标题: Portfolio Management【Reading 62】Sample [打印本页]
作者: invic 时间: 2012-4-3 10:20 标题: [2012 L2] Portfolio Management【Session 18- Reading 62】Sample
Gerald Santana, CFA is the president and CEO of Dartmouth Ltd., a hedge fund management firm located in New York. The firm has been in existence for nearly fifteen years, and has shown consistently impressive returns since inception. Dartmouth has a wide variety of investments across a broad range of asset types that are based around the world. Members of the firm have a great deal of experience in assessing the currency exposure associated with investing in international markets. Due to a recent influx of new funds, Santana and his team have a substantial amount of uninvested cash and are currently evaluating several investment opportunities.
One potential investment for the fund is a 25 percent stake in a closely-held manufacturing company located in Ireland which produces textiles for export to the United States. Prices are set and paid for in U.S. dollars, but all costs of production are incurred in Euros. Santana is somewhat concerned about the potential currency exposure of the company, although he is quite familiar with the risks involved with investing in foreign firms with multinational operations. He intends to do further analysis of expected returns given various anticipated interest rate and exchange rate scenarios.
Additionally, Santana is considering placing some interim funds in some British bonds that appear cheap and are currently yielding a premium over other country’s comparable securities. In his opinion, inflation rates should remain reasonably stable over the next year and the real exchange rate between the two countries is expected to remain constant. The securities are highly liquid, so he does not anticipate any problem selling the bonds should he decide to liquidate the position prior to his anticipated one-year holding period.
Current spot rates:- U.S. Dollar ($) per Euro (€) 0.7600
- U.S. Dollar ($) per British pound (₤): 0.5100
Current 1-year interest rates:- United States 4.50%
- Great Britain 6.25%
Expected one-year inflation rates:- United States 2.25%
- Great Britain 5.00%
International market efficiency is an effective impediment for managers from utilizing active asset allocation between countries to consistently beat the world index. However, there are six potential impediments to the international flow of capital. Which of the following factors is least likely to have an impact on market efficiency? A)
| Psychological barriers. |
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Interest rate risk, although present across all markets, is not one of the six potential barriers to international capital mobility. The other three barriers are transaction costs, political risks, and foreign currency risk. (Study Session 18, LOS 62.a)
Which of the following statements regarding real exchange rates and domestic currency return is least accurate? A)
| Real exchange rate risk occurs if the nominal exchange rate does not change by the amount predicted by the inflation differential. |
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B)
| The real exchange rate is the spot exchange rate divided by the ratio of the consumption basket price levels. |
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C)
| Real exchange rate movements are defined as changes in the nominal exchange rate that are not explained by inflation differentials. |
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The real exchange rate is the spot exchange rate multiplied by the ratio of the consumption basket price levels. (Study Session 18, LOS 62.e)
If the Euro experiences 7 percent real appreciation versus the dollar, the value of the investment in the Irish company will be impacted, all other things equal. Which of the following statements best describes the impact on Dartmouth’s investment? The Irish company will be: A)
| hurt by the appreciation of the Euro because the firm’s products will be more expensive in the United States. |
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B)
| helped by the appreciation of the Euro because its costs of production will decline. |
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C)
| hurt by the appreciation of the Euro because its costs of production will increase. |
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The currency appreciation will make the company’s products more expensive in the U.S., which will decrease sales. Costs will remain the same, so profitability will decline. (Study Session 18, LOS 62.l)
According to the money demand model of equity exposure for a company, which of the following statements is most accurate? The money demand model: A)
| predicts that currency depreciation will lead to lower equity prices in a developed country. |
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B)
| predicts that depreciation in the value of the domestic currency will cause an increase in the competitiveness of domestic industry. |
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C)
| explains the positive correlation between changes in domestic currency and stock returns. |
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According to the money demand model, increased real economic activity leads to increased demand for the domestic currency. This increase in domestic currency demand causes the value of the domestic currency to appreciate, which in turn leads to increased stock returns. (Study Session 18, LOS 62.n)
Santana wants to quantify the additional exchange rate risk associated with the purchase of the British securities. Calculate the expected exchange rate change at the end of one year.
If real rates remain constant, the change in the exchange rate is equal to the inflation differential. The current difference between the two countries rates is 2.75% (5.00% − 2.25%), so the expected depreciation of the pound is 2.75%. The expected exchange rate is calculated as: $0.5100/₤ × (1 − 0.0275) = $0.4960/₤ (Study Session 18, LOS 62.f)
Assume that the British pound will depreciate by 3 percent over the next year. Calculate the hedge fund’s expected return on the British investment for a one year holding period.
The hedge fund is located in New York, so the domestic currency is the U.S. $. The expected dollar return on the British bond for one year is approximately equal to the British interest rate minus the depreciation of the pound. Therefore: 6.25% - 3.00% = 3.25% (Study Session 18, LOS 62.f)
作者: invic 时间: 2012-4-3 10:20
John Swanson is an economic advisor for the international division of BMC Investments. He has been asked to gather economic data and present a seminar to other analysts regarding international economic concerns. The following three issues were raised in the seminar. Choose the most reasonable statement that Swanson should make in replying to the questions raised.The issue of growth rates across various countries was discussed and there was some disagreement regarding future expectations for growth rates across countries. Which of the following statements most accurately describe expectations of future growth rates under neoclassical theory? A)
| The best method for measuring the difference in growth rates internationally is using endogenous growth theory. |
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B)
| Conditional convergence is predicted for countries with similar economic attributes, including savings and population growth rates. |
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C)
| High-growth countries that have historically made high investment for growth will ultimately enter a steady state. |
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Under neoclassical theory the concept of convergence implies that high-growth countries that have historically made high investment for growth will ultimately enter a steady state. Absolute convergence, not conditional convergence, is predicted for countries with similar economic attributes, including savings and population growth rates. There is empirical evidence to suggest that countries that invest more will grow faster, but the accelerated growth is not permanent. Endogenous (new) growth theory is not of much value in explaining differences in growth rates internationally.
