FIN 358 International Finance
PROJECT
Due Tuesday, December 12, 11:59pm.
Please prepare a report for a country of your choice. Your report should be 15 pages long including
detailed analysis of exchange rate, country stock index and macroeconomic data. There will be
two parts in your report: country analysis and investment analysis. In addition you should submit
a 1 page summary with your overall recommendation. The summary should state whether you
recommend or not to invest in a country stock index for the next five years. It should summarize
the main reasons for your recommendation based on macroeconomic risks, past performance (riskreturn tradeoff such as Sharpe ratio) and potential benefits for portfolio diversification.
I.
Country Analysis
(a) Macroeconomic trends and risks
Discuss Balance of Payments (Current Account surplus or deficit) , exchange rate,
GDP growth, inflation, monetary policy, fiscal deficits/surpluses, yields on
government bonds compared to the US T-bonds for the last 5-10 years.
Macroeconomics data can be searched from the Central bank website of a country
and from the IMF website among other sources. Exchange rate is available from
the The Pacific Exchange Rate Service or from FRED database among other
sources.
(b) Is the country open to foreign investments? Discuss restrictions on foreign
investments, capital controls, political environment and any other risks of
investment in the country.
II.
Investment Analysis
Find the monthly data on the country’s major stock index (see MSCI Barra or other
source). Show the country stock index return in local (foreign) currency rfc and in
USD r($). Note the conversion from the return in local currency into the USD using
% change in exchange rate term e:
𝑒=
(𝑆𝑡 − 𝑆𝑡−1 )
𝑆𝑡−1
𝑟($) = 𝑟𝑓𝑐 + 𝑒
1
Look at the performance for the last 10-20 years of the country return in dollars r($)
relative to the MSCI world index return (ACWI) and the USA index return. For the
USA index use either MSCI index for USA or SP500 index. The data for the ACWI
index and the USA index can be obtained from MSCI Barra website. The SP500
index data are available e.g. from Yahoo Finance.
(a) Report the mean, standard deviation and the Sharpe ratio for the country return in
dollars r($), USA index return and ACWI. Compare and discuss them. (Note:
The T-bill (4 weeks or 3 months) can be used as a risk-free asset and data are
available from the Fed website.)
(b) Find the correlation between the country stock index return and the USA index
return. Would it be beneficial from the point of view of international portfolio
diversification to invest in this country for an investor holding only the USA
index portfolio?
2
Peter Franch Wamberg
8/5/2015
Denmark
Fin 358 International Finance Project
The first part, I: Country Analysis, of the project will serve to provide the reader with a clear picture of
how Denmark’s Macroeconomic qualities and data shape it as an economy and country. The goal of the
presented data in I: Country Analysis section of this project is to provide sufficient information in order
for the reader to proceed to the second part of the project: II: Investment Analysis. In this part of the
paper I will discuss investment opportunities, as well as restrictions and risks for the international
investor seeking capital gains in Denmark.
I: Country Analysis
Before getting into the different facts, analysis and eventually discussions, which will be derived from
Denmark’s economic data; providing the uninformed reader with a few basic, informative characteristics
of Denmark, will help the reader relate, as well as understand, the issues and possibilities the economy
of Denmark possesses.
Denmark (dark-green marked country).
Member of the Scandinavian region.
Capital: Copenhagen (Approx. 1,900,000 inhabitants).
Approximate population is 5,600,000
(600,000/5,600,000=10.7% not born in Denmark).
Currency: Danish Krone (Exchange rate as of 8/5/2015 to
the U.S. Dollar is DKK6.86/1USD).
Memberships include but are not limited to: The UN, OECD,
EU, NATO, Schengen, IMF and WTO.
Monarchy.
Government: The liberal party.
1st place in least corrupt countries in the world 2013.
Corporate tax rate: 24.5%; Personal income 37.48-59%.
Very open to foreign investments (foreign and domestic
investors generally treated equally under law).
Central Bank: Danmarks Nationalbank.
I: Country Analysis (macroeconomic trends):
This part of the project will be divided into 7 different sections:
1.
2.
3.
4.
5.
6.
7.
Balance of Payments-Current Account Surplus or Deficit (All Values in US Millions)
Exchange Rate (Fixed Rate with the Euro)
GDP Growth
Inflation
Monetary Policy
Fiscal Deficits/Surpluses
Yields on Government Bonds Compared to the US T-Bonds for the last 5-10 Years
1: Balance of Payments-Current Account Surplus of Deficit (all values in US millions):
Definition of Current Account: “The difference between a nation’s savings and its investments. The
current account is an important indicator about an economy’s health. A positive current account balance
indicates that the nation is a lender to the rest of the world.”-Investopedia
According to the data gathered from the IMF’s database, the current account has enjoyed a trade
surplus from 2009 through 2014; exports have exceeded imports. Exports ranged from 91,108.11 to
111,671.35 with an increasing trend from 2009-2011 at 91,108.11-111,245.26. In 2012 the exports
dropped to 105,449.55 and climbed back to its peak at 111,671.35 in 2013, where it has kept a steady
level. An important detail to remember is that the balance on goods and services also has remained
postive throughout the same period; at an almost entirely increasing level, with merely minor drops.
