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标题: Portfolio Management and Wealth Planning【Reading 22】 [打印本页]
作者: prashantsahni    时间: 2012-3-24 10:20     标题: [2012 L3] Portfolio Management and Wealth Planning【Session 8 - Reading 22】

Which of the following arguments makes the case for international diversification?
A)
The presence of increased Sharpe ratios with international investing.
B)
Correlations are said to have increased over time.
C)
Corporations are becoming more global in their orientation.


Higher Sharpe ratios imply a higher excess return per level of risk. If correlations have increased over time, then the risk reduction benefit of international diversification is curtailed. If corporations become more global, it would also imply higher correlations, thus diversifying across borders becomes a less effective method of decreasing portfolio risk.
作者: prashantsahni    时间: 2012-3-24 10:21

Which of the following would benefit an investor who is considering foreign markets?
A)
Depreciating foreign currencies.
B)
Withholding taxes on foreign investments.
C)
Lower correlations between international assets.


Lower correlations would result in reduced portfolio risk for the global investor. The other answer choices would actually be a detriment for an investor considering foreign markets. Foreign governments sometimes tax the interest and dividends earned by investors, thereby reducing investment return. A depreciating foreign currency would lower the dollar denominated return to a U.S. investor who invests globally.
作者: prashantsahni    时间: 2012-3-24 10:21

Which of the following is NOT a reason why investors should consider constructing global portfolios?
A)
Increasingly integrated global capital markets.
B)
Lower correlations between international assets.
C)
Appreciating foreign currencies.


Global diversification is attractive because foreign markets offer lower correlations and the opportunity for higher return. If the foreign currency appreciates, the domestic investor will also benefit. Increasingly integrated global capital markets would actually harm the investor because correlations would increase.
作者: prashantsahni    时间: 2012-3-24 10:21

A domestic stock has an expected return of 12% and a standard deviation of 18%. A foreign stock has an expected return of 25% and a standard deviation of 33%. An investor has 60% of the domestic stock in their portfolio and 40% in the foreign stock. If the correlation between the stocks is 0.70, what is the portfolio’s standard deviation?
A)
24.00%.
B)
22.15%.
C)
17.20%.


The standard deviation of the portfolio will be a function of the weights in the assets, their risk, and the correlation between them. It is calculated as:
作者: prashantsahni    时间: 2012-3-24 10:22

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 ₤/€ exchange rate will lead to what total return to the British investor in terms of pounds?
A)
0.00%.
B)
-0.25%.
C)
-0.50%.


-0.05 + 0.05 + (-0.05)(0.05) = -0.0025 or -0.25%.
作者: prashantsahni    时间: 2012-3-24 10:22

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 equal to 6%.
C)
must have been less than 6%.


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%.
作者: prashantsahni    时间: 2012-3-24 10:22

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)
4.5%.
B)
5.5%.
C)
15.5%.


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%.
作者: prashantsahni    时间: 2012-3-24 10:23

The following data applies to a foreign stock investment: What is the contribution of currency risk?
A)
46.93%.
B)
8.93%.
C)
22.02%.


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%
作者: kim226    时间: 2012-3-24 10:24

Which of the following statements regarding foreign currency risk is least accurate? 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.


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.
作者: kim226    时间: 2012-3-24 10:24

Which of the following with respect to correlations of international security markets is least accurate?
A)
Greater capital mobility leads to increased correlations.
B)
Low correlations have been especially valuable to the international investor during times of crisis.
C)
Trade agreements lead to increased correlations.


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.
作者: kim226    时间: 2012-3-24 10:24

Which of the following statements concerning currency risk is most accurate? Currency risk:
A)
slightly reduces the risk of foreign investments through diversification of the asset risk.
B)
slightly magnifies the risk of foreign investments.
C)
greatly magnifies the risk of foreign investments.