The vice president of equity analysis believes that Japan is an integrated world market with few impediments to international flow of capital. Which of the following factors would NOT cause Swanson to question the international efficiency of Japan? A)
| The gross domestic product (GDP) is less for Japan than the local GDP. |
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B)
| Foreign currency risk is not completely hedged away. |
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C)
| The accounting system in Japan is not in accordance with Generally Accepted Accounting Principles (GAAP). |
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The level of GDP is not a factor in questioning the international efficiency of a country. In addition to the other factors mentioned in this question, there are several other impediments to international flow of capital. The six potential impediments to international flow of capital are psychological barriers, legal restrictions, transaction cost, discriminatory taxation, political risks, and foreign currency risk.
Swanson has reason to believe that Japan will soon be making monetary policy changes that will cause the yen to suddenly depreciate 1%. If the value of a Japanese firm falls when the yen depreciates, the asset return and currency movement are: A)
| negatively correlated from a U.S. investor's perspective which exaggerates the currency movement impact. |
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B)
| positively correlated from a U.S. investor's perspective which lessens the currency movement impact. |
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C)
| positively correlated from a U.S. investor's perspective which exaggerates the currency movement impact. |
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If the value of a Japanese firm falls when the yen depreciates, the asset return and currency movement are positively correlated from a U.S. investor’s perspective, and this exaggerates the currency movement impact.
作者: invic 时间: 2012-4-3 10:21
Which of the following is considered an impediment to international capital mobility? A)
| Foreign currency risk. |
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Foreign currency risk is an impediment to international capital mobility. The other risks listed exist in any market, domestic or international (note: Greek risk refers to derivative securities models).
作者: invic 时间: 2012-4-3 10:21
Which of the following is NOT an impediment to international capital mobility? A)
| Psychological barriers. |
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C)
| Discriminatory taxation. |
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The impediments to international capital mobility do not include model risk. Model risk exists in all markets.
作者: invic 时间: 2012-4-3 10:22
If the international markets are segmented, which of the following is most accurate? A)
| Risk will not be priced the same in all markets. |
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B)
| The international capital asset pricing model will still be valid. |
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C)
| The extended capital asset pricing model must be used to price international assets. |
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If markets are segmented, then assets with similar risk/return parameters will not necessarily be priced the same.
作者: invic 时间: 2012-4-3 10:22
Which of the following is NOT a factor that favors international market integration? A)
| Many institutional investors diversify internationally. |
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B)
| Governments borrow and lend internationally. |
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C)
| International tax laws are determined by the International Monetary Fund (IMF). |
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There is little in the way of uniform international tax law. Further, the IMF does not determine tax law. The other factors listed promote market integration.
作者: invic 时间: 2012-4-3 10:23
International market integration requires significant international capital mobility. In terms of volume of transactions, what has happened to international capital flows over the past two decades? A)
| As a percent of domestic gross domestic product (GDP), international capital flows have remained constant. |
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B)
| International capital flows have increased modestly. |
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C)
| International capital flows have increased dramatically. |
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The past two decades have witnessed large increases in the volume of international capital flows.
作者: invic 时间: 2012-4-3 10:23
Which of the following will NOT encourage international market integration? A)
| International political stability. |
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B)
| Absence of trade restrictions. |
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C)
| Widespread use of the international capital asset pricing model (ICAPM). |
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Widespread use of the ICAPM will not enhance market integration. If markets are integrated, then the ICAPM will be a useful model for international asset pricing.
作者: invic 时间: 2012-4-3 10:23
Users of the capital asset pricing model (CAPM) must assume that: A)
| inflation remains moderate. |
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B)
| all investors are risk-averse. |
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C)
| exchange rates are not excessive. |
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One of the assumptions of the CAPM is that all investors are risk-averse, preferring more return and less risk, all else equal. The other assumptions are not required.
作者: invic 时间: 2012-4-3 10:24
Horace Malthusson likes to use the CAPM in his stock valuation. When using the CAPM to value stocks, Malthusson assumes that he can borrow money at the risk-free rate, tax rates are stable, and every investor has the same expected rate of return. The assumptions required by the CAPM differ from Malthusson’s assumptions with regard to:
The capital asset pricing model requires that investors assume there are no taxes. Malthusson’s other assumptions match those of the CAPM.
作者: invic 时间: 2012-4-3 10:24
The capital asset pricing model (CAPM) is least effective when used to value: |
B)
| extremely volatile stocks. |
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The CAPM uses beta to reflect volatility, so it can handle volatile stocks. Thinly traded stocks are a problem, but as long as trading is sufficient to provide a beta, the CAPM can be used. It is also possible to estimate beta for thinly traded stocks. However, the CAPM does not work at all for bonds. It uses an equity risk premium, and as such is designed for use only with equities.
作者: invic 时间: 2012-4-3 10:24
Which of the following assumptions is NOT needed to justify the extended capital asset pricing model? A)
| World markets are integrated (i.e. no segmentation). |
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B)
| Investors throughout the world have identical consumption baskets. |
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C)
| The rate of inflation must be identical throughout the world. |
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The rate of inflation need not be identical throughout the world. In a world where identical consumption baskets exist and where purchasing power parity holds exactly at any point in time, exchange rate changes would mirror inflation differences between any two countries.
作者: invic 时间: 2012-4-3 10:25
Which of the following assumptions is needed to justify the extended capital asset pricing model (CAPM)? Investors throughout the world have: A)
| identical consumption baskets. |
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B)
| similar consumption baskets. |
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C)
| nearly-identical consumption baskets. |
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Investors throughout the world need to have identical consumption baskets to justify the extended CAPM.
作者: invic 时间: 2012-4-3 10:25
Which of the following assumptions is needed to justify the extended capital asset pricing model (CAPM)? Purchasing power parity (PPP) holds: A)
| approximately at any point in time. |
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B)
| approximately over extended periods of time. |
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C)
| exactly at any point in time. |
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The extended CAPM assumes that PPP holds exactly at any point in time.
作者: invic 时间: 2012-4-3 10:25
Some market participants have argued that, under certain circumstances, the domestic capital asset pricing model (CAPM) can be extended to the international environment. When using the domestic CAPM in the international environment, the model is referred to as the:
When using the domestic CAPM in an international setting, the model is referred to as the extended CAPM.
