kim226

Which of the following statements concerning currency risk is most accurate? Currency risk:

A) slightly reduces the risk of foreign investments through diversification of the asset risk.

B) slightly magnifies the risk of foreign investments.

C) greatly magnifies the risk of foreign investments.

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Currency risk only slightly magnifies the risk of foreign investments because it is only about half that of foreign stock risk on average and much of it can be diversified away in a portfolio of currencies. Also foreign currency risk and foreign asset risk are not additive due to correlations between them of less than one.

kim226

All of the following are reasons investors should consider constructing global portfolios EXCEPT:

A) additional choice. Markets outside the U.S. represent more than 50% of available investment choices.

B) non-U.S. securities often outperform U.S. securities.

C) reduced foreign exchange risk. Spreading assets over multiple currencies dampens portfolio volatility.

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Increased foreign exchange risk is the cost of going global. In terms of the home currency (which could be the USD or other currency) including assets denominated in foreign currencies can increase portfolio volatility. This is a particular concern when the foreign currencies depreciate against the home currency.

kim226

According to a study on bond returns during the period 1987-1996, the U.S. dollar generally weakened relative to the other countries in the study (specifically, Canada, Euro area, Japan and the U.K.). Which of the following statements regarding the impact of exchange rates on security returns is CORRECT?

A) Exchange rates have little impact on returns.

B) When the home currency is weakening, the investor should invest more in foreign bonds.

C) When the home currency is weakening, the investor should invest less in foreign bonds.

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When the home currency is weakening, the investor should invest more in foreign bonds. As the dollar weakens, a U.S. investor will earn a higher return on foreign investments because each foreign currency unit buys more dollars.

kim226

The following data applies to a foreign stock investment:

• The loss on the stock in foreign currency terms was 12%.
• The foreign currency has depreciated by 6%.
• The standard deviation of stock returns was 33% and the standard deviation of the foreign currency was 14%.
• The correlation between the stock returns and the currency is 0.20.

What is the expected return of the portfolio?

A) -18.72%.

B) -18.00%.

C) -17.28%.

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To obtain the return in domestic currency terms use the following formula that considers the return in local currency terms as well as the exchange rate change:

-0.12 - 0.06 + (-0.12 × -0.06) = -0.1728 or -17.28%

kim226

The following data applies to a foreign stock investment:

• The loss on the stock in foreign currency terms was 12%.
• The foreign currency has depreciated by 6%.
• The standard deviation of stock returns was 33% and the standard deviation of the foreign currency was 14%.
• The correlation between the stock returns and the currency is 0.20.

What is the risk of the portfolio in U.S. dollar terms as measured by the standard deviation?

A) 14.70%.

B) 38.34%.

C) 5.34%.

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We will use the formula for portfolio risk that considers the risk of the asset in foreign currency terms, the risk of the foreign currency, and the correlation between the two:
σ$2 = 0.332 + 0.142 + 2(0.33)(0.14)(0.2) = 0.1470
σ$ = √0.1470 = 0.3834 = 38.34%

kim226

The following data applies to a foreign stock investment:

• 
  The gain on the stock in foreign currency terms was 15%.
• 
  The foreign currency has depreciated by 8%.
• 
  The standard deviation of stock returns was 35% and the standard deviation of the foreign currency was 11%.
• 
  The correlation between the stock returns and the currency is 0.10.

What is the contribution of currency risk?

A) 11.00%.

B) 37.72%.

C) 2.72%.

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The contribution of currency risk measures the risk incremental to foreign asset risk from currency risk and is the difference between the asset risk in domestic currency terms and the risk of the foreign asset in foreign currency terms. To obtain the contribution of currency risk, we must first calculate the risk of the asset in domestic currency terms. To obtain the risk of the asset in domestic currency terms, we use the formula for portfolio risk that considers the risk of the asset in foreign currency terms, the risk of the foreign currency, and the correlation between the two:
σ$2 = 0.352 + 0.112 + 2(0.35)(0.11)(0.1) = 0.1423
σ$ = √0.1423 = 0.3772 = 37.72%
Contribution of Currency = 37.72% - 35.00% = 2.72%

kim226

Relative to the efficient frontier that includes only domestic investments, the efficient frontier that also includes foreign investments will plot to the:

A) left and top.

B) left and bottom.

C) right and top.

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If return is plotted on the y-axis and risk is plotted on the x-axis, the efficient frontier that includes foreign investments will plot to the left and top of the frontier that includes only domestic investments. This means that the global frontier has lower risk and greater return than the purely domestic efficient frontier.

kim226

Relative to the efficient frontier that includes only domestic investments, the efficient frontier that also includes foreign investments will have:

A) higher return and higher risk.

B) lower return and higher risk.

C) higher return and lower risk.

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Due to low correlations, the efficient frontier that adds foreign investments to a domestic only portfolio will have higher returns and lower risk over time.

kim226

Which of the following most accurately represents the relationship between the global efficient frontier and a domestic efficient frontier? The global efficient frontier will contain portfolios with:

A) lower risk for a given return and higher return for a given risk level than portfolios on the domestic efficient frontier.

B) lower risk for a given return and lower return for a given risk level than portfolios on the domestic efficient frontier.

C) higher risk for a given return and higher return for a given risk level than portfolios on the domestic efficient frontier.

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Due to the low to moderate correlations between global markets, the global efficient frontier will contain portfolios with lower risk for a given return and higher return for a given risk level than portfolios on the domestic efficient frontier.

kim226

Which of the following statements about an efficient frontier that adds international bonds to a portfolio of international equities is CORRECT? It will:

A) plot the lower right of a frontier that includes only international equities.

B) dominate a frontier that includes only international equities.

C) be dominated by a frontier that includes only international equities.

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The frontier that includes international bonds will plot to the upper left of the frontier that includes only international equities because it offers a higher return for a given amount of risk (i.e., it dominates the frontier that includes international equities only).