Currency risk only slightly magnifies the risk of foreign investments because it is only about half that of foreign stock risk on average and much of it can be diversified away in a portfolio of currencies. Also foreign currency risk and foreign asset risk are not additive due to correlations between them of less than one.
作者: kim226    时间: 2012-3-24 10:25

All of the following are reasons investors should consider constructing global portfolios EXCEPT:
A)
additional choice. Markets outside the U.S. represent more than 50% of available investment choices.
B)
non-U.S. securities often outperform U.S. securities.
C)
reduced foreign exchange risk. Spreading assets over multiple currencies dampens portfolio volatility.


Increased foreign exchange risk is the cost of going global. In terms of the home currency (which could be the USD or other currency) including assets denominated in foreign currencies can increase portfolio volatility. This is a particular concern when the foreign currencies depreciate against the home currency.
作者: kim226    时间: 2012-3-24 10:26

According to a study on bond returns during the period 1987-1996, the U.S. dollar generally weakened relative to the other countries in the study (specifically, Canada, Euro area, Japan and the U.K.). Which of the following statements regarding the impact of exchange rates on security returns is CORRECT?
A)
Exchange rates have little impact on returns.
B)
When the home currency is weakening, the investor should invest more in foreign bonds.
C)
When the home currency is weakening, the investor should invest less in foreign bonds.


When the home currency is weakening, the investor should invest more in foreign bonds. As the dollar weakens, a U.S. investor will earn a higher return on foreign investments because each foreign currency unit buys more dollars.
作者: kim226    时间: 2012-3-24 10:27

The following data applies to a foreign stock investment: What is the expected return of the portfolio?
A)
-18.72%.
B)
-18.00%.
C)
-17.28%.


To obtain the return in domestic currency terms use the following formula that considers the return in local currency terms as well as the exchange rate change:

-0.12 - 0.06 + (-0.12 × -0.06) = -0.1728 or -17.28%
作者: kim226    时间: 2012-3-24 10:27

The following data applies to a foreign stock investment: What is the risk of the portfolio in U.S. dollar terms as measured by the standard deviation?
A)
14.70%.
B)
38.34%.
C)
5.34%.


We will 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$2 = 0.332 + 0.142 + 2(0.33)(0.14)(0.2) = 0.1470
σ$ = √0.1470 = 0.3834 = 38.34%
作者: kim226    时间: 2012-3-24 10:27

The following data applies to a foreign stock investment: What is the contribution of currency risk?
A)
11.00%.
B)
37.72%.
C)
2.72%.


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$2 = 0.352 + 0.112 + 2(0.35)(0.11)(0.1) = 0.1423
σ$ = √0.1423 = 0.3772 = 37.72%
Contribution of Currency = 37.72% - 35.00% = 2.72%
作者: kim226    时间: 2012-3-24 10:29

Relative to the efficient frontier that includes only domestic investments, the efficient frontier that also includes foreign investments will plot to the:
A)
left and top.
B)
left and bottom.
C)
right and top.


If return is plotted on the y-axis and risk is plotted on the x-axis, the efficient frontier that includes foreign investments will plot to the left and top of the frontier that includes only domestic investments. This means that the global frontier has lower risk and greater return than the purely domestic efficient frontier.
作者: kim226    时间: 2012-3-24 10:29

Relative to the efficient frontier that includes only domestic investments, the efficient frontier that also includes foreign investments will have:
A)
higher return and higher risk.
B)
lower return and higher risk.
C)
higher return and lower risk.


Due to low correlations, the efficient frontier that adds foreign investments to a domestic only portfolio will have higher returns and lower risk over time.
作者: kim226    时间: 2012-3-24 10:30

Which of the following most accurately represents the relationship between the global efficient frontier and a domestic efficient frontier? The global efficient frontier will contain portfolios with:
A)
lower risk for a given return and higher return for a given risk level than portfolios on the domestic efficient frontier.
B)
lower risk for a given return and lower return for a given risk level than portfolios on the domestic efficient frontier.
C)
higher risk for a given return and higher return for a given risk level than portfolios on the domestic efficient frontier.