One reason for this minor drop in exports relative to imports in 2012 can be explained by the
appreciation in the DKK relative to the Euro in late 2011-early 2012, causing the Danish exports to
become more expensive to surrounding nations with the Euro; notable that it is a minor decrease in
exports considering this movement in currency appreciation/depreciation.
2009
2010
2011
2012
2013
2014
Balance of Payments
Current Account (Excludes Reserves and Related Items)
10,767.02
18,182.63
19,874.64
18,749.78
24,248.24
21,493.81
Goods, Credit (Exports)
91,108.11
95,029.88
111,245.26
105,449.55
111,671.35
111,449.17
Goods, Debit (Imports)
82,126.26
85,904.67
101,102.08
96,947.44
99,785.56
101,320.69
Balance on Goods
8,981.85
9,125.22
10,143.19
8,502.11
11,885.79
10,128.30
Services, Credit (Exports)
56,243.31
61,211.25
66,494.40
65,999.26
70,686.08
72,486.81
Services, Debit (Imports)
52,338.06
52,310.15
58,643.06
58,179.69
63,268.76
64,238.57
12,887.09
18,026.31
17,994.52
16,321.67
19,303.10
18,376.73
Balance on Goods and Services
The quantitative data presented in the “Balance of Payments” above, can be further explained using the
average and standard deviation. These low standard deviations calculated represent stable exports on
both goods and services; as well as stable positive balances in these accounts; I would like to stress the
fact that these numbers have a low volatility, despite the slight increase in the value of the Danish Krone
in 2012 relative to the Euro; indeed is positive for Danish exports.
Category
Goods, Credit (Exports):
Balance on Goods
Average
x
𝜇 = Σ n= 104,325.5533
𝜇=Σ
x
=9,794.407936
n
Standard Deviation
∂= Σ
∂= Σ
√(𝑥−𝜇)2
𝑛−1
√(𝑥−𝜇)2
𝑛−1
= 9,110.024182
=1,215.327826
Services, Credit (Exports):
Balance on Goods and Services
𝜇=Σ
𝜇=Σ
x
= 65,520.18152
n
x
=17,151.57199
n
∂= Σ
∂= Σ
√(𝑥−𝜇)2
𝑛−1
√(𝑥−𝜇)2
𝑛−1
=6,017.081574
=2,301.319483
This numeric data supports the stability and non-exisiting volatility of Denmark’s goods and services’
difference between exports and imports; the fact that Denmark is running a stable trade surplus.
The financial account has a good, but different story; it’s increased dramatically from 2009-2014; from a
-26,358.65 to +35,340.33 in 2014. This could be because Danes are purchasing less foreign assets (such
as real estate), whereas foreigners have been acquiring more Danish assets.
Financial Account (Excludes Reserves and Related Items)
-26,358.65
-5,326.85
7,887.28
17,345.52
30,148.71
35,340.33
This positive change would indicate an increase in the ownership of Danish real assets (such as bank
deposits, loans, corporate/governemt bonds, equity, factories, real estate etc.) These numbers could
very well indicate an increase in foreign business interest in Denmark. The average for the financial
account is 9,839.391115; and with a very high standard deviation of 23,079.13275. It should be noted
that this high standard deviation is positive in this case; it represent a drastic increase in the acquisitions
of Danish assets made by foreigners, and possibly a decrease in the purchases of foreign assets made by
Danish citizens.
However, the balance on the current, capital and financial account together has gone from a positive
33,670.67 to a negative 7,998.67 after net errors and omissions.
33,670.67
4,279.69
10,554.14
1,852.06
-647.33
-7,998.67
2: Exchange Rate: (Fixed Rate with the Euro):
For the most relevant anlysis to be reached I’ll focus on the exchange rate between the Danish Krone
(DKK) and the Euro; I’m doing this since the majority of Denmark’s trade is through the use of Euros,
between other members of the EU (However, I’ll also include the exchange rates between the U.S.
Dollar and Danish Krone, since this is a class at an American university). To reach a more in depth
analysis/picture of the exchange rate of the Danish Krone; including a quick note about the relationships
of the Norweigan and Swedish Krona compared to the Danish Krone is only unavoidable. This is because
these 3 currencies are very closely related and compete on a big scale, on a daily basis.
As shown in the graph below, the Danish Krone has had a fairly stable relationship with the Euro since
January of 2000; it has stayed in between 7.425-7.468; no volatile/extreme changes in value. This is
positive for the investor who (who owns the Euro as his/her domestic currency) might be interested in
Denmark; this graph doesn’t only show the relationship between the Danish Krone and Euro for the past
couple of years; this is almost 15 years worth of data (when going even further back in time, we still only
see minor controlled changes in value). The trendline included in the graph shows this seemingly
immovable relationship in value between the Danish Krone and Euro, and how it stays in the
DKK7.44/1€ to DKK7.456/1€.
