Global Investment Management Flashcards

Question 1

What is meant by global investing in a portfolio context?

Accepted Answer

Global investing means holding securities from companies, governments or funds located in several countries, rather than limiting a portfolio to one home market. Investors do this to reach more opportunities, spread risk across economies that do not move in lockstep, and access industries that may be scarce or absent domestically.

Question 2

What is home country bias, and why does it matter for investors?

Accepted Answer

Home country bias is the tendency to hold a disproportionate share of a portfolio in domestic stocks and bonds, even though foreign markets hold a large share of the world's market value. It matters because it can leave portfolios concentrated in one economy, currency and set of industries, raising exposure to local shocks.

Question 3

What is the difference between developed and emerging markets?

Accepted Answer

Developed markets are economies with mature financial systems, established regulation, high income levels and generally deep, liquid capital markets, such as the United States, Japan and much of Western Europe. Emerging markets are economies that are industrializing and growing quickly, with less mature institutions, shallower markets and typically higher volatility.

Question 4

What is a benchmark index, and why do global investors compare their portfolios to one?

Accepted Answer

A benchmark index is a rules-based measure of a market or segment, such as a basket of large foreign stocks, used as a reference point for performance. Investors compare portfolios to a benchmark to judge whether active decisions added value after costs, and to keep the portfolio's risk aligned with the intended mandate.

Question 5

What are the main asset classes that global investors commonly hold across borders?

Accepted Answer

The main cross-border asset classes are equities, which are shares of ownership in companies; fixed income, which are bonds or loans issued by governments and corporations; cash and money market instruments; and real assets such as real estate investment trusts or commodities. Each carries different return drivers and risks.

Question 6

What is a depositary receipt, and how does it help a domestic investor buy foreign shares?

Accepted Answer

A depositary receipt is a certificate issued by a bank that represents shares of a foreign company held by a custodian in that company's home market. American Depositary Receipts trade on United States exchanges in dollars, letting domestic investors buy foreign companies through familiar brokerage accounts while owning economic interests in the underlying shares.

Question 7

What is the difference between an active and a passive global strategy?

Accepted Answer

An active global strategy uses research and judgment to choose countries, sectors or securities in an effort to outperform a benchmark. A passive strategy tracks a chosen index at low cost, accepting benchmark returns rather than trying to beat them. The choice depends on costs, beliefs about market efficiency and personal goals.

Question 8

What is the difference between a return in local currency and a return in the investor's base currency?

Accepted Answer

A local currency return measures how an asset's price changed in the currency of the market where it trades, ignoring exchange rates. A base currency return converts the investment into the investor's own currency, so it includes the effect of exchange rate movements. That is the money the investor actually spends or saves.

Question 9

What is an exchange rate, and how is it quoted?

Accepted Answer

An exchange rate is the price of one currency expressed in units of another, such as the number of Japanese yen needed to buy one United States dollar. Quotes are written as a currency pair, with the base currency first and the quote currency second. Rates move with supply and demand for each currency.

Question 10

What is currency risk, and how does it affect a foreign investment?

Accepted Answer

Currency risk is the chance that changes in exchange rates will reduce or increase the value of a foreign investment when converted back to the investor's base currency. If the foreign currency weakens against the base currency, returns shrink even if the local asset price is unchanged.

Question 11

How does a currency hedge reduce exposure to exchange rate movements?

Accepted Answer

A currency hedge uses a derivative, such as a forward contract, to fix or limit the exchange rate for a future date. Gains or losses on the hedge tend to offset currency-driven changes in the investment's base currency value. Hedging reduces currency volatility but usually carries a cost.

Question 12

What is a currency carry trade, and what risk does it involve?

Accepted Answer

A currency carry trade borrows in a currency with a low interest rate and invests in a currency with a higher rate, earning the difference if exchange rates stay stable. The main risk is that the higher yielding currency falls sharply, which can erase the interest gains and produce large losses.

Question 13

How can interest rate differences between two countries influence their exchange rate?

Accepted Answer

Higher interest rates in one country can attract foreign capital seeking better yields, which raises demand for that currency and tends to strengthen it. Lower rates can have the opposite effect, encouraging investors to move money elsewhere. Interest rates are only one influence, because inflation, growth and risk sentiment also shape currency values.

Question 14

What is a natural hedge, and how can it reduce currency exposure without derivatives?

