LOS b: Distinguish between the asset return and currency return for an international security.

Q1. Which of the following with respect to correlations of international security markets is FALSE?

A)   Greater capital mobility leads to increased correlations.

B)   Trade agreements lead to increased correlations.

C)   Low correlations have been especially valuable to the international investor during times of crisis.

Q2. Which of the following statements regarding foreign currency risk is FALSE? Foreign currency risk:

A)   is about twice that of foreign bond risk.

B)   is about twice that of foreign stock risk.

C)   is often diversified away in a portfolio of foreign assets.

Q3. The following data applies to a foreign stock investment:

• The gain on the stock in foreign currency terms was 22%.
• The foreign currency has appreciated by 7%.
• The standard deviation of stock returns was 38% and the standard deviation of the foreign currency was 24%.
• The correlation between the stock returns and the currency is 0.10.

What is the contribution of currency risk?

A)   8.93%.

B)   46.93%.

C)   22.02%.

Q4. A U.S. investor holds assets denominated in British pounds. A 10% increase in the value of the assets in pounds and a 5% increase in the $/? exchange rate will lead to what total return to the U.S. investor in terms of dollars?

A)   15.5%.

B)   4.5%.

C)   5.5%.

Q5. A French investor earned a 12% return, in terms of Euros, on an investment in dollar assets in the U.S. If the return on the investment in dollars was 6%, then the change in the exchange rate:

A)   must have been greater than 6%.

B)   must have been less than 6%.

C)   must have been equal to 6%.

Q6. A British investor holds assets denominated in euros. A 5% decrease in the value of the assets in euros and a 5% increase in the ?/

LOS b: Distinguish between the asset return and currency return for an international security. fficeffice" />

Q1. Which of the following with respect to correlations of international security markets is FALSE?

A)   Greater capital mobility leads to increased correlations.

B)   Trade agreements lead to increased correlations.

C)   Low correlations have been especially valuable to the international investor during times of crisis.

Correct answer is C)

During times of crisis, international correlations are usually higher, and offer the investor less diversification benefit. Trade agreements and increased capital mobility increase correlations as capital flows across borders.

Q2. Which of the following statements regarding foreign currency risk is FALSE? Foreign currency risk:

A)   is about twice that of foreign bond risk.

B)   is about twice that of foreign stock risk.

C)   is often diversified away in a portfolio of foreign assets.

Correct answer is B)

Foreign currency risk is only about half that of foreign stock risk on average. It is about twice that of foreign bond risk however. Much of it can be diversified away in a portfolio of currencies.

Q3. The following data applies to a foreign stock investment:

• The gain on the stock in foreign currency terms was 22%.
• The foreign currency has appreciated by 7%.
• The standard deviation of stock returns was 38% and the standard deviation of the foreign currency was 24%.
• The correlation between the stock returns and the currency is 0.10.

What is the contribution of currency risk?

A)   8.93%.

B)   46.93%.

C)   22.02%.

Correct answer is A)

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 = 0.38² + 0.24² + 2(0.38)(0.24)(0.1) = 0.2202

σ_$ = √0.2202 = 0.4693 = 46.93%

Contribution of Currency = 46.93% - 38.00% = 8.93%

Q4. A ffice:smarttags" />U.S. investor holds assets denominated in British pounds. A 10% increase in the value of the assets in pounds and a 5% increase in the $/? exchange rate will lead to what total return to the U.S. investor in terms of dollars?

A)   15.5%.

B)   4.5%.

C)   5.5%.

Correct answer is A)

Since the $/? exchange rate increased, the value of the pound assets increased with respect to dollars. The total return is 0.10 + 0.05 + (0.05)(0.10) = 0.155 or 15.5%.

Q5. A French investor earned a 12% return, in terms of Euros, on an investment in dollar assets in the U.S. If the return on the investment in dollars was 6%, then the change in the exchange rate:

A)   must have been greater than 6%.

B)   must have been less than 6%.

C)   must have been equal to 6%.

Correct answer is B)

The equation for total return in euros = ($ return) + (change in exchange rate) + ($ return)(change in exchange rate).

Thus,
0.12 = 0.06 + (change in exchange rate) + (0.06)(change in exchange rate),
0.12 - 0.06 = (change in exchange rate) + (0.06)(change in exchange rate)
0.06 = (1.06)(change in exchange rate)
0.06/1.06 = change in exchange rate = 0.0566 or 5.66% < 6%.

Q6. A British investor holds assets denominated in euros. A 5% decrease in the value of the assets in euros and a 5% increase in the ?/

thanks.