INTERNATIONAL FINANCIAL MANAGEMENT
(Modified version of J. Madura's Appendix D Investment Project)
This project allows you to learn more about international investing and exchange rate behavior and risk. You are to form groups of 2 people and create a small portfolio of aUS publicly traded multinational companies and aforeign companies whose stocks are listed on a US exchange, either as an American Depository Receipt (ADR) or as a direct listing in the U.S.. ADRs are foreign stocks listed on US exchanges, denominated in US dollars. As a result, the ADR price movements reflects movements in both the value of the underlying company and the exchange rate.
The US stockshould have international business, and the foreign stock should be from two different countries). You will be tracking & analyzing the behavior of these stocks and their markets over the semester, and examining how these international stocks diversify your domestic portfolio and how they affect your risk/return tradeoff. Details of the project to help guide you in your analysis are explained below.
I hope you enjoy learning more about currencies, some international companies, and international diversification.
Data to Obtain:
a) Pick a US publicly-traded company (I picked KO - COKE ) which have data available from January 2013 and download their average weekly prices from January 2013-Dec. 29, 2017 [note: use the adjusted closing price]. , (or a similar source), click on "symbol lookup" at the top of the page to find the ticker symbol for a particular stock, and look up information about your company.
b) Pick a foreign stock(LG electronics korea)thatis listed on a U.S. stock exchanges either directly listed or listed in ADR form (American Depository Receipts-see definition on p. 84 of textbook)and which have been listed since 2013. Download average weekly prices (adjusted closing prices) from January 2013 to Dec.29, 2017 from YahooFinance, or another online site, or from the Library's Bloomberg terminal or the terminal containing Datastream. To find a list of foreign stocks listed in the US, you can go to the NYSE site and check the international stocks , or you could go to NASDAQ and search by region, or look for ADRs of foreign companies which are listed in the U.S.
c) Obtain weekly data on the two exchange rates (against the US dollar) which are the exchange rates relevant to the home country of your foreign stock. Weekly data can be obtained from the Library's Bloomberg terminal, or from the terminal that containing the Datastream database, and for some currencies in the St Louis FRED site [if you are not familiar with either,
e) Obtain data or charts on economic indicators for the on the two home countries of your ADRs. Charts for all countries appear in (but you can't download data from this site). If you wish to obtain data so you can make your own charts, you can examine , the St Louis FRED , the OECD , or the IMF data.
Note: By January 30, email me your choices of stocks so I can approve them before you begin your work. Also be sure to sign up for a group on the Canvas site.
Paper Sections and topics to be addressed in your paper:
Section I: Describing your 4-stock portfolio
(i) Discuss your reasons for picking the firms in this portfolio. Do you expect these stocks to allow you to either increase return, reduce your portfolio risk, or both? Is your portfolio focused on an industry across countries, or are you diversifying across industries as well as countries? Why?
(ii) For the US firm, examine the firm's annual report, and then write a paragraph or two discussing the firm's exposure to exchange rate and country risk. In particular: What kind of international operations does the company have? To what regions of the world does it sell its products?
Is there information on from what regions of the world the firm buys its supplies? Does the annual report mention which currencies are most important to the company? Does the company appear diversified in its global operations, or concentrated in a specific region, and how do you think the answer affects the risks faced by the company? Does the annual report mention how the company has been impacted by foreign exchange rate changes, and whether the company manages its foreign exchange risk using financial derivatives? If so, which ones?
(iii) For the foreign firm, discuss the following (i) why you picked that particular foreign stock, and how you expect the stock to help you diversify your portfolio, (ii) when the foreign became listed in the US and on what US exchange, (iii) any information on the firm's sales/ presence in the US market, (iv) summary of how the stock has been trading since 2013.
(iv) Include charts for each of the 2 stocks showing the trends of weekly prices from Jan. 2013-Dec.29, 2017
Section 2: Exchange Rate Discussion
Given that exchange rates affect the US$ value of the foreign stocks listed in the US, in Section 2 you examine the trends in your two exchange rates and some economic factors which may be affecting those exchange rates over the 2013-2017 period. For this section, address the following tasks:
(i) Graph your two exchange rates (using the weekly data you obtained), and also compute the mean, minimum and maximum of each exchange rate. Discuss the trends of each currency----has the currency appreciated, depreciated, or both? How do the standard deviations of the currencies compare?
(ii) Compute the weekly % changes in the exchange rates using the formula: 100* [S($/FX)t - S($/FX)t-1 ]/S($/FX)t-1 . Then, compute the means and standard deviations of these weekly % changes, and discuss how the two currencies compare---is one currency more volatile than the other?
(iii) Compute the correlation between the weekly % changes in the two exchange rates---how correlated are these exchange rates over the 2013-2017 period?
(iv) Using the country economic information over the 2013-2017 from www.tradingeconomics.com (or from another source if you prefer), discuss for each country how the trends in inflation, interest rates, real interest rates (which you need to estimate), real GDP growth, and current account balances compare to the trends in the U.S. Based on our discussion of exchange rate determination, do the exchange rates for the two countries appear to move in the direction suggested by our Class Week 2 discussion? (e.g. As an example, when examining inflation rates in the foreign country vs the inflation rate in the US, does it appear that the country with the higher inflation rate tends to depreciate?)
Which economic factors appear to be the most influential over the period? Was the Central Bank of your country intervening in the foreign exchange market over the period? Were there any other major political or global events which impacted the exchange rate over the 2013-2017 period?
(v) Use charts or tables of this economic data to illustrate your discussion. Be sure to cite your sources properly!
