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SuggestedEndofCHAPTER15Solutions - CHAPTER 15 INTERNATIONAL...

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CHAPTER 15 INTERNATIONAL PORTFOLIO INVESTMENT SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS QUESTIONS 1. What factors are responsible for the recent surge in international portfolio investment (IPI)? Answer: The recent surge in international portfolio investments reflects the globalization of financial markets. Specifically, many countries have liberalized and deregulated their capital and foreign exchange markets in recent years. In addition, commercial and investment banks have facilitated international investments by introducing such products as American Depository Receipts (ADRs) and country funds. Also, recent advancements in computer and telecommunication technologies led to a major reduction in transaction and information costs associated with international investments. In addition, investors might have become more aware of the potential gains from international investments. 2. Security returns are found to be less correlated across countries than within a country. Why can this be? Answer: Security returns are less correlated probably because countries are different from each other in terms of industry structure, resource endowments, macroeconomic policies, and have non-synchronous business cycles. Securities from a same country are subject to the same business cycle and macroeconomic policies, thus causing high correlations among their returns. 3. Explain the concept of the world beta of a security. Answer: The world beta measures the sensitivity of returns to a security to returns to the world market portfolio. It is a measure of the systematic risk of the security in a global setting. Statistically, the world beta can be defined as: Cov(R i , R M )/Var(R M ), where R i and R M are returns to the i-th security and the world market portfolio, respectively.
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4. Explain the concept of the Sharpe performance measure. Answer: The Sharpe performance measure (SHP) is a risk-adjusted performance measure. It is defined as the mean excess return to a portfolio above the risk-free rate divided by the portfolio’s standard deviation. 5. Explain how exchange rate fluctuations affect the return from a foreign market measured in dollar terms. Discuss the empirical evidence on the effect of exchange rate uncertainty on the risk of foreign investment. Answer: It is useful to refer to Equations 11.4 and 11.5 of the text. Exchange rate fluctuations mostly contribute to the risk of foreign investment through its own volatility as well as its covariance with the local market returns. The covariance tends to be positive in most of the cases,
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