Class notes
FIN 3710 Chapter 19 Notes
- Course
- FIN 3710
- Institution
- Baruch College
This is a comprehensive and detailed note on Chapter 19; Globalization and international investing for Fin 3710. *Essential Study Material!!
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Chapter 19 - Globalization and International InvestingCHAPTER 19
GLOBALIZATION AND INTERNATIONAL INVESTING
1. False. Investments made in a local currency have the added risk associated with
exchange rates. If an investment were made in dollars, the business risk of the firm
would be the only risk borne by the investor. If the investment is made in the local
currency, the investor takes on both business risk and exchange rate risk.
2. False. In almost all cases the statement is true, however, such diversification benefit is
not assured. In those cases where there is no correlation coefficient between the
international investment and the U.S. portfolio, a diversification gain cannot be assured.
In fact, should a high standard deviation security with zero or one correlation with the
U.S. portfolio be added, the overall standard deviation of the portfolio would increase.
3. False. Evidence shows that the minimum-variance portfolio is not the efficient choice.
A capitalization-weighted portfolio of world indexes is likely to produce a better risk-
return trade-off than the minimum-variance portfolio.
4. True. By hedging, it is possible to virtually eliminate exchange rate risk. The result is a
set of returns based on the foreign stocks and not the currency fluctuations.
5.
a. $10,000/$2 = £5,000
£5,000/£40 = 125 shares
The investor can buy 125 shares.
b. To fill in the table, we use the relation:
1 + r(US) = [(1 + rf (UK)] E1/E0
Dollar-Denominated Return (%)
Price per Pound-Denominated 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 at year-end equals the exchange rate at initial investment.
6. 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.
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
, Chapter 19 - Globalization and International Investing
7.
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.
Dollar Value of Stock
Price per 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: 1,500 500 –500
[ = 5000 (2.10 – E1)]
Total Dollar Proceeds
Price per at Given Exchange Rate
Share (£) Exchange Rate: $1.80/£ $2.00/£ $2.20/£
£35 9,375 9,250 9,125
£40 10,500 10,500 10,500
£45 11,625 11,750 11,875
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Rate of return (%)
Price per at Given Exchange Rate
Share (£) Exchange Rate: $1.80/£ $2.00/£ $2.20/£
£35 –6.25% –7.50% –8.75%
£40 5.00% 5.00% 5.00%
£45 16.25% 17.50% 18.75%
b. 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.
8. Currency Selection
EAFE: [0.30 (– .10)] + (0.10 0) + (0.60 .10) = .03 or 3.0%
Manager: [0.35 (– .10)] + (0.15 0) + (0.50 .10) = .015 or 1.5%
Loss of 1.5% relative to EAFE.
Country Selection
EAFE: (0.30 .20) + (0.10 .15) + (0.60 .25) = .225 or 22.50%
Manager: (0.35 .20) + (0.15 .15) + (0.50 .25) = .2175 or 21.75%
Loss of 0.75% relative to EAFE.
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
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