DKK/EUR
7.47
7.46
7.45
7.44
7.43
7.42
7.41
Aug-15
Aug-15
Oct-13
Sep-14
Sep-14
Dec-11
No v - 1 2
Jan-11
Feb-10
Apr-08
Mar-09
Jun-06
May-07
Jul-05
Aug - 0 4
Oct-02
Sep - 0 3
Dec-00
No v - 0 1
7.4
Jan-00
As mentioned above I would not deem it
anything else than appropriate to also
compare the performance of the Danish
Krone to the Swedish and Norweigan Krona.
These currencies have many similarities and
are fairly close in terms of their value. The
Danish Krone has been stronger than the
Swedish Krona since November 1992; and
stronger than the Norweigan Krone since
January 1991 (according to the Pacific
Exchange Rate Service). The reason why this
is worth mentioning is because these
currencies are very tighly related and
intervene in each others’ economies
constantly. It is possible to pay with Danish
Kroner in Sweden and Norway, and vice
versa.
Based on the historical performance of the Danish Krone, it has presents itself as a very stable currency
with little or no drastic change in value, when comparing it to its closest competitors; the Euro, Swedish
and Norweigan Krona. It has stayed in the same close range with the Euro, and been stronger than those
of Sweden and Norway for decades.
DKK/USD
Oct-13
No v - 1 2
Dec-11
Jan-11
Feb-10
Mar-09
Apr-08
May-07
Jun-06
J ul - 0 5
Aug-04
Sep-03
Oct-02
No v - 0 1
Dec-00
10
9
8
7
6
5
4
3
2
1
0
Jan-00
Interestingly enough; the U.S. Dollar
actually dropped in value compared to the
Danish Krone during the financial crisis (the
drop in value started in August 2006 and
went to 4.73DKK/1$ in July 2008); after that
its trend stayed in the 4.5DKK-5.9DKK/1$
until December 2014, where it went to
6.0356DKK/1$. The latest rate between the
Danish Krone and U.S. Dollar was
6.8386DKK/1$ in August 2015 according to
the Pacific Exchange Rate Service. Worth to
note that the Danish Krone stayed strong
against the U.S. Dollar during the financial
crisis of 2008.
3: GDP Growth:
The definition of “Real Gross Domestic Product” (GDP) is an inflation-adjusted measure that reflects the
value of all goods and services produced in a given year, expressed in base year prices. Often referred to
as “Constant Price”, “Inflation-corrected GDP” or “Constant Dollar GDP”.
The “GDP constant Prices (Percent Change)”
graph shows the percentage change in GDP
constant prices from 2013 to 2015; the
continuing numbers are the predictions made
by specialists. The predictions show a positive
increase in the GDP from 2014 through 2020.
Based on the definition above we see that the
value of goods and services are increasing. In
2013 the value had decreased by -0.4870%;
moving along in time it had increased to almost
positive 1% in 2014 where it has been projected
to increase at a decreasing rate until 2020. The
“Gross Domestic Product, Current Prices
(National Currency Billions)” graph, shows us
the decrease from year 2014-2015 from about
340-297 Billion DKK, since 2015 however, it has
been increasing at a steady rate to about 378B
(projected in 2020). These graphs show a
healthy increase in the Gross Domestic Product
of Denmark.
400
Billions DKK
One important graph and “aspect” of the GDP
that should not be left out; it the GDP Per
Capita and its change within the same time
period. One could argue that it “obviously”
follows the exact same trend as the “Gross
Domestic Product, Current Prices (National
Currency Billions)”; since it is the same number
divided by the Danish population. This measure
is however helpful, because it tells us that the
performance of the Danish workforce, and
therefore growth in the economy and an
increase in productivity.
GROSS DOMESTIC PRODUCT,
CURRENT PRICES (NATIONAL
CURRENCY BILLIONS)
350
300
250
200
150
100
50
0
2013 2014 2015 2016 2017 2018 2019 2020
To sum up, the gross domestic product is one of
the primary indicators of a country’s economic
performance. Per Capita Gross Domestic Product
is used as an indicator of standard of living as
well, with higher GDP per capita meaning a
higher standard of living (one fun fact that may
be interpreted as a supporting argument of the
information given above; Denmark has been
ranked #1,2 and 3 as the happiest nation
worldwide several years in a row, ranked first in
entrepreneurship and equality).
GROSS DOMESTIC PRODUCT
PER CAPITA, CURRENT PRICES
70,000.00
60,000.00
50,000.00
40,000.00
30,000.00
20,000.00
10,000.00
0.00
2013 2014 2015 2016 2017 2018 2019 2020
4: Inflation:
INFLATION RATE (%)
4
3.5
3
2.5
Percent
As the central bank of Denmark, Danmarks
Nationalbank is in charge of monetary policies in
Denmark. One of the main objectives of
Danmarks Nationalbank is to ensure stable prices,
meaning, keeping the inflation as low as possible.
It has been the objective of the monetary policy,
for decades now, to keep the exchange rate of
the Danish Krone stable. First this was done to
keep it stable against the Deutsche Mark, now the
Euro. One of the reasons for this is that the cost
of living in Denmark, generally is fairly high. The
main goal is to keep the inflation close to, but
below 2%.
