Ch015 International Portfolio Investments.doc

eun & resnick 4echapter 15 international portfolio investmentsinternational correlation structure and risk diversificationoptimal international portfolio selectioneffects of changes in the exchange rateinternational bond investmentinternational mutual funds: a performance evaluationinternational diversification through country fundsinternational diversification with adrsinternational diversification with websinternational finance in practice: live here, invest abroadinternational diversification with hedge fundswhy home bias in portfolio holdings?international finance in practice: stay-at-home shareholderssummarymini case: solving for the optimal international portfolioappendix 15a: international investment with exchange risk hedgingappendix 15b: solving for the optimal portfolio international correlation structure and risk diversification1 in the context of investments in securities (stocks and bonds), portfolio risk diversification refers to:a) the time-honored adage “dont put all your eggs in one basket”b) investors ability to reduce portfolio risk by holding securities that are less than perfectly positively correlatedc) the fact that the less correlated the securities in a portfolio, the lower the portfolio riskd) all of the aboveanswer: d) 2 in the graph at right, x and y representa) u.s. stocks and international stocksb) international stocks and u.s. stocksc) systematic risk and unsystematic riskd) none of the aboveanswer: a)3 you will get more diversificationa) across industries than across countriesb) across countries than across industriesc) across stocks and bonds than across countriesd) none of the aboveanswer: b)4 systematic risk is:a) nondiversifiable riskb) the risk that remains even after investors fully diversify their portfolio holdingsc) a and bd) none of the aboveanswer: c)5 the “world beta” measures thea) unsystematic riskb) sensitivity of returns on a security to world market movementsc) risk-adjusted performance d) risk of default and bankruptcyanswer: b)6 the less correlate the securities in a portfolio,a) the lower the portfolio riskb) the higher the portfolio riskc) the lower the unsystematic risk.d) the higher the diversifiable risk.answer: a)7 regarding the mechanics of international portfolio diversification, which statement is true?a) security returns are much less correlated across countries than within a county.b) security returns are more correlated across countries than within a county.c) security returns are about as equally correlated across countries as they are within a county.d) none of the aboveanswer: a)8 systematic riska) is also known as non-diversifiable risk.b) is market riskc) refers to the risk that remains even after investors fully diversify their portfolio holdings.d) all of the aboveanswer: d)9 a fully diversified u.s. portfolio is about a) 75 percent as risky as a typical individual stock.b) 27 percent as risky as a typical individual stock.c) 12 percent as risky as a typical individual stock.d) half as risky as a fully diversified international portfolioanswer: b)10 studies show that international stock markets tend to move more closely together when the volatility is higher. this finding suggests thata) investors should liquidate their portfolio holdings during turbulent periods.b) since investors need risk diversification most precisely when markets are turbulent, there may be less benefit to international diversification for investors who liquidate their portfolio holdings during turbulent periods.c) this kind of correlation is why international portfolio diversification is smart for todays investor.d) none of the aboveanswer: b)optimal international portfolio selection11 the “sharpe performance measure” (shp) is:a) a “risk-adjusted” performance measureb) the excess return (above and beyond the risk-free interest rate) per standard deviation riskc) the sensitivity level of a national market to world market movementsd) a) and b)answer: d)12 with regard to estimates of “world beta” measures of the sensitivity of a national market to world market movements,a) the japanese stock market is the most sensitive to world market movementsb) the u.s. stock market is the least sensitive to world market movementsc) both a) and b)d) none of the aboveanswer: c)13 the “sharpe performance measure” (shp) is:a) b) c) d) none of the aboveanswer: a)14 the mean and standard deviation (sd) of monthly returns, over a given period of time, for the stock markets of two countries, x and y are country mean (%) sd (%)x1.574.87y1.927.64assuming that the monthly risk-free interest rate is 0.25%, the sharpe performance measures, shp(x) and shp(y), and the performance ranks, respectively, for x and y are:a) shp(x) = 0.271, rank = 1, and shp(y) = 0.219, rank = 2b) shp(x) = 0.271, rank = 2, and shp(y) = 0.219, rank = 1c) shp(x) = 18.84, rank = 1, and shp(y) = 23.04, rank = 2d) shp(x) = 23.04, rank = 2, and shp(y) = 18.84, rank = 1answer: a) 15 with regard to the oipa) the composition of the optimal international portfolio is identical for all investors, regardless of home country.b) the composition of the optimal international portfolio are varies depending upon the numeraire currency used to measure returns.c) the composition of the optimal international portfolio is identical for all investors, regardless of home country, if they hedge their risk with currency futures contracts.d) both b) and c)answer: b)effects of changes in the exchange