# 24 this is lower than the unhedged dollar denominated

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The standard deviation is now 10.24%. This is lower than the unhedged dollar- denominated standard deviation, and is only slightly higher than the standard deviation of the pound-denominated return. 25-2

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Chapter 25 - International Diversification 6. Currency Selection EAFE: [0.30 × (–10%)] + (0.10 × 0%) + (0.60 × 10%) = 3.0% Manager: [0.35 × (–10%)] + (0.15 × 0%) + (0.50 × 10%) = 1.5% Loss of 1.5% relative to EAFE. Country Selection EAFE: (0.30 × 20%) + (0.10 × 15%) + (0.60 × 25%) = 22.50% Manager: (0.35 × 20%) + (0.15 × 15%) + (0.50 × 25%) = 21.75% Loss of 0.75% relative to EAFE. Stock Selection [(18% – 20%) × 0.35] + [(20% – 15%) × 0.15] + [(20% – 25%) × 0.50] = – 2.45% Loss of 2.45% relative to EAFE. 7. 1 + r(US) = [1 + r f (UK)] × (F 0 /E 0 ) = 1.08 × (1.85/1.75) = 1.1417 r(US) = 14.17% 8. You can now purchase: \$10,000/\$1.75 = £5,714.29 This will grow with 8% interest to £6,171.43. Therefore, to lock in your return, you would sell forward £6,171.43 at the forward exchange rate. 9. A naïve investment by an investor who resides in Foreign Country A might include only a small fraction of the portfolio invested in the home country, and a relatively greater weight invested in U.S. securities. This might not be an appropriate approach for a foreign investor who is likely to be comfortable with a home bias, just as American investors seem to be. A reasonable way to scale down the weight invested in foreign countries (for example, the portfolio weight maintained by the investor from Foreign Country A in U.S. securities) is to focus on the weight of U.S. imports in the entire consumption basket of the investor (including durable goods) rather than emphasizing market capitalization. Since this consumption basket includes health care, for example, as well as other substantial items that have no import component, the resultant desired weight in U.S. securities will be smaller than market capitalization would suggest. CFA PROBLEMS 1. Initial investment = 2,000 × \$1.50 = \$3,000 Final value = 2,400 × \$1.75 = \$4,200 Rate of return = (\$4,200/\$3,000) - 1 = 0.40 = 40% 25-3
Chapter 25 - International Diversification 2. a. 3. c. 4. a.The primary rationale is the opportunity for diversification. Factors that contribute to low correlations of stock returns across national boundaries are: i. imperfect correlation of business cycles ii. imperfect correlation of interest rates iii. imperfect correlation of inflation rates iv. exchange rate volatility b. Obstacles to international investing are: i. Availability of information , including insufficient data on which to base investment decisions. Interpreting and evaluating data that is different in form and/or content than the routinely available and widely understood U.S. data is difficult. Also, much foreign data is reported with a considerable lag. ii. Liquidity , in terms of the ability to buy or sell, in size and in a timely manner, without affecting the market price. Most foreign exchanges offer (relative to U.S. norms) limited trading, and experience greater price volatility. Moreover, only a (relatively) small number of individual foreign stocks enjoy liquidity comparable to that in the U.S., although this situation is improving steadily.

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