2
1.5
1
0.5
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
0
Also, as shown in the graph there has been some cases of higher versus lower inflation rates since 2000;
considering that the Central Bank of Denmark wants to keep these rates low, they’ve done a stable job
keeping them low. The highest was in 2008 (financial crisis) and the lowest was in 2014, lower than 1%.
x
n
𝜇 = Σ =1.93019
∂= Σ
√(𝑥−𝜇)2
𝑛−1
=0.733569%
These statistical measures show us that the average inflation rate during the time period of 2000-2021 will
be (if these inflation rate estimates are correct) lower than 2%; which is the goal of the Danske
Nationalbank. Furthermore, the standard deviation in these numbers is also considerably low; 0.733569%.
What this number tells us is little deviation from the mean (average) of 1.93019%. This is also good news,
considering that these estimates turn out to be true or at least, within a close range.
5: Monetary Policy:
The fixed exchange rate policy means that Denmark’s policy is aimed at keeping the Krone strong/stable
against the Euro; the Central Bank of Denmark conducts monetary policy by setting the monetary-policy
interest rates; furthermore, these interest rates are linked to the lending as well as the deposit facilities
made available by the Central Bank of Denmark to the banks and mortgage banks.
When Denmark changes its interest rates relative to those of the ECB, this normally has an effect on the
exchange rate of the Danish Krone against the Euro; through the money market, the monetary policy
interest rates also affect the lending and deposit rates offered to firms and consumers.
6: Fiscal Deficits/Surplus:
This significant drop in debt, as shown in the graph to the
right, marks a significantly positive change in the performance
regarding government spending.
CENTRAL
GOVERNMENT
DEBT
490
Amount in Bilion DKK
The Danish Government debt has received the highest
ranking, AAA/Aaa, from the largest international credit rating
agencies. This is partially because of the low level of debt and
the composition of long term-liabilities. There has been a
decline in central government debt as a percentage of the
GDP over the past 2 years, which should be noted since it has
not been that long since the financial crisis, it represents a
turning point after the debt accumulation that happened
during the crisis.
487
487
485
480
475
470
465
458
460
455
2011 2012 2013 2014 2015
Year
7: Yields on Government Bonds Compared to the U.S. T-Bonds for the Past 5-10 Years:
The yields on Danish Government bonds have actually stayed close to the U.S. T-bonds for many years; the
rates on the Danish bonds have been a little higher than the U.S. rates with the greatest difference
(favorable to the Danish bonds) in 2008, almost 300 basis points difference. At its highest the Danish was
almost 6%, whereas the U.S. T-note was only 3%. The Danish rates, however, have been lower than the U.S.
rates, which was in 2014. Excluding the financial crisis in 2008, the rates on these two have been relatively
close, with a similar pattern in movements, and a stable +0-1% for the Danish rate.
Generally speaking, Denmark is open to foreign investments. It is a small country with an open economy;
because of its high dependence of foreign trade (exports is the largest component of the Danish GDP)
Denmark trade and investment policies are liberal and truly do, encourage foreign investment. The Danish
business environment has been characterized as one of the most attractive in the world, reflecting a great
macroeconomic environment, excellent infrastructure and a well-educated and flexible labor force.
Restrictions include the purchase of real estate in Denmark by foreigners; EU citizens and companies may
purchase any type of real estate except for vacation properties without authorization from the
government. Non EU citizens need to have been present in Denmark for at least 5 years in a row, before
being allowed to purchase real estate; again, vacation homes require authorization from the government.
This obviously puts a restriction on real estate investment, as a foreign investor.
Denmark has been considering imposing capital controls, but with hardship from banks; reasoning that the
country must allow the free flow of capital, one reason for this being that Denmark is a member of the
European Union. The Spokeswoman for Economy Minister and Deputy Prime Minister Morten Östergaard,
Sigga Nolsoee, said that the government has no plan on imposing restrictions on capital movements.
The political environment in Denmark is very stable, (it has been ranked the least corrupted country in the
world) it is a democratic system, citizens exert their influence indirectly through voting, and generally a very
safe place to be.
Part II: Investment Analysis:
In this part of the paper, there will be paid close attention to the investment opportunities through analysis.
The actual calculations can be viewed in the Excel file submitted.
The major stock index in Denmark is called OMX Copenhagen (^OMXC20), or commonly referred to as C20.
It has the 20 “biggest players” of the publicly traded Danish companies, these include A.P. Møller Mærsk,
Pandora, Vestas, Novo Nordisk with many more.
The index’s data as well as various other, very thorough calculations are all included in the excel file
submitted. This file includes returns, variances, standard deviations, correlations between Denmark, the
U.S. and the World standard, as well as the Sharpe ratio.
The Danish stock index is (in my opinion) a stable index, just to give a quick idea of its performance for the
past 2 months, it has had a return of 0.54% and 0.69%; this positive gain seems to be the general trend. All
this can be seen in the Excel file.