rate16 emerald energy is an oil exploration and production company that trades on the london stock market. assume that when purchased by an international investor the stocks price and the exchange rate were 5 and 0.64/$1.00 respectively. at selling time, one year after the purchase date, they were 6 and 0.60/$1.00. calculate the investors annual percentage rate of return in terms of the u.s. dollars.a) 0.20%b) 20.00%c) 1.28%d) 28.00%answer: d) rationale: 17 emerald energy is an oil exploration and production company that trades on the london stock market. over the past year, the stock has enjoyed a 20 percent return in pound terms, but over the same period, the exchange rate has fallen from $2.00 = 1 to $1.80 = 1. calculate the investors annual percentage rate of return in terms of the u.s. dollars.a) 3.5%b) 9.25%c) 8%d) there is not enough information to compute the investors annual percentage rate of return in terms of the u.s. dollars.answer: c)rationale: the currency return is given by using equation 15.4 we have the dollar-denominated return on the stock as:ri$ = ri + ei + ri ei = 20% 10% 2% = 8%18 emerald energy is an oil exploration and production company that trades on the london stock market. over the past year, the stock has gone from 50 per share to 55, but over the same period, the dollar has depreciated ten percent. calculate the investors annual percentage rate of return in terms of the u.s. dollars.a) 3.5%b) .01%c) 0%d) there is not enough information to compute the investors annual percentage rate of return in terms of the u.s. dollars.answer: b)rationale: the pound-denominated stock return is 10% using equation 15.4 we have the dollar-denominated return on the stock as:ri$ = ri + ei + ri ei = 10% 10% .01% = .01%19 the realized dollar returns for a u.s. resident investing in a foreign market will depend on the return in the foreign market as well as on the exchange rate fluctuations between the dollar and the foreign currency.calculate the variance of the monthly rate of return in dollar terms, if the variance of the foreign markets return (in terms of its own currency) is 1.14, the variance between the u.s. dollar and the foreign currency is 17.64, the covariance is 2.34, and the contribution of the cross-product term is 0.04.a) 21.16b) 23.50c) 26.89d) 28.65answer: b) rationale: equation 15.5: var(ri$) = 1.14 + 17.64 + 2 2.34 + 0.04 = 23.5020 emerald energy is an oil exploration and production company that trades on the london stock market. assume that when purchased by an international investor the stocks price and the exchange rate were 5 and 0.64/$1.00 respectively. at selling time, one year after purchase, they were 6 and 0.60/$1.00 . if the investor had sold 5, the principal investment amount at the same time that the stock was purchased, forward at the forward exchange rate of 0.60/$1.00. the dollar rate of return would be:a) 0.26%b) 26.00%c) 28.00%d) 30.00%answer: b)rationale:find the dollar-base cost basis at time zero and dollar-based values at time one:21 assume that you have invested $100,000 in british equities. when purchased the stocks price and the exchange rate were 50 and 0.50/$1.00 respectively. at selling time, one year after purchase, they were 60 and 0.60/$1.00. if the investor had sold 50,000 forward at the forward exchange rate of 0.55/$1.00. the dollar rate of return would be:a) 10.90%b) 7.58%c) 28.00%d) 9.09%answer: b)rationale:find the dollar-base cost basis at time zero and dollar-based values at time one:22 assume that you have invested $100,000 in british equities. when purchased the stocks price and the exchange rate were 50 and 0.50/$1.00 respectively. at selling time, one year after purchase, they were 45 and 0.60/$1.00. if the investor had sold 50,000 forward at the forward exchange rate of 0.55/$1.00. the dollar rate of return would be:a) 27.27%b) 1.09%c) 28.00%d) 9.09%answer: a)rationale:find the dollar-base cost basis at time zero and dollar-based values at time one:23 assume that you have invested $100,000 in japanese equities. when purchased the stocks price and the exchange rate were 100 and 100/$1.00 respectively. at selling time, one year after purchase, they were 110 and 110/$1.00. if the investor had sold 10,000,000 forward at the forward exchange rate of 105/$1.00 the dollar rate of return would be:a) 27.27%b) 4.32%c) 28.00%d) 9.09%answer: b)rationale:find the dollar-base cost basis at time zero and dollar-based values at time one:24 assume that you have invested $100,000 in japanese equities. when purchased the stocks price and the exchange rate were 100 and 100/$1.00 respectively. at selling time, one year after purchase, they were 110 and 110/$1.00. the dollar rate of return would be:a) 0%b) 4.32%c) 28.00%d) 9.09%answer: b)rationale:you can do this problem in your head, but heres the brute force approach:25 which of the following is a true statement?a) generally, exchange rate volatility is greater than bond market volatility.b) when investing in international bonds, it is essential to control exchange risk to enhance the efficiency of international bond portfolios.c) the real-world evidence suggests that investing in swiss bonds largely amounts to investing in swiss currency.d) all of the aboveanswer: d) 26 compared with bond marketsa) the risk of investing in foreign stock markets is, to a lesser degree, attributable to exchange rate uncertainty.b) the risk of investing in foreign stock markets is, to a much greater degree, attributable to