Following are the problems that mar an optimal international diversification:
1. Unfavorable exchange rate movements
2. Frictions in international markets
3. Manipulation of security prices
4. Unequal access to information
Choose the appropriate answer from the options given below:

Correct option is D

Optimal international diversification involves spreading investments across countries to reduce risk and enhance returns. However, several challenges hinder its effectiveness:

1. Unfavorable Exchange Rate Movements (1):
   Currency fluctuations can erode the returns of foreign investments. For example, if the domestic currency appreciates relative to the foreign currency, the value of foreign investments in domestic terms decreases.

2. Frictions in International Markets (2):
   These include legal restrictions, market inefficiencies, and transaction costs, which can prevent seamless investment across borders. Examples include capital controls or regulatory barriers in certain countries.

3. Manipulation of Security Prices (3):
   In some markets, price manipulation or insider trading undermines investor confidence and distorts fair value assessment, affecting diversification benefits.

4. Unequal Access to Information (4):
   Investors in domestic markets often have more information about local companies and economies compared to foreign markets. This asymmetry in information leads to suboptimal decision-making.

Information Booster:

Key Challenges in International Diversification:

1. Exchange Rate Volatility: Investors must account for currency risk, as even profitable investments can yield losses due to unfavorable currency movements. Hedging strategies can mitigate this risk.
2. Market Frictions: Regulatory differences, lack of transparency, and higher costs make international investments more challenging than domestic ones.
3. Market Integrity: Emerging markets may face issues like price manipulation or lack of investor protections, reducing confidence in international diversification.
4. Information Gaps: Unequal access to data about foreign markets leads to increased reliance on intermediaries and greater risks.