Differentiate between foreign portfolio investments and direct foreign investments.
Investing in the foreign markets has additional benefits due to geographic diversification. A foreign investment can be classified into two major categories which are direct investment and portfolio investment.
Direct investment refers to directly investing in the resources of foreign country. It is possible through establishing foreign business operations or by acquiring foreign business assets from the home country. If an investor buys stocks of a company that invests directly in foreign country, that is also classified under direct investment.
On the other side, foreign portfolio investment refers to purchasing of securities or other financial assets of a foreign company. Such financial assets may be stocks, bonds, mutual funds, American depository receipts (ADR) etc.
Unlike direct investments, portfolio investments do not provide ownership in the assets of foreign companies. The degree of control over the management of the foreign company is very high in direct investment as compared to foreign portfolio investments. Direct investment is often viewed as a long term investment in foreign country's economy, whereas portfolio investments are considered as a short term move to generate returns. Direct investment is usually undertaken by large multinational corporations, or private equity investors. Portfolio investment is made by individual investors, brokers or institutional investors. As the time frame of portfolio investments is smaller than that of direct investments, they are more liquid in nature. Direct investment may require transfer of funds, technologies and other resources. Whereas, portfolio investment leads to capital inflows. In simple terms, foreign direct investment is active participation in foreign economy and foreign portfolio investment is passive participation in the foreign businesses.
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