exchange rate uncertainty.c) exchange risk is lower than default risk and interest rate risk.d) all of the aboveanswer: a) international bond investment27 exchange rate fluctuations contribute to the risk of foreign investment through three possible channels:(i)- the volatility of the investment due to the volatility of the exchange rate(ii)-the contribution of the cross-product term(iii)- its covariance with the local market returnswhich of the following contributes and accounts for most of the volatility?a) (i) and (ii)b) (ii) and (iii)c) (i) and (iii)d) only (ii) answer: c) 28 in may 1995 when the exchange rate was 80 yen per dollar, japan life insurance company invested 800,000,000 (i.e., $10,000,000) in pure-discount u.s. bonds. the investment was liquidated one year later when the exchange rate was 110 yen per dollar. if the rate of return earned on this investment was 46% in terms of yen, calculate the dollar amount that the bonds were sold at.a) $10,618,000b) $10,720,000c) $14,600,000d) none of the aboveanswer: a) rationale:let x = sale price of the bonds in u.s. dollarsthen,29 a zero-coupon british bond promises to pay 100,000 in five years. the current exchange rate is $2.00 = 1.00 and inflation is forecast at 3% in the u.s. and 2% in the u.k. per year for the next five years. the appropriate discount rate for a bond of this is would be 10% if it paid in dollars. what is the appropriate price of the bond?a) 62,092.13 = $124,184.26b) 65,196.13 = $130,392.26c) none of the aboveanswer: b)rationale: there are at least two ways to approach this:this exact problem is not done in this chapter, but your students should be able to do this if they learned anything in previous chapters. use your judgment, pick your battles.30 recent studies show that when investors control exchange risk by using currency forward contracts,a) they can substantially enhance the efficiency of international bond portfolios.b) they can substantially enhance the efficiency of international stock portfolios.c) a) and b)d) the risk of investing in foreign stock markets is can be completely hedged.answer: a)31 recent studies show that when investors control exchange risk by using currency forward contracts to hedgea) international bond portfolios outperform domestic bond portfoliosb) international bond portfolios dominate domestic stock portfolios in terms of risk-return efficiency.c) a) and b)d) none of the aboveanswer: b)international mutual funds: a performance evaluation32 advantages of investing in u.s.-based international mutual funds includea) lower transactions costs relative to direct investingb) circumvention of many legal and institution barriers to direct portfolio investment in many foreign marketsc) professional management, potentially expertise in security selection, definitely record-keeping.d) all of the aboveanswer: d)33 the record of investing in u.s.-based international mutual funds a) suggests that its a bad ideathe costs outweigh the benefits for u.s. investors.b) without exception, they have higher returns than the u.s. market (as proxied by the s&p 500 index) and slightly lower risk.c) suggests that for the most part, they have higher returns than the u.s. market (as proxied by the s&p 500 index) but with slightly higher risk.d) none of the aboveanswer: c)34 the record of investing in u.s.-based international mutual funds a) shows that most funds have a beta much less than one.b) shows them to be a raging arbitrage opportunity.c) shows that they offer less diversification benefits than just investing in u.s.-based mncsd) none of the aboveanswer: a)35 the record of investing in u.s.-based mncs a) shows that the share prices of u.s.-based mncs behave much like those of domestic firms, without providing effective international diversification.b) shows that the share prices of u.s.-based mncs behave much differently than those of domestic firms, providing effective international diversification.c) shows that the share prices of u.s.-based mncs behave much like the currency returns of their foreign markets.d) none of the aboveanswer: a)36 the record of investing in u.s.-based stock mutual funds a) shows that the movements of the u.s. stock market account for about 20 percent of the fluctuations of the value of u.s.-based stock mutual funds.b) shows that the talent of individual portfolio managers accounts for about 90 percent of the fluctuations of the value of u.s.-based stock mutual fundsluck the other ten percent.c) shows that the movements of the u.s. stock market account for about 90 percent of the fluctuations of the value of u.s.-based stock mutual funds.d) none of the aboveanswer: c)international diversification through country funds37 u.s.-based mutual funds known as country funds.a) invest in the government securities of different sovereign governments, giving risk-free portfolios effective exchange rate diversification.b) invests exclusively in stocks of a single country.c) invests exclusively in government securities of a single country.d) none of the aboveanswer: b)38 advantages of investing in mutual funds known as country funds include:a) speculation in a single foreign market at minimum costb) using them as building blocks of a personal international portfolio.c) diversification into emerging markets that are otherwise practically inaccessibled) all of the aboveanswer: d)39 a closed end mutual funda) invests in bonds of a particular maturity, when they mature, the fund closes.b) trades on a stock exch