Recommendation based on analysis:
Before I get into my actual recommendations about actions I deem appropriate to take, regarding the
investment opportunities Denmark offers, I would like to address Real Estate Investing, which was briefly
discussed in restrictions in part one of the paper; as an international investor. Considering the harsh
restrictions the Danish government has chosen to put on international real estate investors (mentioned in
the first part of paper) and the tax on capital gains (can be up to 50%) earned from real estate investing;
one could argue, taking your money in other investment directions, would be the better alternative.
Of course there are two sides to this; the negative aspect of successfully investing in real estate in Denmark
is obviously the hefty tax-rate; however, I would still deem it an extremely safe and stable environment to
pursue this kind of capital gain. As mentioned earlier, Denmark has been ranked the least corrupted
country in the world, it provides one of the most effective work-forces worldwide, and it should also be
mentioned that “Danish design” is famous globally (there is a reason for this). Because of these positive
aspects (including many more), real estate investments can be preferable as well as profitable, if the taxrate does not cause too much pain.
Based on the information provided throughout this entire paper, it is my recommendation to invest in the
very stable and secure market Denmark offers. The overall reason for this (referring to the qualitative
aspects in part one) is that Denmark presents a very advanced, internationally focused, safe and advanced
economy. Advanced and internationally focused includes that Danes have been ranked as the number one
non-native English speakers in the world, internationally focused because Denmark is a part of the EU and
Schengen; with little natural resources Denmark needs to use its advantages to stay competitive. It is also
worth mentioning that the state of Denmark’s economy is on the right track, and the Danish Krone is a
stable currency.
Referring to the quantitative data presented in this paper (as well as in the Excel spreadsheet) it is, again,
recommended to invest in Denmark. Even though Denmark has a very, very little economy compared to
many other countries, it still has many opportunities for the international investor. When comparing the
largest index, the C20, in Denmark to the S&P500 in the United States (this is not an entirely fair/realistic
comparison, considering the difference in sizes) we see an enormous difference in risks:
US: ∂ = Σ
DK: ∂ = Σ
√(𝑥−𝜇)2
𝑛−1
√(𝑥−𝜇)2
𝑛−1
World: ∂ = Σ
= 311.9
=25.4
√(𝑥−𝜇)2
𝑛−1
=67.3
These numbers represent the standard deviation in monthly index prices for the last 15 years; one thing to
keep in mind is that the S&P500 includes 500 companies, the C20 only has 20 companies. When analyzing
the Excel file attached, it is also interesting to see how much higher the average annual returns the C20
index offers, compared to that of the S&P500. C20 has an average annual return of 11% while the S&P500
has a 4% average annual return. These higher returns obviously come with a higher annualized standard
deviation; the C20 has a standard deviation of 19%, whereas the S&P had an annualized standard deviation
of 15%. It is worth noticing how much higher the annualized return in Denmark is though:
C20: Average annual return: 11%; Standard Deviation: 19%
S&P500: Average annual return: 4%; Standard Deviation: 15%
That is a difference of 7% in average annual return and only 4% in standard deviation; this increase in
return came at a “lower than expected” risk.
Regarding the correlations between Denmark and the U.S.; it is definitely a noteworthy correlation of about
0.67. Modern Portfolio Theory states that adding assets to a diversified portfolio that have correlations of
less than 1, with each other, can decrease risk without sacrificing return. Such diversification will serve to
increase the Sharpe ratio of the portfolio. When analyzing the data we do see that the general tendency of
the returns is a mirror-effect (increase in the C20 is generally associated with an increase in the S&P500).
When comparing the Sharpe ratios of these indexes; the C20 in Denmark has the highest:
C20: 0.468
S&P500: 0.119
World: 0.049
What the Sharpe ratio tells us is the average return in excess of the risk free rate per unit of volatility or
total risk; generally, the higher the Sharpe ratio, the more attractive the risk adjusted return is.
When considering the Sharpe ratio it is very clear that the C20 offers the investor a bigger average return in
excess of the risk free rate per unit of volatility; which again, represents a reason as to why international
investors should strongly consider Denmark.
Based on the info included in this project it is my advice to invest in Denmark. The numbers included speak
for themselves, it is far from a bad place to put ones money; Denmark has a stable economy, is open to
foreign investment, it is a very advanced nation, the economy and people have proved themselves to do
very well while relying mostly on the exports of services (almost no natural resources), the currency has
also proved to stay fairly stable during long periods of time, etc.
Overall, a very stable economy with great potential for capital gains.
Project based on Germany
I.
Country Analysis
The following paper presents a country analysis and an investment analysis. I did not only
chose Germany, because it is my home country, but moreover I was curious to know which
effects being part of the EU has on the German economy.
First of all, I will start with the macroeconomic trends and risks.
a) The Balance of Payments shows the record of a country’s international transactions over a
certain period of time. It is presented in the form of a double-entry bookkeeping. Transactions
are either recorded as credit or as debit. The major three accounts of the Balance of Payment
is the current account, the financial account and the official settlements account.
The current account is the balance of international trade, net unilateral transfers and net
income receipts from abroad. If the imports exceed the exports, then a country is running a
trade deficit, vice versa a trade surplus.
As it can be seen in the graph1, Germany only had current account surpluses for the past years.
The current account surplus declined during the crisis of 2009 as Germany was exporting less
to other countries due to recession.