作者: invic 时间: 2012-4-3 10:26
Which of the following assumptions is required in order to extend the domestic capital asset pricing model (CAPM) to an international setting? A)
| All countries have identifiable consumption baskets. |
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B)
| Purchasing power parity holds at all times. |
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C)
| Exchange rate risk is perfectly hedged. |
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Extending the CAPM to an international setting requires two additional assumptions: (1) purchasing power parity holds at all times, and (2) all investors have identical (not identifiable) consumption baskets.
作者: invic 时间: 2012-4-3 10:26
The exchange rate between the U.S. and Canada was 1.5 to 1 ($/Can$) one year ago. At that time, the ratio of the price levels of the U.S. consumption basket to the Canadian consumption basket was also 1.5. During the year, U.S. inflation was 4% and Canadian inflation was 2%. What must the end-of-period nominal exchange rate be in order for the end-of-period real exchange rate to be the same as the beginning of period real exchange rate?
The beginning-of-period real exchange rate is 1 (X = S (PF/PD) = 1.5 (1 / 1.5) = 1). After the inflation during the year, the ratio of the price levels (PF/PD) will be 0.6538 [= (1 × 1.02) / (1.5 × 1.04) = 1.02 / 1.56]. Hence, for the real exchange rate to equal one, the rate must be 1 / 0.6538 = 1.53.
作者: invic 时间: 2012-4-3 10:27
A domestic investor from the U.S. invested in securities in Mexico one year ago. At that time, the exchange rate was $0.07/peso. The ratio of the price levels of the domestic consumption basket to the foreign consumption basket was equal to 7. Over the past year the U.S. inflation rate was 2% and the inflation rate in Mexico was 6%. The current end-of-the year spot exchange rate is $0.085/peso. What was the beginning real exchange rate one year ago?
The real exchange rate is defined as the actual spot exchange rate, S, multiplied by the ratio of the price levels of the consumption baskets in the two countries.X = S(PF / PD) = 0.07(1 / 7) = 0.01.
What is the end of year real exchange rate?
Real exchange rate movements are defined as changes in the exchange rate that are not explained by inflation differentials.X = S(PF / PD) = 0.085(1.06 / 7.14) = 0.01262
Which of the following statements regarding the real exchange rate is least accurate? Using the data in this example, the: A)
| constant real rate implies that the changes in the nominal rate are simply a reflection of the inflation differential. |
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B)
| changes in rates imply that exchange rate risk was present. |
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C)
| change in the nominal exchange rate does not reflect the inflation differential; therefore, the real exchange rate has changed. |
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In this example, the real rate was not constant over this period of time. The beginning exchange rate was 0.01 and the ending exchange rate was 0.013. The nominal exchange rate does not reflect the inflation differential and the real rate has changed. Changes in the real rate of interest reflect the fact that exchange rate risk is present and these changes can have a significant impact on realized returns.
作者: bapswarrior 时间: 2012-4-3 10:38
Suppose the real currency exchange rate between two countries changes during the year. Which of the following best describes the change in real exchange rates? A)
| The change in the nominal exchange rate does not reflect the inflation differential. |
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B)
| International markets are segmented. |
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C)
| The market in one country outperforms the market in the other. |
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If the real exchange rate changes during a period, the exchange rate change does not mirror the inflation differential.
作者: bapswarrior 时间: 2012-4-3 10:39
At the beginning of the period, the exchange rate between Country A and Country B is 3 (quoted as A/B). The ratio of the prices of the consumption basket in Country A to Country B is 2. During the year, Country A has inflation of 10% and Country B has inflation of 0%. At the end of the year, the exchange rate is 3.5. What is the end-of-period real exchange rate?
The real exchange rate is calculated as: X = S (PF/PD). Using Country A as the home country, the end-of-period real exchange rate is: X = 3.5(1 / 2.2). The ratio of the price levels reflects the inflation rates in the two countries (1 × 1.0 = 1 for Country B; 2 × 1.1 = 2.2 for Country A).
作者: bapswarrior 时间: 2012-4-3 10:41
A Korean investor (currency = won) is considering the purchase of a U.S. bond. The current exchange rate is 100 (won to $). Korean inflation is 1% and U.S. inflation is 5%. Interest rates in Korea are 4% and in the U.S. are 8%. Assuming that the real rate remains constant, what is the domestic currency return from the purchase of the U.S. bond?
The domestic currency return on the U.S. bond is equal to the foreign interest rate plus the currency appreciation. Since the inflation differential favors Korea and the real rate is assumed to be constant, the dollar will appreciate by –4%. Hence, the domestic currency return is 4% [= 8% foreign rate + (–4%) currency appreciation].
作者: bapswarrior 时间: 2012-4-3 10:41
A U.K. investor is considering the purchase of a Japanese bond. The current exchange rate is 150 (yen to pounds). The real rate is assumed to be constant. Inflation in Japan is 0% and interest rates are 2%. U.K. inflation is 3% and interest rates are 5%. What is the domestic currency return to the purchase of the Japanese bond?
The domestic currency return on the Japanese bond is equal to the foreign interest rate plus the currency appreciation. Since the inflation differential favors the Japanese bond and the real rate is assumed to be constant, the yen will appreciate by 3%. Hence, the domestic currency return is 5% (= 2% foreign rate + 3% currency appreciation).
作者: bapswarrior 时间: 2012-4-3 10:42
A U.S. investor purchased a U.K. bond one year ago. The exchange rate at the time was 1.6 to 1 (dollars to pounds) and the beginning-of-period ratio of the price levels of the consumption baskets was 2 ($ to £). During the year, inflation in the U.S. was 6% and in the U.K. was 11%. Today the exchange rate is 1.7. Which of the following is closest to the end-of-period real exchange rate?
The end-of-period real exchange rate is calculated as: X = S (PF/PD). Here, the new price levels are 1.11 for the U.K. (1 × 1.11 = 1.11) and 2.12 for the U.S. (2 × 1.06 = 2.12). Hence, the end-of-period real rate is 0.890 [= X = S (PF/PD) = 1.7 (1.11 / 2.12)].
作者: bapswarrior 时间: 2012-4-3 10:42
A U.S. investor purchased a U.K. bond one year ago. The exchange rate at the time was 1.5 to 1 (dollars to pounds) and the beginning-of-period ratio of the price levels of the consumption baskets was 2 to 1 (dollars to pounds). Beginning of the year interest rates were 7% in the U.S. and 12% in the U.K. Inflation during the year was expected to be 5% in the U.S. and 10% in the U.K. Today the exchange rate is 1.6. What is the ex-post domestic currency return on the U.K. bond to the U.S. investor?
