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Current Worst Most Best Risk Worst Most Best Risk
Rating Case Probable Case Stability Case Probable Case Stability

Japan 90 76 83 88 12 76 85 94 18
United States 89.5 78 90 93 15 80 85 88 8
China 62 58 63 65 7 60 70 74 14
India 56 50 60 63 13 58 65 67 9
Indonesia 49.5 40 48 50 10 40 60 64 24

Sources: A: International Country Risk Guide, September 2001, Table 2C; B: International Country Risk Guide, September 2001,
Table 3C.

country to a higher risk category. Table 21.7B shows that U.S. political risk was forecast to
deteriorate in five years (2006) to the level of Japan.
Finally, Table 21.8 shows ratings of political risk by each of its 12 components. Corruption
(variable F) in China is rated worse than in India and equal to that of Indonesia. In democratic
accountability (variable K), China ranked worst and India best, while Indonesia ranked better
than both in external conflict (variable E).
Bodie’Kane’Marcus: VI. Active Investment 21. International Investing © The McGraw’Hill
Essentials of Investments, Management Companies, 2003
Fifth Edition




734 Part SIX Active Investment Management



TA B L E 21.8
Political risk points by component, September 2001

This table lists the total points for each of the following political risk components out of the maximum points indicated.
The symbol ‘ indicates a rise in the points awarded to that specific risk component from the previous month (an
improving risk), while the symbol “ indicates a decrease (deteriorating risk). The final columns in the table show the
overall political risk rating (the sum of the points awarded to each component) and the change from the preceding
month.
A Government stability 12 E External conflict 12 J Ethnic tensions 6
B Socioeconomic conditions 12 F Corruption 6 K Democratic accountability 6
C Investment profile 12 H Religious tensions 6 L Bureaucracy quality 4
D Internal conflict 12 I Law and order 6
Political
Risk Rating
Country A B C D E F G H I J K L

United States 10 10.5 11 12 10.5 4 5.5 6 6 5 5 4 89.5 0
‘12.0 “11.0
Japan 10.5 8.5 12 3 6 5 5 6 5 4 88 0.5
“7.5
China 10 7 10 9.5 1 2 4 4 4 1 2 62 0.5
‘7.5 “8.0 “7.0 “8.0
India 3.5 2 3 2 4 2 6 3 56 1.5
‘9.5 ‘7.0
Indonesia 2 6.5 10 1 2.5 1 2 2 4 2 49.5 2



Each monthly issue of the International Country Risk Guide of the PRS Group includes
great detail and holds some 250 pages. Other organizations compete in supplying such evalua-
tions. The result is that today™s investor can become well equipped to properly assess the risk
involved in international investing.


21.3 INTERNATIONAL INVESTING: RISK, RETURN,
AND BENEFITS FROM DIVERSIFICATION
U.S. investors have several avenues through which they can invest internationally. The most
obvious method, which is available in practice primarily to larger institutional investors, is to
purchase securities directly in the capital markets of other countries. However, even small in-
vestors now can take advantage of several investment vehicles with an international focus.
Shares of several foreign firms are traded in U.S. markets in the form of American deposi-
tory receipts, or ADRs. A U.S. financial institution such as a bank will purchase shares of a
foreign firm in that firm™s country, then issue claims to those shares in the United States. Each
ADR is then a claim on a given number of the shares of stock held by the bank. In this way,
the stock of foreign companies can be traded on U.S. stock exchanges. Trading foreign stocks
with ADRs has become increasingly easy.
There is also a wide array of mutual funds with an international focus. Single-country funds
are mutual funds that invest in the shares of only one country. These tend to be closed-end
funds, as the listing of these funds in Table 21.9 indicates. In addition to single-country funds,
there are several open-end mutual funds with an international focus. For example, Fidelity of-
fers funds with investments concentrated overseas, generally in Europe, in the Pacific Basin,
and in developing economies in an emerging opportunities fund. Vanguard, consistent with its
indexing philosophy, offers separate index funds for Europe, the Pacific Basin, and emerging
markets. The nearby box discusses a wide range of single-country index funds.
Bodie’Kane’Marcus: VI. Active Investment 21. International Investing © The McGraw’Hill
Essentials of Investments, Management Companies, 2003
Fifth Edition




