Investment Concerns - International or Domestic

Investors generally have three broad concerns when an investment is made. They care about how much money the investment will earn over time, they care about how risky the investment is, and they care about how liquid, or convertible, the asset is.

1) Rate of return - the percentage change in the value of an asset over some period of time.

Investors purchase assets as a way of saving for the future. Anytime an asset is purchased the purchaser is forgoing current consumption for future consumption. In order to make such a transaction worthwhile the investors hopes (sometimes expects) to have more money for future consumption than the amount they give up in the present. Thus investors would like to have as high a rate of return on their investments as possible.

Example 1: Suppose a Picasso painting is purchased in 1996 for $500,000. One year later the painting is resold for $600,000. The rate of return is calculated as,

Example 2: $1000 is placed is a savings account for 1 year at an annual interest rate of 10%. The interest earned after one year is $1000 x 0.10 = $100. Thus the value of the account after 1 year is $1100. The rate of return is,

This means that the rate of return on a domestic interest bearing account is merely the interest rate.

2) Risk

The second primary concern of an investor is the riskiness of the assets. Generally, the greater the expected rate of return, the greater the risk. Invest in an oil wildcat endeavor and you might get a 1000% return on your investment ... if you strike oil. The chances of doing so are likely to be very low however. Thus, a key concern of investors is how to manage the tradeoff between risk and return.

3) Liquidity

Liquidity essentially means the speed with which assets can be converted to cash. Insurance companies need to have assets which are fairly liquid in the event that they need to pay out a large number of claims. Banks have to stand ready to make payout to depositors etc.

International Finance Theory and Policy - Chapter 10-3: Last Updated on 12/31/05