Due to the low to moderate correlations between global markets, the global efficient frontier will contain portfolios with lower risk for a given return and higher return for a given risk level than portfolios on the domestic efficient frontier.
作者: kim226    时间: 2012-3-24 10:30

Which of the following statements about an efficient frontier that adds international bonds to a portfolio of international equities is CORRECT? It will:
A)
plot the lower right of a frontier that includes only international equities.
B)
dominate a frontier that includes only international equities.
C)
be dominated by a frontier that includes only international equities.


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).
作者: kim226    时间: 2012-3-24 10:30

Which of the following statements with respect to international bonds is CORRECT? 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)
often quite low, suggesting that international bonds should be a component of an international portfolio.
C)
high, but the returns to bonds are sufficient to warrant their inclusion in an international portfolio.


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.
作者: kim226    时间: 2012-3-24 10:31

Adding international bonds to an international stock portfolio has the potential for:
A)
higher returns but also higher risk.
B)
lower returns for the same amount of risk.
C)
higher returns for the same amount of risk.


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.
作者: kim226    时间: 2012-3-24 10:32

Joe Murad, a U.S. investor, invested in foreign securities. The following data is available:Murad’s return on his foreign securities investment is:
A)
9.70%.
B)
9.00%.
C)
8.30%.


Use the following formula to compute the return in dollars:
R$ = RLC + S + (RLC)(S)
R$ = return on the foreign asset in U.S. dollar terms
RLC = return on the foreign asset in local currency terms
S = percentage change in the foreign currency
Return = 0.14 + (-0.05) + (0.14) (-0.05) = 8.30%


The risk of the portfolio in U.S. dollar terms as measured by its standard deviation is:
A)
34.35%.
B)
11.80%.
C)
36.75%.


The formula used below considers the risk of the asset in foreign currency terms, the risk of the foreign currency, and the correlation between the two:
σ2$ = σ2LC + σ2S + 2σLCσSρLC,S
where:
σ2$ = variance of the returns on the foreign asset in U.S. dollar terms
σ2LC, σLC = variance and standard deviation of the foreign asset in local currency terms
σ2S, σS = variance and standard deviation of foreign currency
ρLC,S = correlation between returns for the foreign asset in local currency terms and movements in the foreign currency.

Variance = (0.30)2 + (0.10)2 + 2(0.3)(0.1)(0.3) = 0.118
Standard deviation = √(0.118) = 34.35%


The contribution of currency risk to the risk of the portfolio is closest to:
A)
4.00%.
B)
4.35%.
C)
5.00%.


The contribution of the currency risk is the difference between the asset risk in domestic currency terms less the risk of the foreign asset in foreign currency terms.
Contribution of currency risk = σ$ - σLC
Contribution of currency risk = 34.35% - 30.00% = 4.35%
作者: kim226    时间: 2012-3-24 10:36

The following data applies to a foreign stock investment: What is the expected return of the portfolio?
A)
13.46%.
B)
30.54%.
C)
29.00%.



To obtain the return in domestic currency terms use the following formula that considers the return in local currency terms as well as the exchange rate change:

22% + 7% + (22% × 7%) = 30.54%
作者: kim226    时间: 2012-3-24 10:37

The following data applies to a foreign stock investment: What is the expected return of the portfolio?
A)
24.20%.
B)
7.00%.
C)
5.80%.

To obtain the return in domestic currency terms use the following formula that considers the return in local currency terms as well as the exchange rate change:
15% - 8% + (15% × - 8%) = 5.80%
作者: kim226    时间: 2012-3-24 10:37

Which of the following statements regarding international diversification is least accurate?
A)
Foreign currency risk will diversify the risk from domestic government monetary and fiscal policies.
B)
Foreign currency risk and foreign asset risk are not additive.
C)
A depreciating foreign currency benefits the international investor.


A depreciating foreign currency harms the international investor by resulting in a lower home currency return. Foreign currency risk and foreign asset risk are not additive because the correlations between them are usually quite low, and sometimes negative. Foreign currency risk also helps diversify domestic fiscal and monetary policies.
作者: kim226    时间: 2012-3-24 10:37

Which of the following best describes the properties of the correlation statistic? If a sample of returns is split in half, the high return half will have:
A)
higher correlations than the low return half. The true correlation is best measured by the whole sample correlation.
B)
lower correlations than the low return half. The true correlation is best measured by the whole sample correlation.
C)
higher correlations than the low return half. The true correlation is best measured by the low return half correlation.