735
21 International Investing


Closed-End Funds Closed-End Funds
TA B L E 21.9
Fund Name Symbol Fund Name Symbol
Sampling of
emerging country
Europe/Middle East Pacific/Asia
funds
First Israel ISL India Fund IFN
Turkish Inv. TKF Jardine Fleming China JFC
Latin America Korea KF
Brazil BZF Malaysia MF
Chile CH Scudder New Asia SAF
Latin Amer. Eqty. LAQ Taiwan TWN
Mexico MXF Thai TTF
Pacific/Asia Global
Asia Pacific APB Emerging Markets Tele. ETF
China CHN Morgan Stanley EmMkFd MSF
First Philippine FPF Templeton Emerging EMF

Open-End Funds

Fund Name Assets (millions)

Fidelity Emerging Markets $ 333
Merrill Developing Cap. Market 87
Merrill Latin Amer. Developing Cap. 130
Montgomery Emerging Mkt. 151
Morgan Stanley Dean Witter EM 785
Scudder Emerging Market Income 127
Templeton Dev. Mkts. 1,400
Vanguard Int™l Index: Emerging 985

Source: The Wall Street Journal, July 5, 2002.


U.S. investors also can trade derivative securities based on prices in foreign security mar-
kets. For example, they can trade options and futures on the Nikkei stock index of 225 stocks
traded on the Tokyo stock exchange, or on FTSE (Financial Times Share Exchange) indexes
of U.K. and European stocks.


Risk and Return: Summary Statistics
Table 21.10 presents annualized average returns and standard deviations in U.S. dollars and in
local currency from monthly returns over the period 1997“2001. Developed countries appear
in panel A and emerging markets in panel B. We use this table to develop insights into the risk
and reward in international investing. The equity markets in both panels of Table 21.10 are
ordered by standard deviation.

Are Investments in Emerging Markets Riskier?
In Figure 21.3, developed countries and emerging markets are ordered from low to high stan-
dard deviation. The standard deviations of investments in emerging markets are charted over
those in developed countries. The graphs clearly show that investment in emerging markets is
largely riskier than in developed countries, at least as measured by total volatility of returns.
Still, you can find emerging markets that appear safer than some developed countries.
Bodie’Kane’Marcus: VI. Active Investment 21. International Investing © The McGraw’Hill
Essentials of Investments, Management Companies, 2003
Fifth Edition




736 Part SIX Active Investment Management


% Per Annum in
TA B L E 21.10 % Per Annum in U.S. Dollars Local Currency
Risk and return
Country Average Standard Dev. Average Standard Dev.
across the globe,
1997“2001
A. Developed countries
U.K. 5.97 15.24 9.39 16.23
Belgium 5.36 17.98 12.42 17.58
Austria 3.09 18.41 4.00 18.32
U.S. 11.98 18.78 11.98 18.78
Denmark 8.30 19.38 15.62 21.04
Netherlands 6.84 19.55 14.34 20.87
Switzerland 8.74 19.86 13.31 21.05
Ireland 10.73 20.16 19.21 21.73
Germany 5.55 20.43 13.13 22.49
Australia 4.86 20.74 12.42 13.01
France 11.45 21.36 18.84 22.81
Canada 10.08 22.41 12.51 19.37
Spain 8.38 24.20 15.94 25.20
Italy 12.30 24.50 20.02 26.47
New Zealand 3.17 24.51 5.99 17.65
Norway 1.57 25.61 7.80 23.34
Portugal 6.51 25.63 14.12 26.10
Japan 3.96 25.96 2.84 19.68
Israel 15.37 28.13 20.98 26.04
Sweden 9.25 29.10 17.45 27.61
Singapore 2.47 32.86 1.98 29.26
Hong Kong 3.01 33.34 3.17 33.32
Taiwan 2.89 38.28 6.67 35.41
Greece 20.50 39.70 28.83 40.64
Finland 29.99 42.09 38.10 43.33
B. Emerging markets
Peru 5.61 23.15 0.36 21.74
Chile 0.39 23.85 8.64 20.89
China 8.23 25.37 8.17 25.37
Colombia 15.96 29.67 0.66 27.81
Czech Rep. 0.54 32.66 4.60 28.71
Mexico 13.44 33.65 14.76 28.49
India 4.36 33.78 9.93 32.75
South Africa 0.33 34.06 16.77 28.22
Argentina 0.47 34.08 0.41 34.29
Poland 2.78 40.83 7.17 35.88
Hungary 10.45 41.29 20.76 40.73
Venezuela 9.81 41.90 1.10 41.14
Philippines 20.63 41.91 9.81 34.76
Brazil 6.09 42.40 19.38 34.91
Malaysia 4.25 51.37 0.49 43.70
Korea 18.56 56.85 22.84 49.30
Thailand 11.92 57.27 3.08 54.66
Russia 29.23 61.25 29.23 61.25
Turkey 29.43 73.54 81.40 73.56
Indonesia 1.67 86.11 2.41 47.37
Bodie’Kane’Marcus: VI. Active Investment 21. International Investing © The McGraw’Hill
Essentials of Investments, Management Companies, 2003
Fifth Edition