Accepted Answer

A natural hedge matches revenues, costs, assets and liabilities in the same currency so that exchange rate movements affect them in offsetting ways. For example, a company earning sales in euros and paying its euro suppliers has less net exposure than one that earns euros but pays in dollars.

Question 15

What is a currency overlay, and why do institutional investors use one?

Accepted Answer

A currency overlay is a separate program that manages the currency exposure of a portfolio apart from its underlying security decisions. Managers can hedge, leave exposure unhedged or take active currency positions, which lets the stock or bond managers focus on their own selections.

Question 16

Why might a hedged foreign bond fund behave differently from an unhedged one?

Accepted Answer

A hedged fund removes most currency movements, so its returns mainly reflect the foreign bond's yield and price changes, along with the hedging cost or benefit. An unhedged fund keeps the currency exposure, so its results can be boosted or reduced by exchange rate moves.

Question 17

What is country risk, and what kinds of events does it include?

Accepted Answer

Country risk is the possibility that political, economic or legal conditions in a specific nation will hurt investment returns. It includes events such as sudden policy changes, capital controls that restrict moving money out, expropriation of assets, sovereign debt default, and weaker property rights or enforcement of contracts.

Question 18

Why does liquidity risk often matter more in smaller emerging markets?

Accepted Answer

It matters more because smaller markets often have fewer buyers and sellers, so trading is thin and prices can move sharply on modest orders. An investor may then need to accept a much lower price to exit a position or be unable to sell quickly at all. Liquidity also dries up during crises.

Question 19

How does a frontier market differ from a more established emerging market?

Accepted Answer

A frontier market is a country with a smaller and less developed investable market than a typical emerging market, often with fewer listed companies, lower trading volumes and more restrictions on foreign ownership. Frontier markets can offer diversification, but they usually carry higher liquidity, political and access risks.

Question 20

What is a sovereign credit rating, and why does it influence borrowing costs?

Accepted Answer

A sovereign credit rating is an agency's assessment of a national government's ability to repay its debt. Higher ratings generally mean lower borrowing costs, because investors demand less extra yield for lending to a government they see as safer. Downgrades can raise yields and sometimes force selling by funds with rating limits.

Question 21

What are capital controls, and how do they affect foreign investors?

Accepted Answer

Capital controls are government rules that limit cross-border flows of money, such as restrictions on converting local currency, repatriating profits or moving funds out of the country. They can trap investment returns inside a market, delay sales and make it harder to rebalance or exit a position on schedule.

Question 22

What is a market's free float, and why does it matter?

Accepted Answer

Free float is the portion of a company's shares that is freely available for public trading, excluding stakes held by governments, founders or other strategic holders. Index providers often weight companies by free float, so a stock with few tradable shares may carry less weight than its total market value suggests.

Question 23

Why do emerging market equity indexes often have heavy concentration in a few sectors or companies?

Accepted Answer

Concentration arises because many emerging market indexes are dominated by a small number of large companies or a few sectors such as financials, energy or materials. Such concentration reflects which firms have grown large and listed, so returns can depend heavily on a handful of holdings.

Question 24

What is the role of a country's inflation rate in evaluating its investments?

Accepted Answer

Persistently high inflation erodes the real value of returns and of bonds that pay fixed interest, and it often prompts central banks to raise interest rates, which can hurt equity valuations. Investors compare inflation with nominal yields to estimate real returns.

Question 25

How does combining assets with low correlation affect portfolio risk?

Accepted Answer

Combining assets whose returns do not move closely together can lower overall portfolio volatility without necessarily lowering expected return. When one holding falls, another may hold steady or rise, so gains and losses partly offset. Correlation is not fixed, however, and tends to rise during market stress.

Question 26

What is the efficient frontier, and what does it show investors?

Accepted Answer

The efficient frontier is a curve showing the set of portfolios that offer the highest expected return for each level of risk, based on estimated returns, volatilities and correlations among assets. Portfolios below the curve are inefficient because a better mix exists, while portfolios on it cannot improve return without taking more risk.

Question 27

How does strategic asset allocation differ from tactical asset allocation?

Accepted Answer

Strategic asset allocation sets long-term target weights for asset classes and regions based on the investor's goals, time horizon and risk tolerance, and changes them infrequently. Tactical asset allocation makes shorter-term adjustments around those targets to take advantage of perceived market opportunities or risks. Many global portfolios combine both approaches.

Question 28

Why does periodic rebalancing matter in a multi-country portfolio?

