Reading 45: The Case for Inter....Diversification－LOS e potential, benefits

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Session 17: Portfolio Management in a Global Context
Reading 45: The Case for International Diversification
LOS e: Evaluate the potential performance and risk-reduction benefits of adding bonds to a globally diversified stock portfolio.

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Adding international bonds to an international stock portfolio has the potential for:

A) lower returns for the same amount of risk.

B) higher returns but also higher risk.

C) lower returns but also higher risk.

D) higher returns for the same amount of risk.

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Answer and Explanation

Plotting the risk return profile for international portfolios, the portfolio that includes international bonds in addition to international stocks will have higher returns for a given amount of risk.

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Which of the following statements with respect to international bonds is TRUE? The correlations between international bond markets are:

A) quite low, but the returns to bonds are too low to warrant their inclusion in an international portfolio.

B) high, but the returns to bonds are sufficient to warrant their inclusion in an international portfolio.

C) often quite low, suggesting that international bonds should be a component of an international portfolio.

D) quite high and the returns to bonds are quite low, so bonds are not recommended for inclusion in an international portfolio.

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Answer and Explanation

The correlations between international bond markets are quite low and the inclusion of international bonds in an international portfolio will result in higher returns for a given amount of risk.

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Which of the following statements about an efficient frontier that adds international bonds to a portfolio of international equities is TRUE?

A) It will dominate a frontier that includes only international equities.

B) It will be dominated by a frontier that includes only international equities.

C) It will plot the lower right of a frontier that includes only international equities.

D) It is indistinguishable from the frontier that includes only international equities.

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Answer and Explanation

The frontier that includes international bonds will plot to the upper left of the frontier that includes only international equities because it offers a higher return for a given amount of risk, i.e. it dominates the frontier that includes international equities only.