Deck 25: International Diversification

Question 1

In 2017, the U.S. equity market represented __________ of the world equity market.

A) 19%
B) 60%
C) 43%
D) 41%

Answer 1

D

Question 2

Over the period 2014-2018, most correlations between the U.S. stock index and stock-index portfolios of other countries were

A) negative.
B) positive but less than 0.9.
C) approximately zero.
D) 0.9 or above.
E) None of the options are correct.

Answer 2

B

Question 3

Which country has the highest in GDP per capita?

A) Luxembourg
B) Canada
C) Germany
D) U.S.

Answer 3

A

Question 4

The yield on a 1-year bill in the U.K. is 8%, and the present exchange rate is 1 pound = U.S. $1.60. If you expect the exchange rate to be 1 pound = U.S. $1.50 a year from now, the return a U.S. investor can expect to earn by investing in U.K. bills is

A) −6.7%.
B) 0%.
C) 8%.
D) 1.25%.
E) None of the options are correct.

Question 5

Suppose the 1-year risk-free rate of return in the U.S. is 5%. The current exchange rate is 1 pound = U.S. $1.60. The 1-year forward rate is 1 pound = $1.57. What is the minimum yield on a 1-year risk-free security in Britain that would induce a U.S. investor to invest in the British security?

A) 2.44%
B) 2.50%
C) 7.00%
D) 7.62%
E) None of the options are correct.

Question 6

Assume there is a fixed exchange rate between the Canadian and U.S. dollar. The expected return and standard deviation of return on the U.S. stock market are 18% and 15%, respectively. The expected return and standard deviation on the Canadian stock market are 13% and 20%, respectively. The covariance of returns between the U.S. and Canadian stock markets is 150. If you invested 50% of your money in the Canadian stock market and 50% in the U.S. stock market, the standard deviation of return of your portfolio would be

A) 12.53%.
B) 15.21%.
C) 17.50%.
D) 18.75%.

Question 7

The major concern that has been raised with respect to the weighting of countries within the EAFE index is

A) currency volatilities are not considered in the weighting.
B) cross-correlations are not considered in the weighting.
C) inflation is not represented in the weighting.
D) the weights are not proportional to the asset bases of the respective countries.
E) None of the options are correct.

Question 8

You are a U.S. investor who purchased British securities for 2,000 pounds, one year ago when the British pound cost $1.50. No dividends were paid on the British securities in the past year. Your total return based on U.S. dollars was __________ if the value of the securities is now 2,400 pounds and the pound is worth $1.60.

A) 16.7%
B) 20.0%
C) 28.0%
D) 40.0%
E) None of the options are correct.

Question 9

Suppose the 1-year risk-free rate of return in the U.S. is 4%, and the 1-year risk-free rate of return in Britain is 7%. The current exchange rate is 1 pound = U.S. $1.65. A 1-year future exchange rate of __________ for the pound would make a U.S. investor indifferent between investing in the U.S. security and investing in the British security.

A) 1.6037
B) 2.0411
C) 1.7500
D) 2.3369

Question 10

The interest rate on a 1-year Canadian security is 8%. The current exchange rate is C$ = US $0.78. The 1-year forward rate is C$ = US $0.76. The return (denominated in U.S. $) that a U.S. investor can earn by investing in the Canadian security is

A) 3.59%.
B) 4.00%.
C) 5.23%.
D) 8.46%.
E) None of the options are correct.

Question 11

__________ are mutual funds that invest in one country only.

A) ADRs
B) ECUs
C) Single-country funds
D) All of the options are correct.
E) None of the options are correct.

Question 12

The __________ index is a widely used index of non-U.S. stocks.

A) CBOE
B) Dow Jones
C) EAFE
D) All of the options are correct.
E) None of the options are correct.

Question 13

Using local currency returns, the S&P 500 has the highest correlation with

A) Euronext.
B) FTSE.
C) Nikkei.
D) Toronto.

Question 14

According to PRS, in 2016, which country had the highest composite risk rating on a scale of 0 (most risky) to 100 (least risky)?

A) Switzerland
B) Canada
C) Germany
D) U.S.