If the sample of returns between two markets is split in half, the high return and higher volatility half will have a higher correlation than the low return half when in fact the true correlation is best measured by the whole sample correlation. This is due to the econometrics of the correlation measure and illustrates the pitfalls of estimating the correlation statistic during periods of increased market volatility. To determine whether markets really have increased their comovement during periods of increased volatility, the analyst should measure the dispersion (standard deviation) of country portfolios.
作者: kim226    时间: 2012-3-24 10:38

Due to estimation error, the analyst should be aware that estimating correlations during volatile periods results in:
A)
higher correlations.
B)
lower correlations.
C)
correlations that must be adjusted for serial correlation.


During periods of increased volatility, correlations will be estimated higher due to estimation error, even if correlations have not actually increased.
作者: kim226    时间: 2012-3-24 10:38

In order to estimate whether correlations have increased during volatile periods, the analyst should calculate the:
A)
autoregressive conditional heteroskedasticity.
B)
standard deviation of an international portfolio.
C)
correlation between markets.


During volatile periods, the correlation will appear to increase, even if it hasn’t, due to the econometrics of the correlation measure. The analyst should examine the standard deviation through time to see if it has increased.
作者: kim226    时间: 2012-3-24 10:38

Which of the following countries is most likely to offer the lowest correlation with other capital markets? A country with:
A)
few multinational corporations and low tariffs.
B)
many multinational corporations and low tariffs.
C)
few multinational corporations and high tariffs.


Countries with few multinational corporations and high tariffs will have segmented capital markets and will be less correlated with other country markets. The higher the proportion of multinational corporations and the more open the capital markets, the more integrated the capital market and the higher the correlation with other country markets.
作者: kim226    时间: 2012-3-24 10:39

Which of the following statements with respect to correlations of international security markets is CORRECT?
A)
The use of historical data will understate the current correlation among assets.
B)
The actions of international investors tend to create lower correlations.
C)
Lower correlations are likely in developed world markets.


The use of historical data will understate the current correlation because correlations have been increasing over time. Higher correlations are common in developed markets. The actions of international investors result in greater capital mobility and higher correlations.
作者: kim226    时间: 2012-3-24 10:40

John Lewis, CFA, and Charlene Birdstrom, CFA, have been called out of retirement by their former employer, Price Williams, Inc. (PWI), to conduct training seminars for newly hired employees in the PWI International Equity Investment Division. Lewis and Birdstrom were asked to take on this project because they each spent 20 years in the area of international equity investments prior to their retirement a few months ago.
During their initial planning meeting, Lewis asked Birdstrom what she thought were the most important issues currently facing international equity investors. Birdstrom commented that the argument against international diversification due to increasing correlations is sure to arise. She states, “The proponents of the argument say correlations have increased over time due to a number of factors, primarily increased free trade and capital mobility, the rise in the number of global corporations, and capital market integration.”
Lewis responds by telling Birdstrom, “I think that the correlations, even if they have increased, are still low enough to justify holding international investments. However, what’s really detrimental to the idea of international diversification is the fact that correlations among markets increase during periods of increased volatility, and then remain elevated. That’s problematic. Of course pessimists also point to specific country returns and argue that diversification is pointless when their chosen market has higher returns. That’s not a valid position as far as I’m concerned.”
Birdstrom thinks it is important to address emerging markets in their seminar. She developed the following exhibit to facilitate discussion:

Exhibit 1 – Emerging Markets Investing


One of the participants at the seminar, Jolee Cardoza, brings up the issue of individual security analysis for firms in emerging markets. She tells the group that she uses a relative value approach to stock valuation, and makes the following assertions about the advantages and disadvantages of using relative value multiples: With respect to his comments about the arguments against international diversification:
A)
both are correct.
B)
only one is correct.
C)
both are incorrect.