Accepted Answer

Rebalancing means restoring portfolio weights to their targets after markets move them away. Without it, assets that have risen most can gradually dominate the portfolio, increasing risk beyond what the investor intended. Rebalancing also encourages a disciplined approach of trimming winners and adding to laggards, though it can involve transaction costs and tax consequences.

Question 29

What role does the investor's base currency play in setting a global target allocation?

Accepted Answer

The base currency sets the expenses and liabilities the portfolio must cover, so foreign assets that match those needs can reduce mismatch risk. An investor with domestic liabilities may hold more domestic assets, while one with foreign obligations may hold foreign assets to match.

Question 30

What does tracking error measure for a passive global fund?

Accepted Answer

Tracking error is the standard deviation of the difference between a portfolio's returns and its benchmark's returns over time. A low tracking error means the portfolio closely follows its index, while a high tracking error signals more deviation, whether from active bets, cash drag, fees or sampling methods.

Question 31

How do management fees and trading costs affect long-term global returns?

Accepted Answer

Fees and trading costs are deducted from returns every period, so even small annual differences compound into meaningful gaps over long horizons. Global portfolios can face higher costs than domestic ones because of foreign custody, currency conversion spreads, transaction taxes and wider bid-ask spreads in some markets.

Question 32

What is a multi-asset or global balanced fund, and who might use one?

Accepted Answer

A multi-asset fund holds a mix of equities, bonds and sometimes cash, real assets or alternatives within one portfolio, often across several countries, and manages the mix to a stated objective. Investors who want diversification without choosing each asset class themselves, or who prefer a single professionally managed holding, may use one.

Question 33

What is withholding tax, and how can it reduce foreign returns?

Accepted Answer

Withholding tax is a tax that a foreign country deducts from dividends, interest or other income paid to investors before the money is sent abroad. It reduces the net yield an investor receives, and the investor may only recover part of it through a tax credit or treaty relief in their home country.

Question 34

What is the purpose of a tax treaty between two countries?

Accepted Answer

A tax treaty between two countries sets rules that determine which country may tax a given type of income and sets maximum withholding rates on dividends, interest and royalties. Its goal is to prevent the same income from being taxed twice and to reduce barriers to cross-border investment.

Question 35

What is a custodian bank, and why do global investors need one?

Accepted Answer

A custodian bank safeguards a portfolio's securities and cash, settles trades, collects income and handles corporate actions such as dividends and voting notices. Global investors need one because foreign securities are often held through local sub-custodians across many markets, and a global custodian coordinates these arrangements and reporting.

Question 36

What is settlement risk, and how does the settlement cycle affect it?

Accepted Answer

Settlement risk is the danger that one party to a trade delivers its securities or cash while the other fails to do so, leaving the first party exposed to a loss. The settlement cycle is the time between trade execution and final exchange, so a longer cycle leaves more time for prices to move or a counterparty to default.

Question 37

How do foreign ownership limits affect an investor's ability to buy shares?

Accepted Answer

Some countries cap the percentage of a company or sector that foreign investors may own, or require approval before purchases above a threshold. Such limits can prevent purchases, cause shares to trade at a premium to locally available shares or force a manager to wait until a stake becomes available.

Question 38

What is the role of a securities regulator in cross-border investing?

Accepted Answer

A securities regulator oversees markets in its country by setting rules for disclosure, trading conduct, licensing of intermediaries and investor protection. In cross-border investing, regulators also share information and cooperate with counterparts abroad, which helps address misconduct that spans multiple jurisdictions. Investors benefit from knowing which regulator oversees each market they hold.

Question 39

What is the difference between a fund's net asset value and its market price?

Accepted Answer

Net asset value is the per-share value of a fund's holdings after subtracting liabilities. Market price is what buyers and sellers pay for a share during trading hours. For funds holding foreign assets, the two can diverge because foreign markets may be closed when the fund's exchange trades, so prices can be stale.

Question 40

Why do global investors need to consider operational risk?

Accepted Answer

Global investors must watch operational risk because cross-border holdings add more points where processes, systems or controls can fail. Operational risk covers losses from errors, system breakdowns, fraud or weak controls rather than from market moves. Different settlement practices, time zones, languages, legal documentation and reliance on several intermediaries all raise this exposure.

Global Investment Management Flashcards

1Foundations of global investing

2Currency and exchange rate risk

3Emerging and frontier markets

4Portfolio construction and diversification

5Taxes, regulation and implementation

Learning Resources