As Germany exports a lot, others demand euro at the FOREX market and this demand for the
euro creates a pressure for the euro to appreciate.
The current account surplus seems to be a problem for various reasons. Peter Navarro, the
economic advisor of Donald Trump accused Germany of currency manipulation, as they
reported their largest current account surplus on February 9th with 270 bn euros.2 He says that
Germany makes their exports more competitive by having a weak euro, compared to the old
Deutsche Mark. However, Germany says that even though the European central bank is based
in Frankfurt it makes no sense that Germany deliberately tries to weaken the euro, as Mario
Draghi is keeping the interest rates near zero and buying bonds in order to stimulate
economies outside of Germany. According to the economist, the real problem Germany has
started a decade ago when employers and unions agreed to restrain wage growth, which
resulted in a devaluation of Germany within the euro zone. The best way out of the imbalance
would be to not to keep cutting wages in down-and-out countries like Greece, but to let them
increase in Germany.
The financial account determines the difference between the capital inflow and capital
outflow.
1
http://www.tradingeconomics.com/germany/current-account
http://www.economist.com/news/europe/21716641-not-reasons-donald-trump-thinks-it-germanys-currentaccount-surplus-problem
2
Germany had a capital and financial account surplus of 9718.91 million euro in February
2017.3 In this year Germany exported more than it imported, thus running a current account
surplus.
As the European central bank sells domestic currency and buys foreign currency from the
market the domestic currency weakens. This will be further explained in the next point.
The Exchange rate is the price of one currency in terms of another. The foreign exchange
market is where buying and selling of different currencies takes place.
The German economy seems set for a solid first quarter in 2017, as the data suggests that Q4’s
momentum extended into the new year.4 In December Germany was experiencing some
contractions due to seasonal factors, however industrial production swung back to expansion
in January. Business sentiment indicators are still showing signs of strength, implying industrial
production growth and a recovery in business investment. In March households experienced
3
4
http://www.tradingeconomics.com/germany/capital-flows
https://www.focus-economics.com/country-indicator/germany/exchange-rate
some higher inflation, however generally German households are in a sound financial position,
benefitting from low indebtedness and a healthy labor market.
In regards to the Euro there should be a distinction between short term and long term
investments. Currently with the new presidential elections in France, where LePen would be
against the EU, and also the Brexit last year, the euro was, or still is, in great risk. However, in
the short term the euro might actually get stronger again. This is due to the EZB, which wants
to end its QE-program (buying government bonds) by the end of this year.5 Last time in
22.01.15 when they introduced the QE-program the euro dropped from 1.40 to 1.05, so it
might actually rise again now. However, in the longer term there are still great risks, because
there is uncertainty if France will also leave the euro and the whole impact Brexit has is still
not clear.
5
http://www.onvista.de/news/trotz-vieler-euro-risiken-der-euro-wird-ueberraschend-staerke-zeigen!60244295
As an investor there would be more advantages to buy bonds in the US rather than in the EU,
as in the US they have higher interest rates and also the permanent rise in the USD.6
However, for export firms in Germany it is a huge advantage to have a weak euro, as this
increases the demand for products in the US, especially in the automobile industry.
Furthermore, the euro gained 1.4% to $1.0861 on Monday following Emmanuel Macron’s
victory in the first round of the French presidential election.7
The next thing I would like to consider is the GDP growth.8
Germany is the fifth largest economy in the world and largest within the euro zone.9 Also it is
the second largest exporter and its exports account for more than one-third of national
output. Therefore, the export of high added value products has been the main driver of
growth in recent years. On the expenditure side: household consumption (55%), gross capital
6
http://www.faz.net/aktuell/wirtschaft/waehrung-euro-verliert-an-wert-chance-oder-risiko-13369251.html
http://www.tradingeconomics.com/germany/currency
8
https://www.theguardian.com/world/blog/2017/feb/23/germanys-gdp-shows-19-rise-over-last-year
9
http://www.tradingeconomics.com/germany/gdp-growth
7
formation (20%) and government expenditure (19%). Exports account for 46% of the GDP,
while imports account for 39%, adding 7% to total GDP.
Increase in home real income (real GDP) growth leads to higher return on home assets and
results in appreciation of home currency.
Germany overtook the UK by showing growth of 1.9% last year, which was mainly due to
consumer spending. Economists say that government and state spending will be the main
drivers of growth in the upcoming quarters. However, external factors such as Brexit, US trade
policy and upcoming elections increase uncertainty and could harm investment, which would
have an effect on the GDP growth.
The following diagram shows the Inflation rate of Germany.10
In February Germany experienced one of the highest inflation rates since August 2012. The
reason for this is an increase in oil and energy prices. Another reason was an increase in food
prices, which rose by 4.4%.11 This created pressure on the European Central Bank as the
10
11
http://www.tradingeconomics.com/germany/inflation-cpi/forecast
https://www.tagesschau.de/wirtschaft/inflation-deutschland-105.html
increase in inflation was close to ECB’s definition of price stability of just under 2%, providing
ammunition for some officials pushing for a gradual exit from unconventional stimulus. An
increase in home inflation leads to depreciation of home currency using relative PPP. As goods
in the home country become more expensive, country import more and this creates a
downward pressure on the home currency.
