LOS i: State the risk pricing relation and the formula for the international capital asset pricing model (ICAPM).

Q1. The international capital asset pricing model (ICAPM) expresses expected returns as:

A)   E(R) = (b × MRP) + (γ₁ × FCRP₁) + (γ₂ × FCRP₂) + … + (γ_k × FCRP_k).

B)   E(R) = R_F + (γ₁ × FCRP₁) + (γ₂ × FCRP₂) + … + (γ_k × FCRP_k).

C)   E(R) = R_F + (b × MRP) + (γ₁ × FCRP₁) + (γ₂ × FCRP₂) + … + (γ_k × FCRP_k).

Q2. In a two-currency world, the international capital asset pricing model expresses expected returns as:

A)   E(R) = R_F + (b × MRP) + (γ_LC × FCRP_LC) + (γ_FC × FCRP_FC).

B)   E(R) = R_F + (γ_LC × FCRP_LC) + (γ_FC × FCRP_FC).

C)   E(R) = R_F + (b × MRP) + (γ_FC × FCRP_FC).

Q3. Which of the following assumptions is needed to justify the international capital asset pricing model (ICAPM)? In the ICAPM, the risk-free rate is:

A)   LIBOR-based, and the market portfolio is the market capitalization weighted portfolio of all risky assets in the world.

B)   the investor’s domestic risk-free rate, and the market portfolio is the market capitalization weighted portfolio of all risky assets in the world.

C)   the investor’s domestic risk-free rate, and the market portfolio is the market capitalization weighted portfolio of all risky assets in the domestic market.

Q4. 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)   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.

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

LOS i: State the risk pricing relation and the formula for the international capital asset pricing model (ICAPM). fficeffice" />

Q1. The international capital asset pricing model (ICAPM) expresses expected returns as:

A)   E(R) = (b × MRP) + (γ₁ × FCRP₁) + (γ₂ × FCRP₂) + … + (γ_k × FCRP_k).

B)   E(R) = R_F + (γ₁ × FCRP₁) + (γ₂ × FCRP₂) + … + (γ_k × FCRP_k).

C)   E(R) = R_F + (b × MRP) + (γ₁ × FCRP₁) + (γ₂ × FCRP₂) + … + (γ_k × FCRP_k).

Correct answer is C)

Where:

E(R) = asset’s expected return

R_F = domestic currency risk-free rate

b_G = sensitivity of the asset i domestic currency returns to changes in the global market portfolio

MRP_G = world market risk premium [E(R_M) – R_F]

E(R_M) = expected return on world market portfolio

γ₁ to γ_k = sensitivities of asset’s domestic currency returns to changes in the value of currencies 1 through k

FCRP₁ to FCRP_k = foreign currency risk premiums on currencies 1 through k  

E(R) = R_F + (b × MRP) + (γ₁ × FCRP₁) + (γ₂ × FCRP₂) + … + (γ_k × FCRP_k).

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.

Q2. In a two-currency world, the international capital asset pricing model expresses expected returns as:

A)   E(R) = R_F + (b × MRP) + (γ_LC × FCRP_LC) + (γ_FC × FCRP_FC).

B)   E(R) = R_F + (γ_LC × FCRP_LC) + (γ_FC × FCRP_FC).

C)   E(R) = R_F + (b × MRP) + (γ_FC × FCRP_FC).

Correct answer is C)

E(R) = R_F + (b × MRP) + (γ_FC × FCRP_FC).

The relevant risk is world market risk. An additional risk premium is added for the asset’s sensitivity to changes in the foreign currency.

Q3. Which of the following assumptions is needed to justify the international capital asset pricing model (ICAPM)? In the ICAPM, the risk-free rate is:

A)   LIBOR-based, and the market portfolio is the market capitalization weighted portfolio of all risky assets in the world.

B)   the investor’s domestic risk-free rate, and the market portfolio is the market capitalization weighted portfolio of all risky assets in the world.

C)   the investor’s domestic risk-free rate, and the market portfolio is the market capitalization weighted portfolio of all risky assets in the domestic market.

Correct answer is B)

In the extended CAPM, the risk-free rate (R_F) is the investor’s domestic risk-free rate and the market portfolio is the market capitalization weighted portfolio of all risky assets in the world.

Q4. 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)   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.

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

Correct answer is B)

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 ffice:smarttags" />U.S. would he use the U.S. Treasury security.