Question 15

The straightforward generalization of the simple CAPM to international stocks is problematic because

A) inflation-risk perceptions by different investors in different countries will differ as consumption baskets differ.
B) investors in different countries view exchange-rate risk from the perspective of different domestic currencies.
C) taxes, transaction costs, and capital barriers across countries make it difficult for investors to hold a world-index portfolio.
D) All of the options are correct.
E) None of the options are correct.

Question 16

The present exchange rate is C$ = U.S. $0.78. The 1-year future rate is C$ = U.S. $0.76. The yield on a 1-year U.S. bill is 4%. A yield of __________ on a 1-year Canadian bill will make an investor indifferent between investing in the U.S. bill and the Canadian bill.

A) 2.4%
B) 1.3%
C) 6.4%
D) 6.7%
E) None of the options are correct.

Question 17

The performance of an internationally-diversified portfolio may be affected by

A) country selection.
B) currency selection.
C) stock selection.
D) All of the options are correct.
E) None of the options are correct.

Question 18

__________ refers to the possibility of expropriation of assets, changes in tax policy, and the possibility of restrictions on foreign exchange transactions.

A) Default risk
B) Foreign exchange risk
C) Market risk
D) Political risk
E) None of the options are correct.

Question 19

Which country has the largest stock market compared to GDP?

A) Japan
B) Germany
C) South Africa
D) U.S.

Question 20

Assume there is a fixed exchange rate between the Canadian and U.S. dollar. The expected return and standard deviation of return on the U.S. stock market are 18% and 15%, respectively. The expected return and standard deviation on the Canadian stock market are 13% and 20%, respectively. The covariance of returns between the U.S. and Canadian stock markets is 150. If you invested 50% of your money in the Canadian stock market and 50% in the U.S. stock market, the expected return on your portfolio would be

A) 12.0%.
B) 12.5%.
C) 13.0%.
D) 15.5%.

Question 21

The manager of Cross Border Fund uses EAFE as a benchmark. Last year's performance for the fund and the benchmark were as follows: $\begin{array}{ccccc}&\text { EAFE } & \text { Return on } & \text { Currency } & \text { Cross } & \text { Manager's } \\&\text { Weight } & \text { Equity } & \text { Aplication } & \text { Border's } & \text { Return } \\&& \text { Index } & E_{1} / E_{0-1} & \text { Weight } &\\ \text { Eur } &0.30&10\%&10\%&0.25&9\%\\ \text { Aus } &0.10&5\%&-10\%&0.25&8\%\\ \text { FE } &0.60&15\%&30\%&0.50&16\%\\\end{array}$
Calculate Cross Border's stock selection return contribution.

A) 1.0%
B) ?1.0%
C) 3.0%
D) 0.25%

Question 22

Which equity index had the highest volatility in terms of U.S. dollar-denominated returns for the period of five years ending in 2018?

A) Shanghai
B) India
C) Nikkei
D) U.S.

Question 23

Which equity index had the lowest volatility in terms of U.S. dollar-denominated returns for the period of five years ending in 2018?

A) Korea
B) Swiss
C) Toronto
D) Nikkei

Question 24

The manager of Cross Border Fund uses EAFE as a benchmark. Last year's performance for the fund and the benchmark were as follows: $\begin{array}{ccccc}&\text { EAFE } & \text { Return on } & \text { Currency } & \text { Cross } & \text { Manager's } \\&\text { Weight } & \text { Equity } & \text { Aplication } & \text { Border's } & \text { Return } \\&& \text { Index } & E_{1} / E_{0-1} & \text { Weight } &\\ \text { Eur } &0.30&10\%&10\%&0.25&9\%\\ \text { Aus } &0.10&5\%&-10\%&0.25&8\%\\ \text { FE } &0.60&15\%&30\%&0.50&16\%\\\end{array}$ Calculate Cross Border's currency selection return contribution.

A) +20%
B) ?5%
C) +15%
D) +5%
E) ?10%

Question 25

The interplay between interest rate differentials and exchange rates, such that each adjusts until the foreign exchange market and the money market reach equilibrium, is called the

A) Purchasing Power Parity Theory.
B) Balance of Payments.
C) Interest Rate Parity Theory.
D) None of the options are correct.

Question 26

WEBS portfolios

A) are passively managed.
B) are shares that can be sold by investors.
C) are free from brokerage commissions.
D) are passively managed and are shares that can be sold by investors.
E) All of the options are correct.