New Funds that Track Foreign Markets
sure in the country or countries of your choice without
LOW-COST FOREIGN INDEX FUNDS
the complications usually associated with buying, own-
CALLED WEBS ELIMINATE SOME OF THE
ing, or monitoring direct investments in foreign coun-
GUESSWORK AND COSTS OF INVESTING
tries. You also have the conveniences of trading on a
ABROAD
major U.S. exchange and dealing in U.S. dollars.
With foreign markets generally stronger this year, a new Some investors may prefer the active management,
way to invest abroad has appeared at a good time. diversity, and flexibility of open-end international equity
WEBS, an acronym for World Equity Benchmark Shares, index funds as a way to limit currency and political
represents an investment in a portfolio of publicly traded risks of investing in foreign markets. As conventional
foreign stocks in a selected country. Each WEBS Index open-end funds, however, the international funds are
Series seeks to generate investment results that gener- sometimes forced by net redemptions to sell stocks at
ally correspond to the price and yield performance of a inopportune times, which can be a particular problem
specific Morgan Stanley Capital International (MSCI) in foreign markets with highly volatile stocks.
index. You pay brokerage commissions on the purchase
You sell these shares rather than redeeming them, and sale of WEBS, but since their portfolios are pas-
but there the similarity to closed-end country funds sively managed, their management and administrative
ends. WEBS are equity securities, not mutual funds. fees are relatively low and they eliminate most of the
WEBS shares trade continuously on a secondary mar- transaction charges typical of managed funds.
ket, the Amex, during regular Amex trading hours, like
Foreign Index Baskets
any other publicly traded U.S. stock listed on the ex-
Ticker Ticker
change. In contrast, mutual fund shares do not trade
WEBS Symbol WEBS Symbol
in the secondary market, and are normally bought and
sold from the issuing mutual fund at prices determined
Australia EWA Malaysia EWM
only at the end of the day. The new funds create and
Austria EWO Mexico EWW
redeem shares in large blocks as needed, thus pre-
venting the big premiums or discounts to net asset Belgium EWK Netherlands EWN
value typical of closed-end country funds. As index Canada EWC Singapore EWS
portfolios, WEBS are passively managed, so their ex-
France EWQ Spain EWP
penses run much lower than for current open- or
Germany EWG Sweden EWD
closed-end country funds.
Hong Kong EWH Switzerland EWL
WEBS shares offer U.S. investors portfolio exposure
to country-specific equity markets, in a single, listed se- Italy EWI U.K. EWU
curity you can easily buy, sell, or short on the Amex. Japan EWJ
Unlike American Depository Receipts (ADRs) that give
you an investment in just one company, WEBS shares SOURCES: Modified from The Outlook, May 22, 1996, and Amex
enable you to gain exposure to a broad portfolio of a website, www.amex.com/indexshares/index_shares_webs.stm,
desired foreign country™s stocks. You gain broad expo- February 2000.


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