SECTION B (50 Marks) QUESTION THREE (25 Marks) THE FUTURE OF INVESTMENT IN EMERGING MARKETS Investing in emerging market has been widely discussed during recent years, with its benefits being high average returns and low correlations with developed markets. The higher returns in emerging markets stem from the higher growth rates due to low labour cost and therefore the attraction from developed countries, high flexibility and low level of unionisation and growth of domestic demand. Returns in emerging markets are also higher because a higher volatility and vulnerability of the economy. Furthermore, the often low liquidity in emerging markets also drives up the returns. Finally, investors in emerging market are usually exposed to currency risk, adding another dimension to investment risk. The latter is made worse by the fact that in the emerging market there is often a positive correlation between share prices and the value domestic currency, whereas the correlation is usually smaller or even negative in developed market. This is caused by stronger dependence on capital inflows. While in early 1990s it was mainly the high returns from investment in emerging markets that gained attention, since the mid-1990s investors have focused more on emerging market's role in diversifying global portfolios. The discussion can be reduced to two different aspects: First, it seems that correlations between markets have increased. For example the correlation between the Page 3 of 7 SECTION B (50 Marks) QUESTION THREE (25 Marks) THE FUTURE OF INVESTMENT IN EMERGING MARKETS Investing in emerging market has been widely discussed during recent years, with its benefits being high average returns and low correlations with developed markets. The higher returns in emerging markets stem from the higher growth rates due to low labour cost and therefore the attraction from developed countries, high flexibility and low level of unionisation and growth of domestic demand. Returns in emerging markets are also higher because a higher volatility and vulnerability of the economy. Furthermore, the often low liquidity in emerging markets also drives up the returns. Finally, investors in emerging market are usually exposed to currency risk, adding another dimension to investment risk. The latter is made worse by the fact that in the emerging market there is often a positive correlation between share prices and the value domestic currency, whereas the correlation is usually smaller or even negative in developed market. This is caused by stronger dependence on capital inflows. While in early 1990s it was mainly the high returns from investment in emerging markets that gained attention, since the mid-1990s investors have focused more on emerging market's role in diversifying global portfolios. The discussion can be reduced to two different aspects: First, it seems that correlations between markets have increased. For example the correlation between the Page 3 of 7