Foreign investment includes both portfolio INVESTMENT and DIRECT INVESTMENT; these two investment types vary in the degree of RISK and control. Foreign-portfolio investment is investment in foreign stocks, BONDS, and other FINANCIAL INSTRUMENTS. Usually there is no intention on the part of the investor to be involved in the MANAGEMENT of the company in which he or she is investing. Investing in the stock of, say, an Indian company can be lucrative, but it involves risks that do not exist in investing in a domestic company. Here is a short list of such risks. Currency risk. Changes in the currency EXCHANGE RATES will affect the profitability of the investment. The Indian company may pay its normal 10,000-rupee DIVIDEND. If the rupee strengthens in value relative to the dollar, the value of the dividend increases to the U.S. investor, and vice versa. Political risk. Favorable political actions, government changes, and events or increased stability will increase the value of the stock, and vice versa. Diplomatic risk. Diplomatic relations between the two countries will affect the value of the investment. Improved relations and an openness of currency exchange between the United States and India will improve the value of the stock, and vice versa. Information risk. Changes in the regulatory environment in either the United States or the foreign country can affect the value of the foreign investment. The foreign investment carries what could be characterized as an information premium. This could be stated in terms of the increased returns the foreign company must pay because of the low quality or quantity of information it provides compared to a U.S. company. So if information is improving just in the United States, this premium widens and the price will fall in order to provide the needed return to compensate the investors for the poorer quality information from the foreign investment, and vice versa. Foreign-direct investment occurs when an investor company in, say, the United States invests in a subsidiary company or project with intentions of being involved in the management of that company. Typically the investing company invests in the ASSETS directly by providing EQUITY funding to a subsidiary in the foreign country. Foreigndirect investment also includes the parent company leaving INCOME in the subsidiary company or loaning money to the subsidiary. Most developing countries consider foreign-direct investment an important part of their development strategy. Consequently they spend a great deal of energy in providing incentives and reforming their legal systems, all in an effort to attract foreign-direct investment.
See also EMERGING MARKET.