What Is International Investments?
International Investments are those investments that are made outside the domestic markets and offer portfolio diversificationPortfolio DiversificationPortfolio diversification refers to the practice of investing in a different assets in order to maximize returns while minimizing risk. This way, the risk is kept to a minimal while the investor accumulates many assets. Investment diversification leads to a healthy portfolio. and opportunities for risk minimization. An investor can make international investments, thereby broadening his portfolio and expanding his horizon of returns.
International investments also serve as a means of adding different financial instrumentsFinancial InstrumentsFinancial instruments are certain contracts or documents that act as financial assets such as debentures and bonds, receivables, cash deposits, bank balances, swaps, cap, futures, shares, bills of exchange, forwards, FRA or forward rate agreement, etc. to one organization and as a liability to another organization and are solely taken into use for trading purposes. to the list when domestic markets are confined and limited by their variety. International investments aim to assure investors of two probabilities; the counter of domestic market risks and the opportunities in foreign markets.
Table of contents
- International investment refers to the allocation of funds in assets, securities, or projects outside one’s home country, aiming to diversify portfolios and capture opportunities in global markets.
- International investments offer the benefit of diversifying one’s investment portfolio, allowing investors to spread their risk across different markets and economies.
- By investing internationally, investors can counterbalance risks associated with domestic markets.
- International investments provide access to a wider range of financial instruments, allowing investors to explore combinations of equity and debt instruments that may not be available in their domestic markets.
International Investments Explained
International investments have gained momentum since the start of this century. While these investments provide greater options, they also have their share of risks. Many investors in the developed economies invest in the growing economies to seek prospects of higher returns. Some investments are made into managed funds, exchange-traded funds, etc. with the purpose of diversification and expectations of modest returns.
There are many legal bodies (Bank for International SettlementsBank For International SettlementsBIS is the Bank for International Settlements. It aims to serve the central banks in promoting monetary and financial stability, fostering international cooperation, and acting as the bank for different central banks and facilitating their collaborations. being one) that oversee the transactions happening across the world. On the one hand, best international investments boost foreign economies and bring in more influx of money; they are also responsible for scaling up market confidence and corporate credence. Investors in one part of the world may find a variety of combinations of equity and debt instruments being traded in some other part of the world.
Best international investments types can be broadly classified into the following categories:
- Government Funds/Aids – These are funds that flow from one economy to the other with the purpose of aid or assistance to the economy as a whole. These transactions are carried out between the governments.
- Cross Border Loans – A loan arrangement where a government or institution seeks loan financing from a foreign bank is known as cross border loans. Cross-border financing became a popular financing vehicle because of its easier accessibility and fewer collateral restrictions.
- Foreign Portfolio Investment – When investors express investment interests in foreign companies, they are known as FPIs. These investors may not have long-term interests necessarily but can be traded easily through exchanges.
- Foreign Direct Investment – FDIsFDIsA foreign direct investment (FDI) is made by an individual or an organization, into a business located in a foreign country. The host nation receives job creation prospects, advanced technology, a higher standard of living, infrastructural development, and overall economic growth. are investments made by foreign multinational companies in an economy. Foreign direct investment is more of a long-term concern and takes any form of investing from equities and debts to property and assets.
The global international investments can be done through these financial instruments.
- American Depository Receipts – These are the most common forms of investing internationally. An investor in the international investment companies of United States can trade in foreign stocks with the help of ADRsADRsADR (American Depository Receipts) is a financial instrument traded in US markets and are issued by US banks. ADRs are listed on the stock exchange and can trade like other stocks. . The stock will be listed on an American exchange and underlying being held by an American custodian bank.
- Global Depository Receipts – These are similar in nature as the ADRs. GDRsGDRsGlobal Depository Receipt is a receipt in which a security certificate is issued by financial intermediaries such as a depository bank, which purchases foreign securities, creates a bank certificate consisting of such shares, and then sells them on the stock exchange. have issued certificates for investors in more than one country to trade with foreign company stocks.
