Tutorial+solutions+chs+20+and+21 - Chapter 20 International...

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Chapter 20 International Portfolio Diversification Answers to Conceptual Questions 20.1 How is portfolio risk measured? What determines portfolio risk? Portfolio risk is measured by the standard deviation (or variance) of return. Portfolio risk depends on the variances and covariances of the assets in the portfolio. 20.2 What happens to portfolio risk as the number of assets in the portfolio increases? As the number of assets held in a portfolio increases, the variance of return on the portfolio becomes more dependent on the covariances between the individual securities and less dependent on the variances of the individual securities. 20.3 What happens to the relevant risk measure for an individual asset when it is held in a large portfolio rather than in isolation? The risk of an individual asset in a large portfolio depends on its return covariance with other assets in the portfolio and not on its return variance. This is called systematic risk. 20.4 In words, what does the Sharpe Index measure? Sharpe’s measure captures the ex post return/risk performance of an asset by dividing return in excess of the riskfree rate by the asset’s standard deviation of return. In other words, it measures the asset’s “bang for the buck.” 20.5 Name two synonyms for “systematic risk.” Systematic risk is the same as non-diversifiable risk. In the context of the CAPM, the only systematic risk is market risk (that is, risk related to the market factor). 20.6 Name two synonyms for “unsystematic risk.” Diversifiable risk is asset-specific (company- or country-specific) or unique risk. In the context of the CAPM, diversifiable risk includes only non-market risk (i.e., risk unrelated to the market factor). 22.7 Which portfolio has the most to gain from currency hedging - a portfolio of international stocks or a portfolio of international bonds? Why? Nearly all of the variation in bond returns within a country come from changes in interest rates in that country. Stocks have a much larger random component. Without the additional security-specific variability of stocks, the percentage of currency risk in the return variance of an international bond portfolio is much higher than in an international stock portfolio. Currency risk hedging is much more effective in reducing the variability of foreign bond investments than of foreign stock investments. 20.8 Is international diversification effective in reducing portfolio risk? Why? International portfolio diversification can reduce portfolio risk in two ways: 1) national stock markets are only loosely linked, and 2) the correlation between exchange rates and national market returns is very low, so domestic-currency returns on foreign investments are further isolated from returns elsewhere in the domestic market. 20.9
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This note was uploaded on 10/29/2010 for the course FINS 3616 taught by Professor Curry during the Three '10 term at University of New South Wales.

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Tutorial+solutions+chs+20+and+21 - Chapter 20 International...

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