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发表于 2012-3-24 10:48
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While in the managerial training program for a large multinational financial services corporation, Galaxi, Inc. (Galaxi), Daniel Waite is assigned to a one-year rotation in the Mediterranean division. Upon arriving at his assignment, Waite purchases a local (foreign currency) bond with an annual coupon of 8.5% for 96.5.
One of Waite’s clients asks him to create a concentrated, two asset portfolio consisting of one European stock and one U.S. stock. Pertinent information on the two stocks and the portfolio is given below: - Expected return of the U.S. stock = 10% with a standard deviation of 23%
- Expected return of the European stock = 12% with a standard deviation of 37%
- Correlation between the two stocks = 0.60
- Weight of the U.S. stock in the portfolio = 70%
- Weight of the European stock in the portfolio = 30%
After completing his training program in the Mediterranean division, it is now time to return to the U.S. Waite sells the bond he purchased when he arrived (a one year holding period) for 98.0. Waite is pleased with his return, which he calculates at 10.4%.
On the plane ride home, Waite sits next to his co-worker, Penny King. Waite and King naturally begin to chat about their experience abroad. King brings up the depressed economic conditions in the Mediterranean and the negative returns she experienced on her local bond investments. She states that her total dollar return on an 8.0% annual coupon bond purchased at the same time as Waite's for 95.0 and sold for 98.0 (at the same time as Waite's) was a disappointing negative 10.74%.
Waite and King turn their discussion to international investing in general. They agree that, despite the increased integration of world markets, investors can benefit from global investing.
“Equity market correlations continue to be low due to a number of factors”, comments King. “There are so many differences in cultural mores, technology, government regulations, and monetary policy that most national economies still move independently of one another. International diversification works.”
“I don’t think that’s entirely true” responds Waite. “If you look at countries like the G-7, with similar government regulations, fiscal philosophies, and monetary policies, then there really isn’t much diversification effect. The correlations aren’t low enough. You have to be quite selective about which foreign markets you get into. Then diversification can really pay off.”
At their layover stop in London, Waite and King unexpectedly meet another colleague from work, Miko Katori. Katori just completed a two year term in Galaxi’s Tokyo office and has been assigned to London. At lunch Katori tells King and Waite about some of the assignments she worked on during the past two years. She is particularly excited about her personal research. “I did a fascinating study using twenty years of bond data and discovered that the correlations between international bond markets can be lower than the correlation between international stock markets. From this I concluded that adding international bonds to a portfolio will reduce risk but not increase return due to the lower returns on bonds compared to equities”Assume that King’s calculation is correct and that Waite made a calculation error. Which of the following is closest to Waite’s actual total dollar return?
Waite forgot to take into account the impact of the percentage change in the dollar value of the foreign currency. Using the information provided by King, we can determine the percentage change in the value of the foreign currency and then calculate Waite's total dollar return. Use the formula for total dollar return:
This may be calculated as:
R$ = RLC + S + RLCSwhere:
| R$ | = Return on foreign asset in U.S. dollar terms | | RLC | = Return on foreign asset in local currency terms | | S | = Percentage change in foreign currency |
Return on King’s bond = (8.0 + 98.0 – 95.0) / 95.0 = 0.115789
Solving for S we get:| R$ King | = 0.115789 + S + 0.115789S | | -0.1074 | = 0.115789 + 1.115789S | | -0.22319 | = 1.115789S |
S = -0.20 or 20.0% depreciation of the foreign currency.
Now, Waite’s total dollar return can be computed.
Return on Waite’s bond in the local currency = (8.5 + 98.0 - 96.5) / 96.5 = 0.103627
R$ Waite = 0.103627 – 0.20 + (.1036)(-0.20)
= 0.103627 - 0.20 - 0.02072 = -0.117 or -11.7%
(Study Session 8, LOS 22.b)
Regarding the statements by Waite and King on the topic of international investing:
Even among countries with similar government regulations, fiscal policies, and monetary policies, such as the G-7 countries, the correlations can be sufficiently low to offer diversification opportunities. (Study Session 8, LOS 22.a)
With respect to Katori’s research, critique her statements regarding her conclusions regarding international bonds in a portfolio context with respect to lower correlations and lower returns.
International bond market correlations can be lower than international equity markets due to differing government fiscal and monetary policies. Thus adding international bonds to a global portfolio offers opportunities for lower risk and higher return. (Study Session 8, LOS 22.a)
Which of the following is NOT a common method used to limit the extent of foreign influence in an emerging market? A)
| Restricting or limiting foreign ownership of stocks in sensitive industries such as banking or defense. |
| B)
| Discriminatory taxes being applied to foreign investors. |
| C)
| Limiting ownership to private investors. |
|
In an attempt to keep capital in their countries, many governments of developing economies place restrictions on the repatriation of capital and profits. Other methods that a developing country may use to maintain control of its market include: - Blocking or limiting foreign ownership of stock in sensitive industries such as banking and defense.
- Discriminatory taxes are sometimes applied to foreign investors.
- Limiting foreign investment to authorized investors which are usually institutional investors.
- Restricting foreign ownership in a corporation to a minority of outstanding shares.
(Study Session 8, LOS 22.j)
What is the standard deviation and expected return of the two-stock portfolio?
| Standard Deviation | Expected Return |
σ2port = w2u.s.σ2u.s. + w2eσ2e + 2wu.s.weσu.s.σe ρu.s.,e
σ2port = (0.7)2(0.23)2 + (0.3)2(0.37)2 + (2)(0.7)(0.3)(0.23)(0.37)(0.6)
σ2port = 0.0596872
σ= √σ2port = √0.0596872 = 0.2443096 = 24.431%
Expect return = wu.s.E(Ru.s.) + weE(Re)
= (0.7)(0.10) + (0.3)(0.12) = 10.6%
(Study Session 8, LOS 22.j)
Which of the following statements about the benefits and risks of international diversification is CORRECT? A)
| The benefits of international diversification as demonstrated by mean-variance analysis could be overstated if return distributions are leptokurtic. |
| B)
| One of the primary arguments in favor of international diversification is that global markets are becoming integrated and the mobility of capital has increased. |
| C)
| Increased correlations calculated during periods of rising volatility are indicative that the true correlation of returns between markets is changing. |
|
Having a leptokurtic distribution means that the probability of large positive and large negative returns is greater than under a normal distribution. If large negative events occur more frequently than assumed by mean-variance analysis, the case for global diversification is weakened. One of the primary arguments against international diversification is that global markets are becoming integrated and the mobility of capital has increased. The problem with estimating correlation during periods of rising volatility is that the correlation will be biased upwards when in fact it has not changed. Therefore, an argument against international diversification may not be valid if it relies on correlations calculated during volatile periods. (Study Session 8, LOS 22.g) |
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