- Foreign Currency Convertible Bonds – A convertible bond that is issued in a foreign currency. A Euro bond issued by a US company in the UK is an example of FCCB wherein the principal repayment, and coupon payments will be made by the US company in Euro. However, the dividend payment upon conversion of the bond to equity will be made in US dollars.
Some examples of global international investments made across the globe:
- The Indian economy saw a tremendous influx of foreign direct investment in recent years.
- FDIs grew from US$ 17 billion in 2013-14 to US$ 36 billion in 2017-18. This was mostly attributed to greater ease of doing business coupled with strengthening the Indian equity market.
- FDIs from Asia have reduced during the period 2015 to 2017. This was large because of the tax-related treaty between the Mauritius and Indian governments. The decline was a remarkable 30% during this period.
FDI fell by over one third during the global recessionGlobal RecessionGlobal recession refers to a condition when the countries across the globe experience an economic downturn for an extended period. It is a form of synchronized economic downfall encountered by the various interrelated economies throughout the world. period in 2009 but later recuperated in 2010.
Important Points To Note
Some important points to note regarding international investment companies are as given below.
- There is not much difference between FDIs and FPIs if both have long term interests. However, FDIs may seek ownership and voting rights provisions as well.
- With increasing technological advances and global reach, FPIs and FDIs have outplayed cross border financing in recent years. ‘
- FPIs can take several forms, most common being equity and mutual fundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etc.
- Foreign direct investment is a subset of international investment.
While the domestic market attracts investors in its own right, international investment theories too have advantages.
- Access to opportunities existing in different markets that indigenous markets might not provide.
- Access to instruments that allow negating currency exchange risk and may guarantee greater gains.
- Offsetting risks pertaining to domestic markets and diversification of a portfolio.
- Political and economic turbulence can greatly affect such investments
- Accessibility to and availability of vital information related to foreign firms and markets is also a concern
- Complications are rendered by legislation and varying operating conditions of foreign markets.
Investments in international markets come with many drawbacks. Some of them are cited below:
- Currency Exchange Rate – Foreign investment at the outset is prone to the risk of currency exchange. Fluctuations in currency exchange can affect big transactions drastically. Currency exchange can affect an equity instrument such that the investor may find different exchange rates at the time of buy and sell.
- Credit Risk – Credit riskCredit RiskCredit risk is the probability of a loss owing to the borrower's failure to repay the loan or meet debt obligations. It refers to the possibility that the lender may not receive the debt's principal and an interest component, resulting in interrupted cash flow and increased cost of collection. can as much affect an international investment as domestic investment. Investors should carefully exercise trades with due prominence to credit ratings.
- Liquidity Risk – One of the biggest concerns of investing in international markets is liquidity riskLiquidity RiskLiquidity risk refers to 'Cash Crunch' for a temporary or short-term period and such situations are generally detrimental to any business or profit-making organization. Consequently, the business house ends up with negative working capital in most of the cases. issues. An investor sitting in the USA might not find buyers for his sale of securities in Japanese markets.
Thus the international investment theories have the above risks too.
Frequently Asked Questions (FAQs)
The international investment comes with several risks that investors should be aware of. These risks include currency exchange rate fluctuations, which can impact the value of investments when converting profits or dividends back into the investor’s home currency. In addition, political and regulatory risks arise from changes in government policies or regulations that can affect investment returns. Economic instability in foreign markets can also pose risks and cultural and language barriers that may impact communication and understanding.
Currency risk in international investment can be managed through various strategies. One approach is to use hedging techniques, such as forward contracts or currency options, to mitigate the impact of currency fluctuations. These instruments allow investors to lock in exchange rates and reduce uncertainty. Another strategy is to invest in currency derivatives, such as currency futures or exchange-traded funds (ETFs) that track currency movements.
Tax implications of international investment can vary based on factors such as residency, source of income, tax treaties between countries, and specific tax laws. Therefore, seeking advice from tax professionals familiar with international taxation is crucial to understanding and complying with relevant tax obligations.
This has been a guide to what is International Investments. We explain its types, risks, examples, financial instruments, & important points to note. You can learn more about excel modeling from the following articles –