However, many say that oil and energy prices will not increase any further, so that inflation
will drop again and stay between 1% and 1.5% in the long term.
The objective of the Monetary policy of the ECB is to ensure price stability.12
Commenting on consistent criticisms from Germany about the bank's persistently low interest
rates, Draghi was resolute, saying: "Low rates are necessary now to get higher rates in the
future... The recovery of all of the Eurozone is the interests of everyone, including Germany."13
Since the ECB announced that all of its key interest rates, as well as the scale of its quantitative
easing program remain unchanged, just with a bit of a decreased rate (from 80 billion
euro/month to 60 billion euro/month), this is not in the interest of Germany. Foreign investors
will not invest in a European country as this policy makes it more favorable to invest in
countries like the USA, as Germany has low interest rates and investors make more revenues
in the US. Furthermore, the monetary policy changes affect the exchange rates the following
way. Monetary expansions lead to lower interest rates and exchange rate depreciation. And
vice versa, monetary tightening leads to higher interest rates and strengthening of the
currency. In the case of Germany, they experience a depreciation in the euro, as they don’t
12
https://www.bundesbank.de/Navigation/EN/Tasks/Monetary_policy/Monetary_policy_decisions/monetary_
policy_decisions.html
13
http://www.businessinsider.com/european-central-bank-monetary-policy-decisions-january-2017-1
have their own central bank, which could raise interest rates again.
The next point I would like to discuss is the Fiscal surplus, which Germany is currently
experiencing.14
For the last three years, Germany only had a budget surplus. This means that Germany took
more money in (taxes and other fees) than it spent (purchases and transfer payments). The
German government recorded a net lending of 23.7 billion euros at the end of 2016, which
was the biggest surplus recorded since German reunification, as revenues grew to 1,411.4
billion euros, due to a large increase in income tax and property tax payments and in social
contributions. Because of the economic boom and high exports, the wages rose which lead to
higher tax revenues. Many politicians demand a decrease in the tax rate and Germany should
start investing the money and not just use it to pay of old debts.15 Germany should spent more
14
http://www.tradingeconomics.com/germany/government-budget
http://www.manager-magazin.de/politik/deutschland/deutschland-haushaltsueberschuss-des-bundes-a1129671.html
15
to boost domestic demand, so that Germans buy more goods from abroad and help to reduce
its criticized trade gap with the rest of the world.16
The last macroeconomic risk concerns the Yields on government bonds compared to the US
Treasury bonds for the last 5-10 years.
Germany’s 10Y increased 0.08% to 0.33 on April 24, 2017. The US reached 2.27.17 The
Germany Government Bond 10Y reached an all-time high of 10.80 in September of 1981 and
a record low of -0.19 in July 2016.
16
17
https://www.ft.com/content/7a06d15e-f9db-11e6-9516-2d969e0d3b65
http://www.tradingeconomics.com/germany/government-bond-yield
US 5Y was lately 1.802, which was much higher compared to Germany which has -0.352.
However, it is very difficult to compare the US bonds, which are priced in dollars with the
German bonds, which are priced in euros. Both have different expectations of inflation and a
relative value of each currency. However, generally the main factors which are responsible for
this big difference in yield are the expectation for inflation and currency changes. People
would demand a higher yield in a country which has more expected deflation and currency
depreciation. There are arbitrage opportunities which make sure of this, called interest rate
parity. However, as long as the European Central bank is still using its bond-purchase stimulus
program and creating low interest rates, the yield on government bonds from Germany will
stay low, compared to the USA. Therefore, it makes no sense for investors currently to buy
bonds.
b) First of all, I would like to consider some general restrictions and openness information
upon foreign investment in Germany. Germany is very open to foreign investment and
supports foreigners. Foreign investment has been a considerable contributor to Germany’s
economic growth and prosperity. For example, the 1956 U.S.-FRG Treaty of Friendship,
Commerce and Navigation, affords U.S. investors national treatment and provides for the free
movement of capital between the US and Germany.18 The investment problems foreign
companies might face are usually the same domestic firms have to deal with, for example high
marginal income tax rates and labor laws which impede hiring and dismissals. One huge
advantage is the reliable legal system. The legal framework is solid and the judiciary is
independent. Before starting a business, companies have to register themselves in the
commercial register and the trade office register. “While Germany's Foreign Economic Law
contains a provision permitting restrictions on private direct investment flows in either
direction for reasons of foreign policy, foreign exchange, or national security, in practice,
restrictions have only been imposed in the sectors of air transport, maritime transport, inland
waterways, and rail transport. Additionally Germany limits the foreign provision of employee
placement services, such as providing temporary office support, domestic help, or executive
search services.”19 In general under German law a foreign owned company which is registered
as a GmbH or AG is treated the same way as a German-owned company. However, Germany
also has a strict competition law, which fights against cartels, merger control and monitoring
abuse. Other benefits would be that Germany has a huge resource of developed
infrastructure, a great transportation system, one of the most technologically advanced
countries, a highly educated labor force and a very low level of corruption.20 However, there
are also some current risks to consider. The member ship in the European Union brought
Germany many advantage over the last years, but it also causes some recent problems in the
18
https://www.export.gov/article?id=Germany-Openness-to-and-Restrictions-upon-Foreign-Investment
https://www.export.gov/article?id=Germany-Openness-to-and-Restrictions-upon-Foreign-Investment
20
http://www.investineu.com/content/germany-–-major-destination-foreign-investment
19
wake of the European sovereign debt crisis. European Union bailouts have high costs (for
example Greece) and if more countries face this issue then this will have a negative effect on
Germany’s economy and balance sheet. Brexit last year should also be considered. Many
industries, especially the automobile industry, will have some serious struggles with new trade
restrictions and customs duties. For 28% of the companies the profit margins already declined,
because imports were more expensive due to the low pound.21 Furthermore, France has some
new elections now and if LePen would win and France would also leave the EU then this will
also have a huge impact on the German economy. Right now it would probably be better to
invest in the US, as investors make more profit there with higher interest rates, as I already
stated when talking about the low exchange rate.
