The advantages and disadvantages of international investment and diversification Essay
The advantages and disadvantages of international investment and diversification
International investment is very important in the development of global economies as well as the development of individual country’s economies. There are different advantages and disadvantages associated to international investment. This essay shall discuss on the disadvantages and advantages associated with international investment as well as diversification. It is worth noting that international markets have a great variety of investment opportunities which can be exploited by both individuals and companies.
Many researchers have come up with ideas in favor of international investment. It is advantageous to invest in the international market because it is thought to offer lower risks as compared to domestic investment. International market does not sacrifice expected return as is the case in domestic market (John, 1996,p. 17). This is because most international capital markets have fairly fixed prices that are predictable in behavior. International investment also gives investors high chances to capitalize on fast growing economies resulting form the internationally invested portfolio.
International investment has made some economies in the developing countries to grow faster as they try to adjust towards the developed economies. International investors therefore are able to get high benefits upon investing. International companies are bound to be relatively cheap as compared to domestic companies in the U. S. This clearly indicates that for every dollar invested internationally, there is higher return that the investors get. Operation cost is cheaper in most international companies than domestic market oriented companies (Grimwade, 2000, p. 2)
In addition, international investment offers psychological benefits such as poverty eradication and higher living standards. International investors from developing countries are likely to experience a lift in their life style up on interaction with the international market practices. Another advantage that comes along with international investment is the diversification of opportunities. At the international market, diversification of stock market as well as the bond market leads to low correlation values than in the entire domestic investments.
International diversification is therefore important on portfolio risk reduction. For example, studies show that international diversification has resulted in low correlation values within the equity markets, ranging from 0. 3 to 0. 4. This is quite an advantage to international investors since they can make more profits (John, 1996, p. 29). It means that there is more stability in the international stock market than in the domestic stock market because there is limited co-movement within the international market.
Low correlations reflected in the bond markets also play a great role in high yields in the long run within the international market. This is as a result of diversification of the international market. The currency of a certain country has a strong influence on bond foreign market returns. Diversification of international trade reduces risks factors within the trading nations. Inefficiencies in markets are less likely to occur, thus preventing exploitation that would lead to extremely high profits.
Lags are only common in the cases where time difference occur between different regions rather than due to market inefficiency. Also, with diversification of international market, it is not evident that stock market volatility may spill over. However, it is disadvantageous to be involved in the international market because of the risks associated with exchange rates at the international market. It is disadvantageous that foreign markets are more volatile as compared by domestic market. This results from foreign currency risks.
However, market analysts advocate for investment in many countries to be based on one currency so as to avoid volatility of portfolio. Currency fluctuations lead to lack of dominance of international market (Grimwade, 2000, p. 36). Bond portfolio is adversely affected negatively by currency fluctuations which result from diversification of international market. International investment is associated with low economic growth for developed countries especially if they invest in developing countries.
More so, it is worth knowing that volatility in the international market within the developing countries is high due to higher discounts offered in the event of competing with the U. S competitors. Thus, the resulting effect of the discounts is less beneficial diversification. Moreover, high expected returns in the international investment are usually faced with trade risk found in different nations. Such risks may include less information disclosure to different destination markets hence low consumption and less trade with consequent less benefit to the international investors.
There are legal issues that as pertains entry in to international trade by investors from certain developing country which may be a stumbling block to the investors. Some countries have strict regulatory rules and heavy taxation to international investors thus reducing the benefit level that should be achieved in the trade. With diversification of market, it is difficult to predict exchange rates within the international market due to currency fluctuation. However, this does not have a long term problem because there are standardized measures for correcting currency fluctuations within the market.
In other words, it is good to understand that currency risks diminish with enlargement of trade region for foreign market. The overall return may not be affected by currency fluctuations for a long time but for a short duration (John, 1996, p. 55). The short run effect may also be as destructive to the international market that in the domestic market. In conclusion, international investment is more advantageous that disadvantageous. Therefore, foreign investment is highly encouraged.
University/College: University of Arkansas System
Type of paper: Thesis/Dissertation Chapter
Date: 30 September 2016
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