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IM-11 CHAPTER 11 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? 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. Finally, investors 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 so? Answer : Security returns are less correlated across countries probably because countries differ in terms of industry structure, resource endowments, country-specific growth patterns and macroeconomic policies. Countries also 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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IM-11 4. Explain the concept of the Sharpe performance ratio. Answer : The Sharpe performance ratio (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 : Issues raised in this and the following question can usefully be addressed with reference to Exhibit 11-2. Exchange rate fluctuations contribute to the risk of foreign investment by adding volatility to returns on a currency-converted basis as well as the exchange rate‘s induced effect on local market returns. The latter effect, a covariance, tends to be positive in most of the cases (i.e., local market returns tend to be positively correlated with increases in the external value of a country‘s currency) implying that the covariance effect adds to exchange risk rather than offsetting it. Exchange risk is found to be much more significant in bond investments than in stock investments. 6.
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