The dollar was expected to appreciate (lower inflation), but depreciated by 6.67% (= 1.6 / 1.5 = 1.0667 or 6.67%) instead. Hence, the return to U.S. investor is the foreign interest rate plus currency appreciation, or 18.67% (= 12% foreign rate + 6.67% appreciation).
作者: bapswarrior 时间: 2012-4-3 10:42
A U.S. investor purchased a U.K. bond one year ago. The exchange rate at the time was 1.5 to 1 (dollars to pounds) and the beginning-of-period ratio of the price levels of the consumption baskets was 2 ($ to £). During the year, inflation in the U.S. was 5% and in the U.K. was 10%. Today the exchange rate is 1.6. What is the end-of-period real exchange rate?
The end-of-period real exchange rate is calculated as: X = S (PF/PD). Here, the new price levels are 1.1 for the U.K. (1 × 1.1 = 1.1) and 2.1 for the U.S. (2 × 1.05 = 2.1). Hence, the end-of-period real rate is 0.838 [= X = S (PF / PD) = 1.6 (1.1 / 2.1)].
作者: bapswarrior 时间: 2012-4-3 10:43
A U.S. investor purchased a Swiss bond one year ago. At the time of purchase, U.S. inflation and interest rates were 2% and 4%, respectively, while Swiss rates were 5% and 7%, respectively. The beginning-of-period exchange rate was 2 ($/SF; SF is the Swiss Franc). The ratio of the price of the U.S. to Swiss consumption baskets at the beginning of the period was also 2. Inflation was exactly as expected during the year. What was the end-of-period real exchange rate?
First calculate the expected spot rate using purchasing power parity: E(S1) = 2 × (1.02 / 1.05) = 1.9429. If the end-of-period nominal rate is 1.94, then the end-of-period real rate must be 0.9985 = X = S (PF / PD) = 1.94[(1 × 1.05) / (2 × 1.02)].
作者: bapswarrior 时间: 2012-4-3 10:43
Steven Retting lives in Canada and is considering investing in a Canadian bond yielding 6% or a U.S. bond yielding 5%. Retting expects the Canadian dollar to appreciate by 3% over the next year.What is the foreign currency risk premium on the U.S. dollar?
The interest rate differential is 1% (Canada – U.S.). We expect the Canadian dollar to appreciate by 3% relative to the U.S. dollar therefore the U.S. dollar will depreciate by 3%. The foreign currency risk premium (FCRP) is the expected exchange rate movement minus the interest rate differential between the domestic currency and the foreign currency. FCRP = −3% − 1% = −4%.
What will be the Canadian currency returns on the U.S. bond?
Since Retting lives in Canada, the Canadian rate is the domestic rate. The interest rate differential is 1% (Canada − U.S.). The foreign currency risk premium (FCRP) is −3% − 1% = −4%. The domestic currency return on the foreign U.S. bond can be calculated as the domestic Canadian interest rate plus the FCRP: 6% − 4% = 2%. Alternatively, the domestic currency return can be calculated as the U.S. interest rate plus the expected currency depreciation: 5% − 3% = 2%
According to the traditional model, if the Canadian currency appreciates, then Canadian industries in the long run should become: A)
| less competitive, and there will be an economic slowdown in Canada. |
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B)
| more competitive, and there will be an economic slowdown in Canada. |
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C)
| more competitive, and there will be an economic expansion in Canada. |
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In the long run, an increase in the value of a country’s currency decreases national competitiveness. Likewise, a decrease in the value of a country’s currency increases national competitiveness in the long run. However, in the short run a decrease in the national currency causes a widening gap in the trade balance and an increase in domestic inflation. Therefore, short-run and long-run reactions to changes in currency differ.
作者: bapswarrior 时间: 2012-4-3 10:44
Which of the following is the formula for the foreign currency risk premium (FCRP)? The FCRP equals: A)
| E[(S1 − S0) / S0] − (rFC − rDC). |
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B)
| E[(S0 − S1) / S0] − (rDC − rFC). |
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The formula for the foreign currency risk premium is: FCRP = [E(S1) – F] / S0. Both remaining formulas are incorrect in the algebra or the subscripts.
作者: bapswarrior 时间: 2012-4-3 10:44
Which of the following describes the foreign currency risk premium (FCRP)? FCRP equals: A)
| expected exchange rate movement minus the ratio of the spot to the forward rate. |
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B)
| forward rate minus the spot rate. |
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C)
| expected exchange rate movement minus the interest rate differential. |
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The FCRP is defined as the expected exchange rate movement minus the interest rate differential. The FCRP will be zero if the expected exchange rate change is purely a function of the relative interest rates.
作者: bapswarrior 时间: 2012-4-3 10:45
A Canadian investor has a domestic currency risk-free rate of 4%. The risk free rate in the U.S. is 5%. The investor expects the Canadian currency (Can$) to appreciate by 1% against the U.S. dollar ($). What is the foreign currency risk premium (FCRP)?
The FCRP is the expected appreciation of the foreign currency minus the interest rate differential (domestic − foreign). Hence, the FCRP is 0% (= –1% appreciation of U.S. dollar minus –1% interest rate differential (i.e., rDC – rFC = 4% – 5% = –1%).
作者: bapswarrior 时间: 2012-4-3 10:45
A Korean investor’s domestic risk-free rate is 3%. The Japanese risk-free rate is 2%. The investor expects that the Korean currency (won) will depreciate by 4% over the next year. What is the foreign currency risk premium (FCRP)?
The FCRP is the expected appreciation of the foreign currency − the interest rate differential (domestic – foreign). Hence, the FCRP is 3% (= 4% appreciation of the yen − 1% interest rate differential). The interest rate differential is calculated as: rDC – rFC = 3% – 2% = 1%.
作者: bapswarrior 时间: 2012-4-3 10:46
A Swiss investor’s domestic risk-free rate is 9%. Japanese risk-free rates are 2%. The investor expects the Swiss Franc (SF) to depreciate by 5%. What is the foreign currency risk premium (FCRP)?
