Exercises from International Diversification

1. The yield on a 1-year bill in the U.K. is 8% and the present exchange rate is 1 pound = U. S. $1.60. If you expect the exchange rate to be 1 pound - U. S. $1.50 a year from now, the return a U. S. investor can expect to earn by investing in U.K. bills is A) -6.7% B) 0% C) 8% D) 1.25% E) none of the above Answer: D Difficulty: Moderate Rationale: r(US) = [1 + r(UK)]F0/E0 - 1; [1.08][1.50/1.60] - 1 = 1.25%. Use the following to answer questions 2-3: Assume there is a fixed exchange rate between the Canadian and U.S. dollar. The expected return and standard deviation of return on the U.S. stock market are 18% and 15%, respectively. The expected return and standard deviation on the Canadian stock market are 13% and 20%, respectively. The covariance of returns between the U.S. and Canadian stock markets is 1.5%. 2. If you invested 50% of your money in the Canadian stock market and 50% in the U.S. stock market, the expected return on your portfolio would be __________. A) 12.0% B) 12.5% C) 13.0% D) 15.5% E) none of the above Answer: D Difficulty: Moderate Rationale: 18% (0.5) + 13%(0.5) = 15.5%. 3. If you invested 50% of your money in the Canadian stock market and 50% in the U.S. stock market, the standard deviation of return of your portfolio would be __________. A) 12.53% B) 15.21% C) 17.50% D) 18.75% E) none of the above Answer: A Difficulty: Difficult Rationale: sP = [(0.5)2(15%)2 + (0.5)2(20%)2 + 2(0.5)(0.5)(1.5)]1/2 = 12.53%. 4. You are a U. S. investor who purchased British securities for 2,000 pounds one year ago when the British pound cost $1.50. No dividends were paid on the British securities in the past year. Your total return based on U. S. dollars was __________ if the value of the securities is now 2,400 pounds and the pound is worth $1.60. A) 16.7% B) 20.0% C) 28.0% D) 40.0% E) none of the above Answer: C Difficulty: Moderate Rationale: ($3,840 - $3,000)/$3,000 = 0.28, or 28.0%. 5. When an investor adds international stocks to her portfolio A) it will raise her risk relative to the risk she would face just holding U.S. stocks. B) she can reduce its risk relative to the risk she would face just holding U.S. stocks. C) she will increase her expected return, but must also take on more risk. D) it will have no significant impact on either the risk or the return of her portfolio. E) she needs to seek professional management because she doesn't have access to international stocks on her own. Answer: B