Lewis’ correlation statement is incorrect. The issue of the stability of correlations among international markets is still unresolved. Although correlations have risen over time, they also appear to increase when volatility increases. This phenomenon occurs due to the econometrics of the correlation measure. Volatility can mask the true correlation. Academic research has found that previously reported increases in correlations during volatile stock markets were manifestations of the volatility and not increases in the true correlations. Lewis’ country-specific comment is correct; just because a country has outperformed in the past does not mean it will continue to do so. No one country will always deliver the best performance. (Study Session 8, LOS 22.g)
Which of the items in Exhibit 1 is least accurate?
A)
Item 1.
B)
Item 2.
C)
Item 3.


Low correlations between markets reduce volatility, but do not directly affect the level of expected return. The inclusion of emerging markets should result in higher expected returns due to their higher expected economic growth, not because they have low correlations with developed markets. (Study Session 8, LOS 22.g)
Which of Cardoza’s assertions about using relative value multiples is least accurate?
A)
Assertion C.
B)
Assertion B.
C)
All of Cardoza’s assertions are true.


Although relative value multiples are easy to calculate, the fact that historical data is used is a disadvantage. Historical data may not be relevant to a company’s future growth prospects. (Study Session 8, LOS 22.g)
All of the following typify emerging market risks EXCEPT:
A)
closed-end mutual fund returns can fluctuate due to changes in investor supply and demand for these instruments.
B)
local governments may restrict the ability to move capital from the country.
C)
free float is low because reverse splits to bolster per share prices occur on a regular basis.


The proportion of stock publicly traded (free float) is frequently low because the government is often the primary owner of most of a company’s stock. (Study Session 8, LOS 22.j)
Which of the following statements regarding the correlation between stock returns and currency movements is CORRECT?
A)
Emerging markets have a negative correlation between local market returns and currency movements.
B)
Both developed and emerging markets have been shown to have a positive correlation between local market returns and U.S. currency movements.
C)
Developed markets have a negative correlation between local market returns and currency movements.


In developed countries, the correlation between local market returns and currency movements is usually negative, whereas in emerging markets, the local market returns and currency returns are usually positively correlated. (Study Session 8, LOS 22.j)
Which of the following statements concerning international investing and global investing is least accurate?
A)
Global investing implies diversification across industries as well as countries.
B)
International investing is principally concerned with diversification across countries.
C)
There is no difference between global and international investing.


International investing is principally concerned with diversification across countries, while global investing diversifies across industries as well as countries. However, there is no assurance that international diversification will be achieved under a global investing strategy—it is possible that the fund manager may decide to commit a disproportionate share of assets to a small set of countries, or even entirely to the investor’s home country. (Study Session 8, LOS 22.i)
作者: kim226    时间: 2012-3-24 10:40

Which of the following would be least appropriate for explaining why the benefits of international diversification are overstated?
A)
Global markets have become more segmented.
B)
Corporations have increased their global merger and acquisition activity.
C)
Global trade has increased.


The benefits of international diversification are overstated if the correlations between markets are higher than expected. If markets were segmented, correlations would be lower. The other responses represent causes of increased correlations between markets.
作者: kim226    时间: 2012-3-24 10:41

An analyst examines the correlation of a sample of stock returns and finds that it is 0.60. She then divides the sample in half based on the volatility of stock returns, sample A has the highest volatility and sample B has the lowest volatility. The correlations in sample A and sample B will be, respectively:
A)
both less than 0.60.
B)
lower than 0.60, higher than 0.60.
C)
higher than 0.60, lower than 0.60.


Due to the econometrics of the correlation measure, the correlation will be higher when volatility is higher, even if the correlation structure of the underlying data has not changed.
作者: kim226    时间: 2012-3-24 10:41

Which of the following is NOT a reason why foreign markets have less liquidity than domestic markets?
A)
The market capitalization is lower in foreign markets.
B)
There are government restrictions on the amount of equity that institutions can hold.
C)
The turnover of foreign stock markets is higher due to price manipulation.