The FCRP is the expected appreciation of the foreign currency minus the interest rate differential (domestic – foreign). Hence, the FCRP is –2% (= 5% appreciation of the yen minus 7% interest rate differential). The interest rate differential is calculated as: rDC – rFC = 9% – 2% = 7%).
作者: bapswarrior 时间: 2012-4-3 10:46
The international capital asset pricing model (ICAPM) expresses expected returns as: A)
| E(R) = RF + (b × MRP) + (γ1 × FCRP1) + (γ2 × FCRP2) + … + (γk × FCRPk). |
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B)
| E(R) = (b × MRP) + (γ1 × FCRP1) + (γ2 × FCRP2) + … + (γk × FCRPk). |
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C)
| E(R) = RF + (γ1 × FCRP1) + (γ2 × FCRP2) + … + (γk × FCRPk). |
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Where:
E(R) = asset’s expected return
RF = domestic currency risk-free rate
bG = sensitivity of the asset i domestic currency returns to changes in the global market portfolio
MRPG = world market risk premium [E(RM) – RF]
E(RM) = expected return on world market portfolio
γ1 to γk = sensitivities of asset’s domestic currency returns to changes in the value of currencies 1 through k
FCRP1 to FCRPk = foreign currency risk premiums on currencies 1 through k
E(R) = RF + (b × MRP) + (γ1 × FCRP1) + (γ2 × FCRP2) + … + (γk × FCRPk).
The ICAPM tells us that the expected return on any asset i is equal to the investor’s domestic risk-free rate, plus a world market risk premium (which is scaled by the asset’s world market beta), plus a foreign currency risk premium for each foreign currency.
作者: bapswarrior 时间: 2012-4-3 10:46
In a two-currency world, the international capital asset pricing model expresses expected returns as: A)
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E(R) = RF + (b × MRP) + (γLC × FCRPLC) + (γFC × FCRPFC). |
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B)
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E(R) = RF + (b × MRP) + (γFC × FCRPFC). |
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C)
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E(R) = RF + (γLC × FCRPLC) + (γFC × FCRPFC). |
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E(R) = RF + (b × MRP) + (γFC × FCRPFC).
The relevant risk is world market risk. An additional risk premium is added for the asset’s sensitivity to changes in the foreign currency.
作者: bapswarrior 时间: 2012-4-3 10:47
Which of the following statements related to the International Capital Asset Pricing Model (ICAPM) is least accurate? A)
| Expected return for any asset is a function of the U.S. Treasury rate, the world market risk premium, and the sensitivity of the asset to changes in all other foreign currencies. |
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B)
| Investors are concerned with nominal returns in their home currency. |
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C)
| All investors should hold some combination of their domestic risk-free asset and the world portfolio. |
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Expected return for any asset is a function of the investor’s domestic risk-free rate, the world market risk premium, and the sensitivity of the asset to changes in all other foreign currencies. Only if the investor is from the U.S. would he use the U.S. Treasury security.
作者: bapswarrior 时间: 2012-4-3 10:47
A Japanese investor is valuing a Korean security. The risk-free rate is 2% in Japan and 3% in Korea. The world market risk premium is 6% and the securities sensitivity to the world market is 1.2. The security is sensitive to changes in the value of two foreign currencies: the Korean won and U.S. dollar. The foreign currency risk premium (SRP) for the won is 2% and the SRP for the U.S. dollar is 1%. The sensitivity to the won is estimated at 1 and the sensitivity to the dollar is estimated at 2. According to the international capital asset pricing model (ICAPM), what is the required return on the security?
In a two foreign currency world, the ICAPM becomes to: E(Ri) = R0 + Biw × RPw + γi1 × SRP1 + γi2 × SRP2. Substituting in the numbers from the problem, we get: E(Ri) = 2% + 1.2(6%) + (1)(2%) + 2(1%) = 13.2%. Remember to use the domestic risk-free rate
作者: bapswarrior 时间: 2012-4-3 10:49
Assume there is a German investor who is restricted to investing only in two currencies—the euro and the U.S. dollar.
The U.S. risk-free rate is 3% and the German risk-free rate is 4%.
The expected appreciation of the U.S. dollar is 2%.
The world portfolio risk premium is 8%.
The currency exposures based on euro returns and world betas for three portfolios are as follows:
| A | B | C |
World Beta | 1.2 | 1.4 | 0.8 |
Currency Exposure | 1.5 | 0.8 | 2.0 |
What is the foreign currency risk premium?
The domestic currency is the German euro. The interest rate differential between the two countries is 1% (Domestic – Foreign). The expected appreciation of the U.S. dollar is 2%. The SRP is +1% (expected appreciation − interest rate differential).
What is the expected return of each security to a German investor?
A German investor would use the German risk free rate of 4%. The world beta for each security is multiplied by the world risk premium. The currency exposure is multiplied by the euro risk premium of 1 (expected appreciation of 2% − the interest rate differential of 1%).E(RA) = 0.04 + (1.2 × 0.08) + (1.5 × 0.01) = 0.04 + 0.096 + 0.015 = 0.151
E(RB) = 0.04 + (1.4 × 0.08) + (0.8 × 0.01) = 0.04 + 0.112 + 0.008 = 0.160
E(RC) = 0.04 + (0.8 × 0.08) + (2.0 × 0.01) = 0.04 + 0.064 + 0.020 = 0.124
Which of the following statements regarding the International Capital Asset Pricing Model (ICAPM) is least accurate? The ICAPM: A)
| can be applied to any financial market. |
|
B)
| assumes risk is priced similarly in all markets. |
|
C)
| is very similar to the domestic CAPM in form, except for an adjustment for currency risk exposure. |
|
The ICAPM applies only in a world with integrated capital markets and therefore cannot be applied to simply any financial market. If markets are segmented, risk may not be priced similarly in all markets and the ICAPM will not be applicable. The ICAPM is very similar to the domestic CAPM in form and application--the only difference is an adjustment for currency risk exposure.