II.
Investment Analysis
After discussing all of the macroeconomic trends and risks it is now important to analyze
Germany’s stock index in comparison to the US and the world.
The following graph shows the performance for the last 20 years of Germany in dollars,
relative to the USA index return and the MSCI world index return.22
21
http://www.manager-magazin.de/finanzen/artikel/brexit-treibt-auslaendische-investoren-verstaerkt-nachdeutschland-a-1132449.html
22
https://www.msci.com/end-of-day-data-country
The following screenshots show the monthly data on Germany’s major stock index return in
local (euro) currency r(€)and in USD r($).
a) The following table demonstrates the mean, standard deviation and the Sharp ratio for
Germany, the USA index return and ACWI. The 3-month T-bill were used as a risk-free asset.
For the last 20 years German stock market offered the same average annualized USD return
of 6.59% as the USA, which was slightly more than the 5.17% of the World.
At the same time the volatility risk (standard deviation) for Germany was higher than the one
from the USA and the World. Germany has a standard deviation of 23,83%, whereas the USA
has 15,27%, similar to the World with 15,50%. In this sense it would be better to invest in the
US than in Germany, as there is less risk. The Sharp ratio of return to risk is less for Germany
with 0,19, than the Sharp ratio for the USA or the World with 0,29 and 0,20. This would also
mean the USA is more favorable with a higher Sharp ratio. However, the Sharp ratio of
Germany is close or nearly similar to the World sharp ratio.
Germany has been going through two main crises during the last 20 years. In 2008 was the big
financial crisis, which sent exports into a tailspin and 2011 the euro crisis. The average loss in
the euro exchange rate was 8.92% per year.
b) In order to answer the question whether it is beneficial from an international diversification
point of view, to invest into Germany for an investor holding only the USA index portfolio, it
is important to look at the correlation between Germany and the USA.
The following table shows the correlation between Germany’s stock index return and the USA
index return.
Usually it is always good for an investor to have diversification, as this increases the sharp ratio
and reduces the nonsystematic variance. However, it is important to have a low correlation in
order to benefit from the diversification. As the correlation between Germany and the USA is
0.82, it would not be beneficial for an investor to invest into Germany. Countries like Japan
would be better for the portfolio, as they give more diversification.
Summary
It is very difficult to say, whether it would be good to invest in Germany’s stock index for the
next five years. Even though Germany has a lower sharp ratio, this does not mean that you
shouldn’t invest in it. In order to achieve portfolio diversification and increase sharp ratio it is
good to invest into various markets. However, an important component of diversification is
international return correlations. The higher the correlation the higher the volatility of the
portfolio. Germany and USA have a very high correlation, which means less benefit to
diversification. Furthermore, the bond buying program of the European Central Bank will
further create a downward pressure on the euro. As an export-led economy Germany may be
well-positioned to benefit from both the ECB’s actions and the continued depreciation of the
euro. U.S. dollar based investors could seek to mitigate the risk of a depreciating euro through
either a single-country play on Germany(currency-hedged) or broad regional exposure to
Europe (currency-hedged).23 However, hedging can also reduce or eliminate gains. With the
QE program, bond purchases have driven sovereign yields to zero or even negative numbers.
This means it would be better to turn to stocks, but as an investor a country like the USA with
high interest rates and a developing currency is much safer and more profitable. Even though
Germany has a current account surplus and one of the highest GDP growth I think the key
factor to consider is currently the political situation. England will leave the EU at the earliest
in two years, so the whole impact this has is not clear yet and France election are also not
finished. Being part of the EU means for Germany that it is very dependent on the other
country’s situation and the decisions of the ECB. All in all, with the unstable situation in the
EU I would not recommend to invest in the stock index for the next five years.
23
https://blackboard.pace.edu/bbcswebdav/pid-3154077-dt-content-rid-8258913_1/courses/FIN-35820099.201720/Investment%20in%20Germany%20%26%20Eurozone_%20Blackrock%284%29.pdf
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