Investment in Foreign Exchanges: Importance, Pros and Cons

Importance of Investment in International Securities Market

Investors and corporations can participate worldwide for the most attractive investment opportunities. The globalization of securities market has enabled rapid increase in the international mobility of capital. The growth and importance of international securities markets can be highlighted as follows:

Attraction of Additional Capital

The increasing competition between marketplaces including greater breadths, depth, and liquidity of markets have reduced execution and financing costs significantly for the benefits of investors, government and corporate issuers. All of these factors are encouraging broader public ownership of securities. It is notable that those countries which enjoy the broadest public ownership of securities, also generally enjoy the greatest political and economic stability. This, in turn, attracts additional capital both from within and abroad. The international securities markets are becoming ever more important sources of capital for governments and corporation and of investment opportunities for individuals and institutions of all nations.

Global Diversification

On the supply side of global securities markets, the benefits of global diversification provides a significant incentive for investing across national borders. In addition, there has been a general shift in the allocation of savings from traditional bank deposits toward investment in equity through mutual and pension funds. These institutionally managed funds have increasingly turned to international markets as a source of higher returns.

Transformation of economy

On the demand side, the capital needs of developing countries and countries making the transition from centrally planned to more market-based economic systems have brought a larger number of firms to the global securities market as a means of raising capital. The barriers between savers resigning in one nation and firms demanding capital located in another nation has been declining over time as communications technology improves and the process of eliminating capital control continues.

Investing in Foreign Securities

For investors, who understand the opportunity and risk of international investing well, there are many ways to gain exposure to foreign securities. There are two ways to investing in foreign securities- direct investment and indirect investment.

Direct Investment 

Investors have three options to make direct investments in foreign companies. One the option is to buy stocks of foreign companies that are traded in domestic exchanges or over-the-counter markets. For example, an American Investor may buy the Unilever Stocks (UK Company) or Sony Stocks (Japanese Company) listed in New York Stock Exchange. This is the simplest form of international investing. The second option of direct investment is to buy securities on foreign exchanges. A German investor buying Intel Stocks in New York Stock Exchange or an American Investor buying the stocks of Standard Chartered Bank in London can reap advantages of the price rise in those stocks, but at the same time, you are exposed to some risk as well. First, you have to be well aware of the regulations of foreign exchange in which you invest. Second, you are exposed to foreign exchange risk as well. You may incur a loss due to the appreciation of your currency despite the increase in the value of your investment.

The third option is to invest in American Depository Receipts, popularly known as ADRs. ADRs are dollar-dominated receipts for the stocks of foreign companies. They are issued against foreign securities that are held in the vaults of banks in the companies’ home countries. American investors investing in ADRs reap advantages of foreign securities and are protected from foreign exchange risk.

Indirect Investment

Indirect international investment can be achieved by investing in the stocks of multinationals that have substantial business interest abroad. For example, companies like Coca-Cola, ExxonMobil and Citigroup earn more than 50 percent of their revenue from foreign operations. Therefore, for an American Investor, investing in the stocks of these companies is equivalent to international investing.

Regardless of the way chosen to invest in foreign securities, investors should learn about the product they are investing in. In addition, knowledge about the political and economic conditions in the country of investment is essential to understand the factors that could affect the investment returns. Investors must focus on their investment objectives, costs, and prospective returns, and balancing them with their risk tolerance.