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Chapter 19  Globalization and International Investing
CHAPTER 19
GLOBALIZATION AND INTERNATIONAL INVESTING
1.
False. Investments made in a local currency have the added risk associated with
exchange rates. If an investment were made in dollars, the business risk of the firm
would be the only risk born by the investor. If the investment is made in the local
currency, the investor takes on both business risk and exchange rate risk.
2.
False. In almost all cases the statement is true, however, such diversification benefit is
not assured. In those cases where there is no correlation coefficient between the
international investment and the US portfolio, a diversification gain cannot be assured.
In fact, should a high standard deviation security, with zero or one correlation with the
US portfolio were added, the overall standard deviation of the portfolio would increase.
3.
False. Evidence shows that the minimumvariance portfolio is not the efficient choice.
A capitalizationweighted portfolio of world indexes is likely to produce a better risk
return tradeoff than the minimumvariance portfolio.
4.
True. By hedging, it is possibly to virtually eliminate exchange rate risk. The result is a
set of returns based on the foreign stocks and not the currency fluctuations.
5.
a.
$10,000/2 = £5,000
£5,000/£40 = 125 shares
b.
To fill in the table, we use the relation:
1 + r(US) = [(1 + r
f
(UK)]
0
1
E
E
Price per
PoundDenominated
DollarDenominated Return (%)
for YearEnd Exchange Rate
Share (£)
Return (%)
$1.80/£
$2.00/£
$2.20/£
£35
12.5%
21.25%
12.5%
3.75%
£40
0.0%
10.00%
0.0%
10.00%
£45
12.5%
1.25%
12.5%
23.75%
c.
The dollardenominated return equals the pounddenominated return when the
exchange rate is unchanged over the year.
6.
The standard deviation of the pounddenominated return (using 3 degrees of freedom)
is 10.21%.
The dollardenominated return has a standard deviation of 13.10% (using 9
degrees of freedom), greater than the pounddenominated standard deviation.
This is
due to the addition of exchange rate risk.
191
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7.
First we calculate the dollar value of the 125 shares of stock in each scenario.
Then we
add the profits from the forward contract in each scenario.
Price per
Dollar Value of Stock
at Given Exchange Rate
Share (£)
Exchange Rate:
$1.80/£
$2.00/£
$2.20/£
£35
7,875
8,750
9,625
£40
9,000
10,000
11,000
£45
10,125
11,250
12,375
Profits on Forward Exchange:
[ = 5000(2.10 – E
1
)]
1,500
500
500
Price per
Total Dollar Proceeds
at Given Exchange Rate
Share (£)
Exchange Rate:
$1.80/£
$2.00/£
$2.20/£
£35
9,375
9,250
9,125
£40
10,500
10,500
10,500
£45
11,625
11,750
11,875
Finally, calculate the dollardenominated rate of return, recalling that the initial
investment was $10,000:
Price per
Rate of return (%)
at Given Exchange Rate
Share (£)
Exchange Rate:
$1.80/£
$2.00/£
$2.20/£
£35
6.25%
7.50%
8.75%
£40
5.00%
5.00%
5.00%
£45
16.25%
17.50%
18.75%
b.
The standard deviation is now 10.24%.
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This note was uploaded on 04/22/2010 for the course BUS BUS 136 taught by Professor Sukwonthomaskim during the Spring '10 term at UC Riverside.
 Spring '10
 SukwonThomasKim
 Management, Exchange Rate, Investing

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