作者: bapswarrior 时间: 2012-4-3 10:49
ong Lee, CFA, is a money manager for a small firm in Seoul. All of Lee’s clients are local. He is considering adding the stock of a U.S. firm, Stockco, to some of his client’s portfolios. Stockco sensitivity to the world index is 0.8 and the risk premium on the index is 6%. The risk-free rate is 3% in the U.S. and 5% in Korea. Stockco is only sensitive to changes in the value of the U.S. dollar. Lee has measured the sensitivity of Stockco to changes in the value of the U.S. dollar to be 1.2. The foreign currency risk premium on the U.S. dollar is 2%. Assuming that Lee uses the international capital asset pricing model (ICAPM), what is the required return on Stockco?
In a single foreign currency world, the ICAPM simplifies to: E(Ri) = R0 + Biw × RPw + γi1 × FCRP1. Substituting in the numbers from the problem, we get: E(Ri) = 5% + 0.8 × (6%) + 1.2 × (2%) = 12.2%. Remember to use the domestic risk-free rate.
作者: bapswarrior 时间: 2012-4-3 10:50
Lee Okazaki is a Japanese investor who is considering investing in the United States equity and bond market. The world risk premium is 5%. The risk-free rate is 2% in Japan and 3.5% in the U.S. The current exchange rate is 120 yen/$ and the ratio of the price levels of Japan to U.S. consumption baskets is expected to be 120 to 1 in one year. The 1-year interest rate in Japan is 2.5% and the one-year rate is 4% in the U.S. The expected inflation rate in the U.S. is 2% and in Japan the expected inflation rate is 1%.Okazaki is considering buying common stock in a U.S. firm that has a world beta of 1.1 and an estimated sensitivity of yen-denominated returns to changes in the U.S. dollar of 0.7. What is the required return for this investment?
The International Capital Asset Pricing Model (ICAPM) for a two world currency is:E(R) = Rf + βgMRPg + γ$(FCRP$).
Rf is the domestic risk free rate, in this example Japan. βg is the World beta. MRPg is the world market risk premium. γ$ is the domestic currency sensitivity. Foreign currency risk premium (FCRP) is the foreign currency risk premium calculated by taking the expected appreciation minus the interest rate differential. Note the first part of this is the expected appreciation of the exchange rate. Using relative purchasing power parity (PPP) the expected spot rate is 120 × (1.01 / 1.02) = 118.8. The exchange rate is currently 120yen/$, and a year from now it will be 118.8 yen/$.
FCRP = [E(S1) − S0] / S0 – (rDC − rFC) = [(118.8 – 120) / 120] – (0.02 − 0.035) = 0.005
E(R) = 0.02 + 1.1(0.05) + 0.7(0.005) = 0.02 + 0.055 + 0.0035 = 0.0785
Okazaki is also considering the purchase of a United States one-year bond. If the real exchange rate remains constant over the next period, what is Okazaki’s expected return over the next year on the U.S. one-year bond?
As long as the real rate remains constant, the expected return on the bond is equal to the U.S. (foreign) interest rate of 4% plus the inflation differential of –1% (inflation in domestic − inflation in U.S.). The expected return to Okazaki is 3% (= 4% −1%).
What will the return be for Okazaki on the 1-year bond if the end-of-period exchange rate is 110:1 instead of the beginning-of-period exchange rate of 120:1?
This indicates that the yen has appreciated over the time period and the real rate has changed. The dollar has depreciated compared to the yen over the time period. The depreciation is (110 / 1) / (120 / 1) − 1 = 0.9167 − 1 = –8.33%. The return to Okazaki is foreign interest rate plus the currency appreciation (in this example, depreciation) = 4% – 8.33% = –4.33%
作者: bapswarrior 时间: 2012-4-3 10:50
Jaro Sumzinski, who lives in Poland, is applying the international capital asset pricing model (ICAPM) to determine the value of a German security. The German currency (Euro) has a risk premium of 1% and the security has a local currency sensitivity of 0.5. The risk-free rate in Poland is 8% and the risk-free rate in Germany is 4%. The world market risk premium is 7% and the securities sensitivity to the world market is 2. What is the required return of the security?
In a single foreign currency world, the ICAPM simplifies to: E(Ri) = R0 + Biw × RPw + γi1 × SRP1. Substituting in the numbers from the problem, we get: E(Ri) = 8% + 2(7%) + (1 + 0.5)(1%) = 23.5%. Remember to use the domestic risk-free rate.
作者: bapswarrior 时间: 2012-4-3 10:52
Paul Wilkes, a U.S. investor, is interested in investing in securities in the Caribbean country of Grenada. He is convinced that current market conditions make the securities of Grenada very attractive relative to those securities of other countries. Wilkes’ current portfolio is composed entirely of domestic securities, with an allocation of 60% equity and 40% fixed income. Wilkes has little experience in global investing, but has decided that the timing is right to invest at least 10% of his portfolio in foreign assets. Wilkes is particularly attracted to the high rate of return attainable in the Grenada market, but first needs to determine if the additional risk outweighs the return.
After carefully developing his investment criteria and researching the financial markets of Grenada, Wilkes has narrowed his potential investments down to one choice. The secondary markets for equities issued in Grenada are more illiquid than Wilkes had previously thought. This lack of liquidity in the equities market leads Wilkes to determine that equities would be an inappropriate investment for his portfolio. However, bonds issued by the government of Grenada seem to have a history of good liquidity as well as steady returns, both of which are qualities Wilkes is seeking for his portfolio. Wilkes must now use various methods to determine expected returns for these bonds, given a one-year time horizon, expected changes in the U.S./Grenada exchange rates, and inflation rates. Wilkes also must consider the foreign currency risk premium of the issue, and decide if it is appropriate given the additional exposure.
The currency of Grenada is the Eastern Caribbean Dollar (ECD). The current exchange rate is 2.50 USD/ECD. The ratio of the price levels of American goods to Grenadian goods is also 2.50. Inflation in the U.S. is expected to be 2% and 3% in Grenada. The end-of-year expected spot exchange rate is 2.75 USD/ECD. The one-year U.S. (risk free) interest rate is 4%, and in Grenada it is 8%.
Also assume that these two currencies are the only ones that exist. The world portfolio risk premium is 6%. The security Wilkes is interested in is a government issue that has a world beta of 1.25 and currency exposure of 0.80.What is the beginning of period real exchange rate and the end of period real rate, respectively?
