Chap025 - Chapter 25 International Diversification CHAPTER...

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Chapter 25 - International Diversification CHAPTER 25: INTERNATIONAL DIVERSIFICATION PROBLEM SETS 1. “International Investing Raises Questions” was published in the Wall Street Journal in 1997. Some of the arguments presented in the article may no longer be compelling more than a decade later. For example, the following statement from the article is no longer true for many U.S. multinationals: “When you look at these multinationals, the factor that drives their performance is their home market.” The same can also be said of the assertion that “… most of their costs especially labor costs – will be incurred in the U.S.” However, the following argument from the article is still valid: “U.S. multinationals tend to be owned by U.S. investors, who will be swayed by the ups and downs of the U.S. market.” An additional argument that is not mentioned in the piece is the fact that, when investing in U.S. multinationals, it is essentially impossible to determine the degree of one’s international exposure. A portfolio of foreign stocks provides an investor a better understanding of this exposure. The correlation between portfolios of foreign stocks and the U.S. equity market is likely to be less than the correlation of a portfolio of U.S. multinationals with the U.S. market. 2. Which of the returns is more relevant to an investor depends on whether the investor hedges the local currency. If the foreign exchange risk has been hedged, then the relevant figure is the stock market returns measured in the local currency. If the foreign exchange risk is not hedged, then the relevant returns are the dollar-denominated returns. 3. 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(UK)] 0 1 E E Price per Pound-Denominated Dollar-Denominated Return (%) for Year End 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 dollar-denominated return equals the pound-denominated return when the exchange rate is unchanged over the year. 25-1
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Chapter 25 - International Diversification 4. The standard deviation of the pound-denominated return (using 3 degrees of freedom) is 10.21%. The dollar-denominated return has a standard deviation of 13.10% (using 9 degrees of freedom), greater than the pound-denominated standard deviation. This is due to the addition of exchange rate risk. 5. a.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
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This note was uploaded on 01/15/2011 for the course FIN 2030 taught by Professor Smith during the Spring '10 term at Auburn Montgomery.

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Chap025 - Chapter 25 International Diversification CHAPTER...

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