Although there is a higher frequency of price manipulation in foreign markets, this does not directly impact turnover. Smaller market capitalizations in these markets, and government restrictions on institutional ownership does limit the liquidity in these markets.
作者: kim226    时间: 2012-3-24 10:42

Which of the following is NOT a barrier to investing in foreign security markets?
A)
Management fees are usually higher in foreign countries.
B)
The high commissions in foreign bond markets.
C)
There is often a lack of familiarity with foreign markets.


The commissions in foreign bond markets are usually quite low. However, there is a lack of familiarity with foreign markets and usually higher management fees, both of which will create barriers to foreign investment.
作者: kim226    时间: 2012-3-24 10:42

Which of the following statements regarding foreign security markets, relative to U.S. security markets is least accurate?
A)
Management fees are usually higher due to the costs of data, research, accounting, and communication.
B)
Government restrictions are usually higher for bonds than for stocks.
C)
Financial reporting is usually less reliable.


Government restrictions on investing in bonds are usually lower in foreign countries relative to the restrictions for foreign stocks. Management fees are usually higher. Financial reporting in foreign countries is usually less reliable and less timely than in the U.S.
作者: kim226    时间: 2012-3-24 10:42

Which of the following statements regarding foreign security markets, relative to U.S. security markets is least accurate?
A)
Withholding taxes are often assessed.
B)
Insider trading is more vigorously enforced.
C)
Trading costs are usually higher.


Insider trading in foreign markets is usually less vigorously enforced. Trading costs are usually higher, and withholding taxes are often applied.
作者: kim226    时间: 2012-3-24 10:43

Global investing is recommended over international diversification because:
A)
corporations are pursuing conglomerate diversification.
B)
governments impose restrictions on the repatriation of capital.
C)
country factors are not as important for stock returns as they once were.


As corporations have become more global, stock returns are more influenced by the industry in which the corporation operates, rather than the country in which the corporation is headquartered. Thus, global investing that diversifies across industries as well as borders, is recommended over traditional international diversification, which diversifies across countries only.
作者: kim226    时间: 2012-3-24 10:43

Global investing refers to diversifying across:
A)
countries.
B)
industries and countries.
C)
industries.


Global investing refers to diversifying across industries as well as countries.
作者: kim226    时间: 2012-3-24 10:43

An investor considers two mutual funds. Mutual Fund A invests in companies around the world, investing in those firms expected to experience superior returns. Mutual Fund B passively invests in companies throughout the world and maintains an exposure to all major industry sectors. Which Mutual Fund will have the lowest amount of unsystematic risk and why?
A)
A, diversifying across borders reduces unsystematic risk.
B)
B, passive investing ensures low unsystematic risk.
C)
B, industry factors have become more important for stock returns.


Mutual Fund B will have the lowest unsystematic risk. To diversify away unsystematic risk, an investor should invest across industries as well as borders. As corporations have become more global, their country of incorporation has less influence on their stock returns. Industry factors have become increasingly important for stock returns as a result. Passive investing only ensures low unsystematic risk when the index being replicated by the passive strategy is well diversified.
作者: kim226    时间: 2012-3-24 10:44

Which of the following best describes the relationship between international diversification and global investing? Global investing diversifies across:
A)
countries and industries. It outperforms international diversification.
B)
countries. It underperforms international diversification.
C)
countries. It outperforms international diversification.


Global investing recognizes the growing importance of industry factors for returns and diversifies across industries and countries. It will provide better diversification than just diversifying across countries (international diversification) as companies are increasingly defined by their industry and less by their country of incorporation.
作者: kim226    时间: 2012-3-24 10:44

A U.S. investor wants to invest internationally to reduce risk and seek higher returns. Which pair of countries’ stock markets would provide the best opportunity to do so?
A)
Germany and Chile.
B)
Great Britain and France.
C)
Germany and France.