Beginning of period real exchange rate:
X0 = S × PF / PD = (2.5USD/ECD)(1.0PGrenada / 2.50PUS) = 1.0 USD/ECD
End of period real exchange rate:
X1 = (2.75 USD/ECD)(1.03PGrenada / 2.55PUS) = 1.11 USD/ECD
PGrenada = 1 × 1.03 = 1.03
PUS = 2.50 × 1.02 = 2.55
(Study Session 18, LOS 62.g)
Has there been a change in the real exchange rate? A)
|
No, inflation remained constant. |
|
B)
|
Yes, purchasing power has changed. |
|
C)
|
No, the inflation differential compensated for the change in the spot rate. |
|
The real exchange rate was 1.00 at the beginning of the period, and at the end it is 1.11. (Study Session 18, LOS 62.g)
For this question, assume the real exchange rate is expected to be constant. What is the expected exchange rate?
If the real rate remains constant, the change in the exchange rate will be the inflation differential. Since the differential is 1%, we would expect to see the ECD depreciate by 1% against the dollar. Hence, the expected exchange rate is = 2.50USD/ECD / (1.01) = 2.475USD/ECD. (Study Session 18, LOS 62.f)
For this question, assume the real exchange rate is expected to be constant. If the U.S. investor wants to buy a bond in Grenada, what would be the approximate expected return of this bond?
The return on the bond should be approximately equal to the foreign interest rate minus the depreciation of the foreign currency = 8% + (–1%) = 7%. (Study Session 18, LOS 62.f)
What is the foreign currency risk premium (SRP)?
SRP = (E(S1) − S0) / S0 − (rDC − rFC)
The expected foreign currency appreciation is = (2.75 − 2.50) / (2.50) = 0.10.
The SRP is the expected foreign currency appreciation minus the interest rate differential:
| SRP | = 10% − (4% − 8%) |
| = 10% + 4% |
| = 14.0% |
(Study Session 18, LOS 62.h)
Using the international CAPM (ICAPM), what is the approximate expected return on this security?
The ICAPM in this case would be:
E(Ri) = Rf + (βg × MRPg) + (γiECD × FCRPiECD)
The ECD risk premium is:FCRPECD | = (E (S1) − S0) / S0 − (rDC − rFC) |
| = 10% − (4% − 8%) |
| = 10% + 4% |
| = 14.0% |
Substituting in values, we get:E(Ri) | = 0.04 + (1.25 × 0.06) + (0.80 × 0.14) |
| = 0.04 + 0.075 + 0.112 |
| = 0.2270 or 22.70% |
(Study Session 18, LOS 62.j)
作者: bapswarrior 时间: 2012-4-3 10:53
Suppose world markets are fully segmented. What will be the effect of segmentation of the international capital asset pricing model (ICAPM)? Risk will be priced: A)
| differently in each national market and the ICAPM will be valid. |
|
B)
| similarly in each national market and the ICAPM breaks down. |
|
C)
| differently in each national market and the ICAPM breaks down. |
|
Segmentation means that risk will be priced differently in each national market, hence the ICAPM, which assumes uniform risk pricing, breaks down.
作者: bapswarrior 时间: 2012-4-3 10:53
For the international capital asset pricing model (ICAPM), which of the following statements regarding the integration of national markets is most accurate? If international markets are: A)
| integrated, there is no need for the ICAPM. |
|
B)
| integrated, the ICAPM breaks down. |
|
C)
| segmented, the ICAPM breaks down. |
|
For the ICAPM to be valid, international markets must be integrated. If markets are segmented, risk will be priced differently in different national markets so the world risk premium will not be a robust comparison measure.
作者: bapswarrior 时间: 2012-4-3 10:53
If international markets are integrated, which of the following statements is least accurate? A)
| The international risk-free rate will be the appropriate base rate for asset pricing. |
|
B)
| Risk will be priced similarly in all markets. |
|
C)
| The international capital asset pricing model will be valid. |
|
There is no such thing as an “international risk-free rate,” hence it cannot be used in asset pricing. In broad terms, both remaining answers will be correct in the presence of well-integrated world markets.
作者: bapswarrior 时间: 2012-4-3 10:54
Paul McCormack is a U.S. investor interested in valuing a Japanese security. Which of the following regression equations would be useful to McCormack in assessing the currency exposure of the Japanese security to changes in the dollar/yen exchange rate? A)
| Local currency return = α + β (world market return). |
|
B)
| Domestic currency return = α + β (exchange rate movement). |
|
C)
| Domestic currency return = α + β (world market return). |
|
To assess currency exposure, regress domestic currency returns against exchange rate movements [Domestic currency return = α + β (exchange rate movement)]. In this formulation, β would be an estimate of the currency exposure and would likely be called γ if used in the international capital asset pricing model.
作者: bapswarrior 时间: 2012-4-3 10:54
A French investor holds a U.K. security. The investor has estimated the currency exposure in local currency terms to be 1.3. What is the currency exposure in domestic currency terms?
The investor estimated γFC = 1.3. To translate local (or FC) exposure to domestic currency exposure, we use: γ = γFC + 1. Hence, the domestic currency exposure is: γ = γFC + 1 = 1.3 + 1 = 2.3.
作者: bapswarrior 时间: 2012-4-3 10:54
Suppose that a U.K. investor holds a U.S. security. The U.S. security has a negative correlation with changes in the value of the U.S. dollar in local currency terms. What does the negative correlation mean for the U.K. investor? The: A)
| security exaggerates the impact of currency movements. |
|
B)
| domestic currency γ is greater than one. |
|
C)
| security provides a natural hedge against currency movements. |
|
A negative correlation means that as the value of the dollar falls (depreciates) the value of the security rises. Hence, the security provides a natural hedge against exchange rate movements to the U.K. investor. If the correlation is negative, the local currency γ will be less than zero.
