Tài chính doanh nghiệp - Finance 407: Multinational financial management - Topic 16: Foreign securities, risks, and expected returns

Topic #16: Foreign securities, risks, and expected returnsL. GattisThe Pennsylvania State UniversityFinance 407: Multinational Financial Management1Poll (New problem Not in Packet)2Suppose you bought euros to buy a share of BMW on the German stock exchange. While holding the shares, the euro depreciated 5% and the euro price of BMW increased 10%. What do you estimate is the total USD return of this investment?5%10% 15%Learning Objectives3Learning ObjectivesStudents understand and can recallthe types of foreign security investmentscosts and benefits of foreign investing Students can computeUSD expected return of foreign investmentsUSD volatility of foreign investmentsBenefits and Risks of Foreign Investing4BenefitsDiversification with current domestic portfolioPossible Higher returns (high growth markets)RisksExchange Rate ChangesIlliquidityLack of Information/TransparencyReliance on foreign legal remediesForeign TaxesPolitical and economic riskSecurity Returns5Expected returns include both capital appreciation and dividends (or interest payments for bonds)In the equation above, the expected return for this security from period 0 to 1 includes the expected capital gain (P1-P0) and expected dividend (D1) paid at the end of the period.Security Returns6Suppose Sony stock is ¥5000 and is expected to be selling for ¥5500 in one year and also pays a dividend of ¥250. What is the expected yen return for a Japanese investor?Yen Return = {(5500-5000)+250}/5000=15%USD Return of Foreign Securities7Suppose Sony stock is ¥5000 and is expected to be selling for ¥5500 in one year and also pay a dividend of ¥250. The spot exchange rate is ¥100/$ and is expected to be ¥105 in one year. What is the expected USD return? A. 9.5% B. 20.5% C. 20.75% D. 17.2%USD Return of Foreign Securities8The spot exchange rate is ¥100/$ and is expected to be ¥105 in one year. What is the expected appreciation of the yen? A. -4.76% B. 5.00% C. 4.76% D. -5% Given the expected foreign return and the expected appreciation of the foreign currency, the USD return isWhere c is the appreciation or the foreign currency and Rfor is the local currency returnUSD Return of Foreign Securities9You expect Toyota’s yen price to increase 10%. Inflation in Japan and U.S. are 5% and 7%, respectively. What is the expected USD return of Toyota? A. 7.9% B. 12.1% C. 23.6% D. 15.1%Comparing Country Bond Returns10Suppose 1-year U.S. notes are yielding 2% and German bunds are yielding 3.5%. What appreciation of the euro will ensure the bonds have the same USD return?A. -1.45% B. 1.45% C. 0.45% D. 1.95%Risk and Foreign Investing11Risk in finance is often defined as the standard deviation of expected returnsA foreign investment is two equal investments in the foreign security and the foreign currency. Therefore, The standard deviation of USD returns of a foreign investment depends on the standard deviation of foreign returns, the standard deviation of exchange rate return, and the correlation between the foreign returns and exchange rate returns.Risk and Foreign Investing12Suppose the SD of SONY’s yen returns is 23% and the SD of he $/Yen rate changes is 17% and the correlation between SONY returns and the $/Y is .31. What is the standard deviation of SONY’s dollar returns?A. 10.6% B. 32.6% C. 30.6% D. 24.0%Buying Foreign Stocks13There are a number of ways to buy foreign stocksBuy Foreign Stocks in Foreign Market thru a U.S. Broker Often involves higher fees than domestic trades and you still must convert dividend payments into USDBuy ADRs14American Depository ReceiptsAn ADR is a receipt that represents a number of foreign shares that are deposited at a U.S. bank.The bank serves as a transfer agent for the ADRsADR share prices are quoted in USD and dividends are automatically converted into USDADRs can be sponsored by the underlying stock issuer or unsponsored15American Depository ReceiptsADR LevelsLevel I ADR: Not registered with SEC, No GAAP financials, Does not trade on major exchanges (ASE, NYSE, NASDAQ). Trade OTC.Level II/III ADR: Registered with SEC; GAAP translation; can trade on major exchanges; Level III can issue new shares in the U.S. Market16American Depository ReceiptsThere are many advantages to trading ADRs as opposed to direct investment in the company’s shares:ADRs are denominated in U.S. dollars, trade on U.S. exchanges and can be bought through any broker.Dividends are paid in U.S. dollars.ADRs save investors between 10 and 40 bps annually compared to investing in the shares directlyADRs do NOT reduce exchange rate riskSee SNE’s and JPYs return for today 17Global Depository Receipts GDRs are similar to ADRs but differ in that they are generally traded on two or more markets outside of the foreign issuer’s home market sold in the U.S. through private placement market (Under Rule 144A) to qualified institutional buyersAllow foreign companies to raise capital in multiple markets and broaden their investor base As of 2001, there were 615 ADRs/GDRs from 33 countries trading in the U.S.iClicker: Class EvaluationHow would you rate today’s class? Highest Lowest18Textbook19Shapiro and Sarin’s Foundation of Multinational Finance 6th Ed. Chapter 13 covers foreign investingAssigned Problems20Suppose you buy a share of Novo Nordisk (Danish Stock) for Kr 150.00. One year later, you collect a Kr 25 dividend and sell the stock for Kr 140.00. The initial spot exchange rate was Kr 5.8 per USD and was Kr 5.2 when you sold the stock and collected the dividend. What was your Kroner rate of return? What was the appreciation of the Kroner? What was you USD rate of return?Kr Return=(140-150+25)/150=10%; Kr App = (5.8-5.2)/5.2=11.54%USD Return = (1+local return)(1+ currency appr)-1=(1.1)(1.1154)-1=22.7%Suppose you buy a German Bund (Gov’t Bond) for €98,000 and it matures in one year at €100,000. U.S. and Euro inflation is expected to be 3% and 6%, respectively. What is your expected USD return?Euro App = (1+$ inflation)/(1+euro inflation)-1=(1.03/1.06)-1=-2.83%; Bund’s Euro Return = (100-98)/98=2.04%USD Return = (1+local return)(1+ currency appr)-1 = (1.0204)(1-.0283)-1=-.85% (-85 bps)The yen is expected to appreciation 2% in one year. U.S. bonds are offering 2.5% return. What is the no arbitrage yield on the Japanese bonds?USD Return = (1+local return)(1+ currency appr)-1; local return = (1+USD Return) /(1+ currency appr)-1Local return = (1.025)/(1.02)-1; r= 0.49%The standard deviation of BMW stock euro returns is 39%. The standard deviation of the Pound/Euro exchange rate returns is 7%. The correlation between BMW euro returns and the Pound/Euro rate returns is 0.72. What is the standard deviation of BMW’s pound returns?SD=(.39^2+.07^2+2*.72*.39*.07)^.5=44.3%