As Chile is an emerging country, it will have low correlations and potentially higher returns with Germany and the U.S., compared to the other pairs of developed world markets.
作者: kim226    时间: 2012-3-24 10:45

Which of the following statements regarding the unsystematic risk of investing in emerging markets is CORRECT? It is:
A)
negligible.
B)
largely diversified away due to low correlations with developed world markets.
C)
still predominant in a large portfolio.


The unsystematic risk arising from emerging markets is largely diversified away in a portfolio of international assets due to low correlations with the developed world.
作者: kim226    时间: 2012-3-24 10:45

Which of the following best describes investing in emerging markets?
A)
Emerging markets have high stand alone risk but have a low correlation with developed world markets. This makes them an attractive addition to a portfolio.
B)
Emerging markets have low stand alone risk and low correlation with developed world markets. This makes them an attractive addition to a portfolio.
C)
Emerging markets have high stand alone risk and a high correlation with developed world markets. Their risk does not justify their addition to a portfolio.


Emerging markets have high stand alone risk but have a low correlation with developed world markets. Their contribution to portfolio risk is not as much as commonly expected. They also have high expected returns. This makes them an attractive addition to a portfolio.
作者: kim226    时间: 2012-3-24 10:46

Which of the following best describes investing in emerging markets?
A)
Emerging markets are segmented from developed world markets. They are priced according to their standard deviation.
B)
Emerging markets are integrated with developed world markets. They are priced according to their contribution to portfolio risk.
C)
Emerging markets are segmented from developed world markets. They are priced according to their contribution to portfolio risk.


Emerging markets are segmented from developed world markets. Due to this segmentation, they have a low correlation with developed world markets. They should be priced according to their contribution to portfolio risk, but instead are priced according to their standard deviation (stand alone risk). This results in them having high expected returns.
作者: kim226    时间: 2012-3-24 10:47

Nancy Sims and Janice Davis are investment analysts for Platinum Investment Advisors. Platinum provides investment advice regarding U.S. and non-U.S. market assets for U.S. investors. They attempt to exploit foreign asset and currency misvaluations whenever possible. Sims specializes in advising on tactical asset allocations and Davis specializes in strategic asset allocations. They analyze both developed and emerging market investments.
Davis is considering adding a portfolio of Korean stocks to a portfolio of U.S. stocks. She gathers the following information on the expected returns, standard deviations, correlations of the current U.S. portfolio and the Korean portfolio. The returns for the Korean portfolio are in U.S. dollar terms. She is considering weighting the overall portfolio so that 70 percent of its assets are in the U.S. and 30 percent are in Korea .
   U.S.
portfolio		Korean
portfolio
Expected Return   8.00%12.00%
Standard Deviation   22.00%32.00%
Correlation   0.60

Sims is considering adding a Japanese stock to a portfolio of U.S. stocks. She is concerned, however, as to what the effect would be on the portfolio’s return from changes in the value of the yen. She gathered the following figures for both the asset and currency for the Japanese investment.
Return on Japanese stock in yen   16%
Beginning spot rate (yen/$)   100
Ending spot rate (yen/$)   125

Another area of interest for Platinum is the Taiwan market. As part of their investigation into the attractiveness of these markets, Sims has been asked to evaluate Taiwanese stocks and the effect of currency risk on the risk of these investments. The standard deviation of the Taiwanese stocks in Taiwanese dollars (TWD) terms is 20 percent. The standard deviation of the U.S. dollar/TWD exchange rate is 15 percent. The correlation between the exchange rate and Taiwanese stock portfolio is 0.4.
In response to an advertisement that Platinum posted on a well-know financial news website, Sims has been contacted by a potential client, Louis Baldi. Baldi would like to know why he should diversify internationally when the U.S. markets have had higher returns than other markets over the past decade. Sims answers that it is difficult to predict the future, and that just because a market has outperformed in the past does not mean that it will outperform in the future. Sims adds that Baldi’s argument against international diversification, known as the “country-specific out-performance” argument was especially popular during the 1990s when the U.S. markets had an extremely long bull run. Davis adds that Baldi needs to diversify across not only countries, but also industries.
What is the expected return on the portfolio of U.S. and Korean assets that Davis is considering?
A)
9.2%.
B)
8.8%.
C)
10.0%.


