Reading 45: The Case for Inter....Diversification－LOS i 2008, investing, industry, discuss

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 17: Portfolio Management in a Global Context
Reading 45: The Case for International Diversification
LOS i: Distinguish between global investing and international diversification and discuss the growing importance of global industry factors as a determinant of risk and performance.

tycoon

Global investing refers to diversifying across:

A) countries.

B) industries and countries.

C) industries.

D) common trade zones.

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Answer and Explanation

Global investing refers to diversifying across industries as well as countries.

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Global investing is recommended over international diversification because:

A) governments impose restrictions on the repatriation of capital.

B) country factors are not as important for stock returns as they once were.

C) corporations are pursuing conglomerate diversification.

D) exchange rate risk is higher with international diversification.

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Answer and Explanation

As corporations have become more global, stock returns are more influenced by the industry in which the corporation operates, rather than the country in which the corporation is headquartered. Thus, global investing that diversifies across industries as well as borders, is recommended over traditional international diversification, which diversifies across countries only.

tycoon

An investor considers two mutual funds. Mutual Fund A invests in companies around the world, investing in those firms expected to experience superior returns. Mutual Fund B passively invests in companies throughout the world and maintains an exposure to all major industry sectors. Which Mutual Fund will have the lowest amount of unsystematic risk and why?

A) B, industry factors have become more important for stock returns.

B) B, passive investing ensures low unsystematic risk.

C) A, active investing ensures low unsystematic risk.

D) A, diversifying across borders reduces unsystematic risk.

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Answer and Explanation

Mutual Fund B will have the lowest unsystematic risk. To diversify away unsystematic risk, an investor should invest across industries as well as borders. As corporations have become more global, their country of incorporation has less influence on their stock returns. Industry factors have become increasingly important for stock returns as a result. Passive investing only ensures low unsystematic risk when the index being replicated by the passive strategy is well diversified.

tycoon

Which of the following best describes the relationship between international diversification and global investing? Global investing diversifies across:

A) countries and industries. It outperforms international diversification.

B) countries. It outperforms international diversification.

C) countries and industries. It underperforms international diversification.

D) countries. It underperforms international diversification.

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Answer and Explanation

Global investing recognizes the growing importance of industry factors for returns and diversifies across industries and countries. It will provide better diversification than just diversifying across countries (international diversification) as companies are increasingly defined by their industry and less by their country of incorporation.