Capital Markets and Invetsment Banking

Abstract

The purpose of this paper is to analyze the effects of international portfolio diversification on an investment portfolio. In doing this, alternative investment vehicles will also be examined. Finally, derivative securities will be discussed, as well as how they can further enhance a portfolio’s performance.

Investment Enhancement Paper

There are several factors to consider when one is trying to evaluate on how to invest their money. A good starting ground however is to evaluate not just which funds to pick, but rather what the portfolio should be comprised of. There are three different separate items that will be evaluated here. First, the effects of international diversification on an investment portfolio will be analyzed. Next, alternative investment vehicles will be examined and discussed. Finally, how the use of derivative securities can further enhance a portfolio’s performance will be explained.

Several people have looked at choices outside of investments within the United Sates. International portfolios are not uncommon anymore. International portfolios can create an even higher diversification for the customer. This is because if the United States stock market crashes, the majority of your portfolio will pretty much be lost. Even if there is a dip, overall, the impacts could be huge. However, if one was to take say 40% of there funds and allocate it in international stock markets, all of your investments will not be contingent on how one specific stock market or economy is doing. Thus, a much broader form of diversification is created.

After one has evaluated if an international portfolio is something that they would want to invest in, the next step is investing alternative investment vehicles. There are several different types of investments. Stocks, bonds, money markets, mutual funds, CD’s and so on. There are also other types of investments that can be made such as property, collector’s items, and so on.

Derivative securities are yet another alternative investment vehicle that can further or enhance a portfolio’s performance. A derivative security is a “security whose returns are dependent on the current price of an underlying asset and they allow investors to offset the position of their cash market positions.” www.commerceinvest.com/Education/terms/TermPages/D.htm

The market for derivative securities has grown very large in the past few years. Worldwide these securities provide “insurance” on an estimated $16 trillion of financial securities. A good comparison is the derivatives market is similar to the insurance industry as “their economic function is to transfer risk from those who do not want to bear it to those who are willing to bear it for a fee.” http://www.sjsu.edu/faculty/watkins/deriv.htm

One form of a derivative security is hedging. Hedging provides the liquidity for the market to fulfill its social function of transferring risk. The derivative market does involve some risk, and the sizes of funds invested in these securities can be considered a bet or a gamble.

A swap is another common term heard. These are contracts involving swapping fixed interest rate payments for adjustable or floating interest payments. A company may have borrowed money under an adjustable interest rate mortgage and is now fearful that the interest rates are going to rise. It wants to protect itself against rise in the interest rates without going through the refinancing of the mortgage. It then looks for someone who will pay the adjustable interest payments in return for receipt of fixed rate payments and that is where the swap takes place.

There are several other contracts that businesses may find of interest. A cap is a contract