作者: bapswarrior 时间: 2012-4-3 10:55
Suppose the value of the euro depreciates by 5 percent in real terms. Of the following firms, which will most likely be hurt by the change in the euro? (The euro is used as the official currency in France and the pound is used in the U.K.) A: A)
| U.K. firm that imports food from French suppliers. |
|
B)
| French firm that exports food to U.K. distributors. |
|
C)
| French firm that imports and resells computers in France. |
|
The firm that imports and resells goods in France, which
作者: bapswarrior 时间: 2012-4-3 10:55
Suppose an analyst is assessing the currency exposure of a French firm that imports bicycles from the U.K. If the value of the British pound appreciates, will the French firm’s cost structure improve or deteriorate? Why? A)
| Deteriorate, because the French cost of imported bicycles will go down. |
|
B)
| Improve, because the French cost of imported bicycles will go down. |
|
C)
| Deteriorate, because the French cost of imported bicycles will go up. |
|
If the pound appreciates, then bicycles imported from the U.K will be more expensive in France. Hence, the cost structure of the French bicycle importer will deteriorate.
作者: bapswarrior 时间: 2012-4-3 10:56
Consider a Canadian firm that exports hockey sticks to the U.S. Prices are set and collected in U.S. dollars. The inflation differential between Canada and the U.S. is 2% (Canadian inflation minus U.S. inflation). What is the valuation impact on the Canadian exporter if the value of the Canadian dollar falls by 2% during the next year? A)
| The firm is helped by the falling value of the Canadian dollar. |
|
B)
| The firm is hurt by the falling value of the Canadian dollar. |
|
C)
| All currency changes are nominal, so the change has no real impact. |
|
The change in the valuation of the currency is fully explained by the inflation differential. Hence, there should be no impact on the valuation of the firm in real terms
作者: bapswarrior 时间: 2012-4-3 10:56
Suppose you are an investor that holds foreign bonds. What does it mean if bonds have positive currency exposure to the foreign currency? A)
| The exposure is always a return enhance attribute of the foreign bond. |
|
B)
| As interest rates go up, the value of the foreign currency increases. |
|
C)
| As interest rates go up, the value of the foreign currency falls. |
|
Positive exposure implies that interest rate changes and currency valuation changes amplify the impact of each other. That is, as local rates increase (bad for bond investors) the value of the local currency tends to fall (bad for foreign bond investors).
作者: bapswarrior 时间: 2012-4-3 10:57
Sally Metford, CFA, has just accepted a position working for the Canadian government. As an economic advisor, Metford has been asked to comment on the implications of changes in domestic currency, government policy, and inflation expectations.According to money demand theory, an increase in economic activity in Canada will most likely lead to a(n): A)
| increase in demand for Canadian dollars causing a depreciation in Canadian currency. |
|
B)
| increase in demand for Canadian dollars causing an appreciation in Canadian currency. |
|
C)
| decrease in demand for Canadian dollars causing a depreciation in Canadian currency. |
|
According to money demand theory, an increase in economic activity in Canada will most likely lead to an increase in demand for Canadian dollars causing an appreciation in Canadian currency. Therefore, the money demand model explains the positive short-run correlation between exchange rate movements and stock returns.
Metford’s supervisor has asked for recommendations regarding interest rate policies. The Canadian government is concerned that the value of the Canadian dollar has approached the upper target range. Assuming the Canadian government introduces a “leaning-against-the-wind” policy, the Canadian government will most likely: A)
| induce negative currency exposure. |
|
|
|
A strong domestic currency will lead local governments to ease interest rates. This is often referred to as a “leaning-against-the-wind” policy that induces positive currency exposure.
Which of the following are most likely to occur if the Canadian real rate of interest increases? There will be a(n): A)
| a positive currency exposure from bond investors. |
|
B)
| capital flow out of Canada. |
|
C)
| increased demand for Canadian currency from abroad. |
|
An increase in the Canadian real rate of interest will cause capital to flow into Canada from foreign investors. This increased demand for Canadian dollars causes an increase in the value of the Canadian dollar. This in turn will create negative currency exposure for bond investors.
作者: bapswarrior 时间: 2012-4-3 10:57
What is the likely long-term impact of real depreciation of a nation’s currency? A)
| Decreased standard of living. |
|
B)
| Increased competitiveness of domestic industry. |
|
C)
| Increased budget deficits. |
|
In the long run, real depreciation makes a nation’s domestic industry more competitive in the international marketplace.
作者: bapswarrior 时间: 2012-4-3 10:58
Assume that a country has a negative trade balance. In the traditional model of the impact of currency appreciation on domestic economic activities, what is the likely short-run impact of currency depreciation? A)
| The cost of imports increases widening the trade balance. |
|
B)
| Domestic industry becomes more competitive narrowing the trade balance. |
|
C)
| The cost of imports decreases narrowing the trade balance. |
|
In the short run, if a country’s currency depreciates in real terms, the cost of imports increases causing a widening in the trade balance (exports – imports) and an increase in domestic inflation. Currency depreciation tends to reduce economic activity in the short run.
作者: bapswarrior 时间: 2012-4-3 10:58
According to the traditional model, a decline in the value of a country’s currency has what effect upon national competitiveness in the long run and domestic inflation in the short run? |
|
C)
| Only one will increase. |
|
Under the traditional model, a decline in the value of a country’s currency increases national competitiveness in the long run and increases domestic inflation in the short run. This will occur due to an increase in exports for the country whose currency is less valuable. In the short run the cost of imports increases for the country with the decline in currency value.
作者: bapswarrior 时间: 2012-4-3 10:58
Suppose a nation’s monetary authority increases real interest rates. What does economic theory tell us will happen to the value of the nation’s currency? A)
| Changes in the nominal rate, not the real rate, cause appreciation. |
|
B)
| The value of the currency will fall. |
|
C)
| The value of the currency will rise. |
|
If the monetary authority (e.g., the central bank) increases real rates, capital will flow into the country. The increased demand for the nation's currency will cause the currency to appreciate
作者: bapswarrior 时间: 2012-4-3 10:59
In the money demand model, what is the relationship between appreciation in the domestic currency and the equity markets? Currency appreciation: A)
| is negatively correlated with equity returns. |
|
B)
| hurts competitiveness and stock market returns. |
|
C)
| is positively correlated with equity returns. |
|
In the money demand model, an increase in real economic activity leads to an increase in the demand for the domestic currency. The increased currency demand causes the value of the currency to appreciate. Because stock prices are highly correlated with gross domestic product growth, the money demand model explains the positive short-run correlation between exchange rate movements and stock returns.
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