8/12/2019 Four Types of Foreign Investments

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(1) FOREIGN DIRECT INVESTMENT- An investment made by acompany or entity based in one country, into a company or

entity based in another country. Foreign direct investments differ

substantially from indirect investments such as portfolio flows,

wherein overseas institutions invest in equities listed on anation's stock exchange. Entities making direct investments

typically have a significant degree of influence and control over

the company into which the investment is made. Open

economies with skilled workforces and good growth prospects

tend to attract larger amounts of foreign direct investment than

closed, highly regulated economies.

EXPLANATION AND EXAMPLE- The investing company may make its

overseas investment in a number of ways - either by setting up a

subsidiary or associate company in the foreign country, by acquiring

shares of an overseas company, or through a merger or joint venture.

The accepted threshold for a foreign direct investment relationship, as

defined by the OECD, is 10%. That is, the foreign investor must own at

least 10% or more of the voting stock or ordinary shares of the investee

company.

An example of foreign direct investmentwould be an American

company taking a majority stake in a company in China. Another

example would be a Canadian company setting up a joint venture to

develop a mineral deposit in Chile.

2.FOREIGN PORTFOLIO INVESTMENT- Securities and other financial

assets passively held by foreign investors. Foreign portfolio investment

(FPI) does not provide the investor with direct ownership of financial

assets, and thus no direct management of a company. This type of

investment is relatively liquid, depending on the volatility of the market

invested in. It is most commonly used by investors who do not want to

manage a firm abroad.

8/12/2019 Four Types of Foreign Investments

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EXPLANATION:Foreign portfolio investment typically involves short-

term positions in financial assets of international markets, and is similar

to investing in domestic securities. FPI allows investors to take part in the

profitability of firms operating abroad without having to directly manage

their operations. This is a similar concept to trading domestically: mostinvestors do not have the capital or expertise required to personally run

the firms that they invest in.

Foreign portfolio investment differs from foreign direct investment (FDI),

in which a domestic company runs a foreign firm. While FDI allows a

company to maintain better control over the firm held abroad, it might

make it more difficult to later sell the firm at a premium price. This is due

to information asymmetry: the company that owns the firm has intimate

knowledge of what might be wrong with the firm, while potentialinvestors (especially foreign investors) do not.

The share of FDI in foreign equity flows is greater than FPI in developing

countries compared to developed countries, but net FDI inflows tend to

be more volatile in developing countries because it is more difficult to sell

a directly-owned firm than a passively owned security.