The expected return of the portfolio is a weighted average of the asset returns: (0.70 × 8%) + (0.30 × 12%) = 9.2%. (Study Session 8, LOS 22.a)
What is the standard deviation of the portfolio of U.S. and Korean assets that Davis is considering?
A)
22.5%.
B)
5.0%.
C)
27.0%.


To calculate the standard deviation of the portfolio, use both the individual stocks risk as well as the correlation between them in the following formula for portfolio variance: (0.702 × 0.222) + (0.302 × 0.322) + (2 × 0.70 × 0.30 × 0.22 × 0.32 × 0.6) = 0.0237 + 0.0092 + 0.0177 = 0.0507. We then take the square root of 0.0507 to obtain the standard deviation of 22.5%. Notice that this is much less than the standard deviation of 32% on the Korean asset. (Study Session 8, LOS 22.a)
What is the expected return on the Japanese stock that Sims is considering?
A)
39.2%.
B)
45.0%.
C)
-7.2%.


The expected return on the Japanese stock in U.S. dollar terms must consider both the return on the asset in yen terms and the change in the value of the yen. The change in the value of the yen is calculated as follows: ((1/125) – (1/100)) / (1/100) = -20%. The return in U.S. dollar terms is then: (1.16)(1-.20)-1 = -7.20%. (Study Session 8, LOS 22.b)
What is the contribution of currency risk for the Taiwanese stocks that Sims is considering?
A)
5.0%.
B)
8.7%.
C)
9.4%.


The risk of the Taiwanese stocks in U.S. dollar terms must consider both the risk of the TWD and the correlation between the TWD and the Taiwanese stocks. The variance of these investments in U.S. dollar terms is: 0.202 + 0.152 + (2 × 0.20 × 0.15 × 0.4) = 0.0865. The standard deviation in U.S. dollar terms is then the square root of the variance: 0.08651/2 = 29.41%. The contribution of currency risk is then: 29.4% - 20.0% = 9.4%. Note that this is much less than the 15% that might otherwise be expected as being the risk of the TWD. (Study Session 8, LOS 22.c)

When investing in foreign markets Sims and Davis should be aware of the correlation between the asset and currency. In developed and emerging markets, what is the typical correlation between the asset and currency?
DevelopedEmerging
A)
NegativePositive
B)
PositiveNegative
C)
PositivePositive


In developed markets, the typical correlation between the asset and currency is negative, with the logic being that when the currency depreciates, the firms in those markets can export more and their stock rises. In emerging markets though, currency devaluations are often accompanied by a lack of confidence in the stock markets, so the correlation is positive. This suggests that currency risk is a greater concern in emerging markets. (Study Session 8, LOS 22.j)
With respect to Sims’ and Davis’ responses to Baldi’s comments:
A)
Sims is correct; Davis is correct.
B)
Sims is correct; Davis is incorrect.
C)
Sims is incorrect; Davis is correct.


Sims is correct. Although the “country-specific out-performance” argument appears attractive when the investor’s home market is doing quite well, past performance is no guarantee of future results. Davis is also correct. An investor needs to diversify across borders and industries. As the world economy and stock markets have become more interconnected, simply diversifying across borders is not as effective as it once was. Increasingly stock returns are determined by the industry the firm is in. Therefore the investor should also diversify across industries. This form of diversification is termed “global” diversification, as opposed to “international” diversification that only diversifies across borders. (Study Session 8, LOS 22.j)
作者: kim226    时间: 2012-3-24 10:48

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:
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?
A)
-11.7%.
B)
-32.4%.
C)
-10.4%.


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:
A)
only one is correct.
B)
both are correct.
C)
both are incorrect.


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.
A)
both are correct.
B)
only one is correct.
C)
both are incorrect.


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:

(Study Session 8, LOS 22.j)

What is the standard deviation and expected return of the two-stock portfolio?
Standard DeviationExpected Return
A)
24.431%10.6%
B)
0.244%11.4%
C)
5.960%10.6%


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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