INVESTING OVERSEAS
Investors should consider additional risk factors if they invest overseas. First, there is country risk, which refers to the risk that is attributable to investing in a particular country. This risk depends on the country’s economic, political, and social environment. Some countries provide a safer investment climate, and there-fore less country risk, than others. Examples of country risk include the risk that property will be expropriated without adequate compensation plus risks associated with changes in tax rates, regulations, and currency repatriation. Country risk also includes changes in host-country requirements regarding local production and employment, as well as the danger of damage due to internal strife.
It is especially important to keep in mind when investing overseas that securities are often denominated in a currency other than the dollar, which means that returns on the investment will depend on what happens to exchange rates. This is known as exchange rate risk. For example, if a U.S. investor purchases a Japanese bond, interest will probably be paid in yen, which must then be converted into dollars before the investor can spend his or her money in the United States. If the yen weakens relative to the dollar, then it will buy fewer dollars, hence fewer dollars will be received when funds are repatriated. However, if the yen strengthens, this will increase the effective investment return. It therefore follows that returns on a foreign investment depend on both the performance of the foreign security and on changes in exchange rates.
- What is country risk?
- What is exchange rate risk?
- On what two factors does the return on a foreign investment depend?
