Principles of Finance Assignment -
Submit a maximum 1,500 words report on the case.
Case Study - International Diversification and Risk Mitigation Potential
In an age of financial globalization, portfolio diversification inevitably involves the purchase of foreign assets of economies with business cycles not highly correlated with the domestic economy. Even so, the impact of external financial disturbances, involving cross-country systemic risk, cannot be effectively diversified away, and where the underlying domestic economy itself is subject to multiple axes of instability, as in the case of MENA countries, the effect of external financial disturbance tends to be all the more acute.
The economies of most Arab oil-exporting countries are sensitive to global financial fluctuations as a result of the combination of volatility in oil prices and high investment concentration in Western countries. Furthermore, the pegging of the currencies of all oil-producing countries in the region (except Kuwait) to the US$ makes monetary variables in these countries sensitive to changes in the US$. A fall in the value of the dollar increases domestic interest rates, forcing both real estate prices and bond prices to decline. In addition, because of the heavy dependence of the countries on imported goods, a fall in the value of the dollar increases inflation of imports into these countries. Most countries in the region enjoy financial surpluses, but risk factors regarding global asset prices and their impact on the economies of these countries cannot be ignored. However, in currency terms, almost 65-70 percent of assets belonging to these countries are in US$ and over 80 percent of earnings from oil export are invested in Western countries.
In recent years, GCC economies, with limited levels of success, have increased economic diversification in an attempt to reduce exposure to volatility in oil prices. In addition, most MENA countries remain dominated by an inefficient public sector. On the regional level, the Middle East exhibits a level of political instability only exceeded in the world by Sub-Saharan Africa and South Asia, rendering geopolitical shocks an important contributor to financial instability in all MENA countries. There is no doubt that the MENA countries are influenced by a number of global risks and, therefore, multiple strategic initiatives-spanning the national, regional, and international levels-are needed to mitigate geopolitical instabilities, exacerbated by the 'Arab Spring,' with a view to restoring shaken confidence in financial markets. During the past year, the rise of what is known as the 'Arab Spring' in countries across the MENA has created uncertainties about the future regional financial prospects. Because these countries are experiencing political and economic shocks, both local and foreign investors are becoming unnerved, with little incentive for commitment to invest in the region. Rather, investors are shifting funds out of the region and reallocating funds within the region to perceived safer havens. In this age of global interdependencies, internationally diversified portfolios promise higher long-term returns than purely domestic ones. On one hand, for non-oil-exporting MENA countries struggling with inefficient financial systems and weak export sectors, dollar returns to local investors on a portfolio of foreign assets generally outstrip those offered on a portfolio of domestic assets. On the other hand, for oil-exporting MENA countries, internationally diversified portfolios- provided that they are not highly concentrated in Western countries- could provide a cushion, softening the detrimental effects of oil price fluctuations and, in general, reduce the impact of global risks.
1- Explain the globalization of markets and identify the forces driving it?
2- Relating to question one above, identify the global issues and describes their inter-relationships thoroughly: Economic, politics.
3- What are alternatives and potential solutions to the investor to alleviate the impact of the risks on the investment?
4- If you were an investor, how can you minimize this risk when investing in the Qatari stock market?
The recommended layout of the case study is suggested to be as follows:
Table of contents
Introduction summarizing the case
Answering the questions and analysis (it should be an essay without inserting the question numbers)