Section 3: ADR & Portfolio Analysis
In this section, you are to examine and discuss your stock and portfolio returns. For this section:
1. Using the weekly ADR & exchange rate data you have obtained, graph & compare the behavior of your each ADR (or US-listed foreign company) with the exchange rate between the foreign market of origin and the US dollar between January 2013 (or earliest date available for the ADR) to Dec. 29, 2017 (probably easier to do so if currency is quoted in #$/1FX terms). Use a two-axis graph to graph the weekly values of the exchange rate relevant to the ADR and the ADR price itself.
Then, discuss: How does the % change in the ADR price compare with the % change in the exchange rate? Do you observe any differences in behavior over the 2013-16 period examined? What do you conclude about the importance of exchange rate changes to your ADR's return over the 2013-2017 period?
2. Next, summarize the performance of your portfolio of four stocks between Jan 2013 and Dec. 29, 2017:
a. Calculate the weekly stock returns for each stock in the portfolio
i.e. 100*[(Pt / Pt-1 ) - 1]-you do this for the 4 stocks you have chosen
b. Calculate the mean return and standard deviation for each of the four stocks (use Excel formulas); calculate the Sharp ratios for each stock (assume an average annualized risk-free rate of 2% for this period).
c. Calculate the correlation coefficients between each pair of stocks using the returns from the 4 stocks calculated over the 2013-2017 period. (this can be done in Excel using the "correlation" function under the "data analysis" category of the "Tools" section. If "data analysis" does not appear under your "Tools" section, simply clicking on "Tools", then "Add-Ins", then "Analysis TookPaks").
d. Calculate the Mean and Standard Deviation for (i) the domestic portfolio of 2 US stocks and (ii) the international portfolio of the 4 stocks (more on how to do this later) over the 2013-2017 period. Calculate the Sharp Ratio for each portfolio.
Based on these calculations, then discuss: What do the Sharp ratios suggest about the risk-return trade-offs of the 4 stocks, the domestic portfolio, and the international portfolio? To what extent have the foreign stocks you chose provided diversification benefits for a US investor over the 2013-17 period?
3. Next, compare the behavior of your 4 stocks with Market ETFs using weekly returns between Jan 2013-Dec. 29, 2017 by completing the following tasks:
(i) Calculate the % weekly returns, standard deviations, and Sharp Ratios for the US ETF, and the two foreign ETFs over the 2013-2017 period. (use same 2% annualized risk-free rate assumption).
(ii) Using the weekly ETF returns you calculated in (i), and the weekly exchange rate returns from Section 2 (ii), calculate the correlation between the ETF return and the % change in its relevant exchange rate %.
(iii) Calculate the correlations between the ETFs, that is between the US ETF (the ‘SPY'returns) & each of the foreign ETF returns over the 2013-2017 period.
(iv) Compare the behavior of each US stock with the US ETF using weekly data by (a) plotting the stock's price against the US ETF (using a 2-sided chart), and (b) calculating the correlations between each domestic stock's return and the return on the US ETF.
(v) Last, compare each ADR stock price with both the US ETF & the ADR's respective market's ETF by (a) graphing the ADR price with the US & foreign ETF prices (using a 2-sided chart-make a chart for each), and by (b) calculating the correlation between the return on the ADR and the returns on the US & the foreign market ETF.
Based on these calculations, then discuss: How do the mean returns & standard deviations of the US market ETF and the foreign market ETFs compare over the 2013-2017 period? How high is the correlation between the US market ETF return and each foreign market ETF return, and what does this correlation suggest about the opportunities for a US investor to diversify his/her portfolio using assets in this foreign country?
What does this correlation between the exchange rate % change and the ETF return suggest about the impact of exchange rate changes on the foreign ETF return over the 2013-2017 period? Do the US stocks you chose appear to follow the US market index ETF closely? Do the ADRs appear to be more correlated (i.e. follow) the US or their country's ETFs? Why do you think this result occurs? Does the relationship change over the time period examined?
4. Last, discuss the stock and exchange rate behavior since Jan.2, 2018:
Provide charts showing the trends of your 4 stocks, the 2 exchange rates, and the US S&P500 ETF, and your two foreign ETFs from January 2, 2018-March 30, 2018 (no need to download additional data-can use the charts from Yahoo, Bloomberg, etc). Then discuss the behavior of your exchange rates, stocks and ETFs since January 2, 2018. How have your 4 stocks performed since January 2, 2018 compared to the ETFs? Has the exchange rate change since January tended to increase or decrease the value of your ADRs? How does the recent quarter compare with the history you examined earlier?
Section 4: Conclusion
What is your conclusion about the effects of your foreign stock choices on your portfolio? What does this exercise suggest about the effects of international diversification? How do you expect the exchange rate changes to impact your ADR returns over the rest of the year, and would you recommend investors consider these stocks for their international portfolios? Why or why not?
Paper Format considerations:
1) You need to address the questions raised in the four sections, but feel free to be creative about how this is organized.
2) Be sure to include a Title page, an introduction, a well-written & organized body of the paper that addresses the questions above, and a conclusion.
3) Be sure to cite your sources using both footnotes (or endnotes) and a bibliography. Remember, the purpose of footnotes is to allow the reader to associate a given fact or quote to a specific source-I should be able to see where you obtained your information. A bibliography is not enough!
4) The page limit for the written part of the paper is 10 written (double-spaced, 11-pt font) pages. The paper should also include charts or tables that support your analysis, but these charts/tables do not count toward the overall page limit. Please be sure to label each chart or table (e.g. Chart 1, etc.).
5) Please submit the following on Tuesday, April 17:
a. A hard copy of your paper
b. Upload the Word document file to the Canvas site
c. Upload your excel file showing your calculations---format will be discussed.