S.
investors experience on foreign
securities?
Chapter 3 - Selecting
Investments in a Global
Market
Questions to be answered:
• Is there an additional advantage of
diversifying in international markets
beyond the benefits of domestic
diversification?
Chapter 3 - Selecting
Investments in a Global
Market
Questions to be answered:
• What alternative securities are available?
What are their cash flow and risk
properties?
Chapter 3 - Selecting
Investments in a Global
Market
Questions to be answered:
• What is the historical return and risk
characteristics of the major investment
instruments?
Chapter 3 - Selecting
Investments in a Global
Market
Questions to be answered:
• What is the relationship among returns
for foreign and domestic investment
instruments? What is the implication of
these relationships for portfolio
diversification?
Reasons for the expansion of
investment opportunities
1. Growth and development of foreign
financial markets
2. Advances in telecommunications
technology
3. Mergers of firms and security exchanges
The Case for Constructing
Global Investment Portfolios
1. Ignoring foreign markets can substantially
reduce the investment choices for U.S.
investors
2. The rates of return on non-U.S. securities
often have substantially exceeded those for
U.S.-only securities
3. The low correlation between U.S. stock
markets and many foreign markets can help
to substantially reduce portfolio risk
Relative Size of U.S. Financial
Markets
1. The share of the U.S. in world capital
markets has dropped from about 65
percent of the total in 1969 to about 48
percent in 2000
2. The growing importance of foreign
securities in world capital markets is
likely to continue
Relative Size of
U.S. Financial Markets
• Can be illiquid
• Grading determines value, but is subjective
• Investment-grade gems require substantial
investments
• No positive cash flow until sold
• Costs of insurance, storage, and appraisal
Returns of Stocks, Bonds, and T-Bills
• Ibbotson and Sinquefield (I&S) examined nominal and
real rates of return for seven major classes of assets in the
United States
– 1. Large-company common stocks
– 2. Small-capitalization common stocks
– 3. Long-term U.S. government bonds
– 4. Long-term corporate bonds
– 5. Intermediate-term U.S. Treasury bills
– 6. U.S. Treasury bills
– 7. Consumer goods (inflation)
Derived Series: Historical
Highlights (1926 - 2001)
• I & S computed geometric and arithmetic mean
rates of return
• They derived four return premiums
– 1. Risk premium
– 2. Small-stock premium
– 3. Horizon premium
– 4. Default premium
Returns of Stocks, Bonds, and T-Bills
COVij
i j
N
Correlation
• relative measure of a
given relationship
Correlation
COVij
rij
i j
i i
2
i
N
Future topics
Chapter 4
• Organization of markets
• Functioning of security markets
• Trading systems