1.Which of the following statements related to the International Capital Asset Pricing Model (ICAPM) is least accurate?

A)   Investors are concerned with nominal returns in their home currency.

B)   The foreign currency risk premium (FCRP) is equal to the expected percentage exchange rate change minus the interest differential.

C)   All investors should hold some combination of their domestic risk-free asset and the world portfolio.

D)   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.

2.Suppose the assumptions underlying the extended capital asset pricing model (CAPM) hold. Which of the following would be TRUE in an extended CAPM world?

A)   Exchange rate changes would mirror inflation differences.

B)   Exchange rate changes could be perfectly hedged in the forward market.

C)   All investors would hold the same "uniform risk-free asset."

D)   Market risk would be measured against an investor's domestic market portfolio.

3.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.

B)   All foreign currency risk premia sum to zero.

C)   Exchange rate risk is perfectly hedged.

D)   Purchasing power parity holds at all times.

4.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:

A)   domestic CAPM.

B)   ICAPM.

C)   extended CAPM.

D)   international CAPM.

5.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.

B)   exactly at any point in time.

C)   approximately over extended periods of time.

D)   approximately from time to time.

6.Which of the following assumptions is needed to justify the extended capital asset pricing model (CAPM)? Investors throughout the world have:

A)   nearly-identical consumption baskets.

B)   similar consumption baskets.

C)   disparate consumption baskets.

D)   identical consumption baskets.

7.Which of the following assumptions is NOT needed to justify the extended capital asset pricing model?

A)   Investors throughout the world have identical consumption baskets.

B)   Purchasing power parity holds exactly at any point in time.

C)   World markets are integrated (i.e. no segmentation).

D)   The rate of inflation must be identical throughout the world.

1.Which of the following statements related to the International Capital Asset Pricing Model (ICAPM) is least accurate?

A)   Investors are concerned with nominal returns in their home currency.

B)   The foreign currency risk premium (FCRP) is equal to the expected percentage exchange rate change minus the interest differential.

C)   All investors should hold some combination of their domestic risk-free asset and the world portfolio.

D)   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.

The correct answer was D)

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.

2.Suppose the assumptions underlying the extended capital asset pricing model (CAPM) hold. Which of the following would be TRUE in an extended CAPM world?

A)   Exchange rate changes would mirror inflation differences.

B)   Exchange rate changes could be perfectly hedged in the forward market.

C)   All investors would hold the same "uniform risk-free asset."

D)   Market risk would be measured against an investor's domestic market portfolio.

The correct answer was A)

If the extended CAPM assumptions hold, the exchange rate changes would be purely a function of inflation differences.

3.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.

B)   All foreign currency risk premia sum to zero.

C)   Exchange rate risk is perfectly hedged.

D)   Purchasing power parity holds at all times.

The correct answer was D)

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.

4.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:

A)   domestic CAPM.

B)   ICAPM.

C)   extended CAPM.

D)   international CAPM.

The correct answer was C)

When using the domestic CAPM in an international setting, the model is referred to as the extended CAPM.

5.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.

B)   exactly at any point in time.

C)   approximately over extended periods of time.

D)   approximately from time to time.

The correct answer was B)

The extended CAPM assumes that PPP holds exactly at any point in time.

6.Which of the following assumptions is needed to justify the extended capital asset pricing model (CAPM)? Investors throughout the world have:

A)   nearly-identical consumption baskets.

B)   similar consumption baskets.

C)   disparate consumption baskets.

D)   identical consumption baskets.

The correct answer was D)

Investors throughout the world need to have identical consumption baskets to justify the extended CAPM.

7.Which of the following assumptions is NOT needed to justify the extended capital asset pricing model?

A)   Investors throughout the world have identical consumption baskets.

B)   Purchasing power parity holds exactly at any point in time.

C)   World markets are integrated (i.e. no segmentation).

D)   The rate of inflation must be identical throughout the world.

The correct answer was D)

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.