Bonds and Bond Derivatives, Second Edition

17

EXCHANGE RATES AND INTERNATIONAL INVESTMENTS

The purpose of this chapter is to provide an understanding of the relationships between exchange rates and international investing. The factors determining currency exchange rates are discussed, as well as the impacts of exchange rates on international trade and investment.

International Investment

International investment increases portfolio diversification if the investment returns in different countries are less than perfectly correlated. Internationally diversified portfolios have lower risk than purely domestic portfolios, if the economies in individual countries are affected by some factors unique to those countries. Returns on international investments are affected by changes in exchange rates. The ensuing discussion examines the impact of exchange rates in detail.

Besides the risk of changing exchange rates, investing in foreign securities has several special costs and risks. First, acquiring information about investments in other countries is more difficult and expensive than obtaining information about domestic investments because of distance and language differences. Travel to foreign countries to acquire information can be quite expensive. Understanding foreign information requires fluency in a foreign language or ready access to a translator. Second, financial disclosure standards differ by country. In some foreign countries, firms are neither required nor expected to reveal nearly as much information to the public as ...