Question 27

When Country A's currency strengthens against Country B's, citizens of Country A will

A) pay less to buy Country B's products.
B) pay more to buy Country B's products.
C) pay more to buy domestically-produced products.
D) not be affected by the change in their currency's value.

Question 28

Exchange-rate risk

A) results from changes in the exchange rates between the currency of the investor and the country in which the investment is made.
B) can be hedged by using a forward or futures contract in foreign exchange.
C) cannot be eliminated.
D) results from changes in the exchange rates between the currency of the investor and the country in which the investment is made and cannot be eliminated.
E) results from changes in the exchange rates between the currency of the investor and the country in which the investment is made and can be hedged by using a forward or futures contract in foreign exchange.

Question 29

The manager of Cross Border uses EAFE as a benchmark. Last year's performance for the fund and the benchmark were as follows: $\begin{array}{ccccc}&\text { EAFE } & \text { Return on } & \text { Currency } & \text { Cross } & \text { Manager's } \\&\text { Weight } & \text { Equity } & \text { Aplication } & \text { Border's } & \text { Return } \\&& \text { Index } & E_{1} / E_{0-1} & \text { Weight } &\\ \text { Eur } &0.30&10\%&10\%&0.25&9\%\\ \text { Aus } &0.10&5\%&-10\%&0.25&8\%\\ \text { FE } &0.60&15\%&30\%&0.50&16\%\\\end{array}$
Calculate Cross Border's country selection return contribution.

A) 12.5%
B) ?12.5%
C) 11.25%
D) ?1.25%
E) 1.25%

Question 30

The possibility of experiencing a drop in revenue or an increase in cost in an international transaction due to a change in foreign exchange rates is called

A) foreign exchange risk.
B) political risk.
C) translation exposure.
D) hedging risk.

Question 31

Using the S&P 500 portfolio as a proxy of the market portfolio

A) is appropriate because U.S. securities represent more than 60% of world equities.
B) is appropriate because most U.S. investors are primarily interested in U.S. securities.
C) is appropriate because most U.S. and non-U.S. investors are primarily interested in U.S. securities.
D) is inappropriate because U.S. securities make up less than 41% of world equities.
E) is inappropriate because the average U.S. investor has less than 20% of his or her portfolio in non-U.S. equities.

Question 32

Home bias refers to

A) the tendency to vacation in your home country instead of traveling abroad.
B) the tendency to believe that your home country is better than other countries.
C) the tendency to give preferential treatment to people from your home country.
D) the tendency to overweight investments in your home country.
E) None of the options are correct.

Question 33

When an investor adds international stocks to his or her U.S. stock portfolio,

A) it will raise his or her risk relative to the risk he or she would face just holding U.S. stocks.
B) he or she can reduce the risk of his or her portfolio.
C) he or she will increase his or her expected return but must also take on more risk.
D) it will have no impact on either the risk or the return of his or her portfolio.
E) he or she needs to seek professional management because he or she doesn't have access to international investments on his or her own.

Question 34

"ADRs" stands for ___________, and "WEBS" stands for ____________.

A) additional dollar returns; weekly equity and bond survey
B) additional daily returns; world equity and bond survey
C) American dollar returns; world equity and bond statistics
D) American depository receipts; world equity benchmark shares
E) adjusted dollar returns; weighted equity benchmark shares

Question 35

U.S. investors

A) can trade derivative securities based on prices in foreign security markets.
B) cannot trade foreign derivative securities.
C) can trade options and futures on the Nikkei stock index of 225 stocks traded on the Tokyo stock exchange and on FTSE (Financial Times Share Exchange) indexes of U.K. and European stocks.
D) can trade derivative securities based on prices in foreign security markets and can trade options and futures on the Nikkei stock index of 225 stocks traded on the Tokyo stock exchange and on FTSE (Financial Times Share Exchange) indexes of U.K. and European stocks.
E) None of the options are correct.

Question 36

The yield on a 1-year bill in the U.K. is 7%, and the present exchange rate is 1 pound = U.S. $1.65. If you expect the exchange rate to be 1 pound = U.S. $1.45 a year from now, the return a U.S. investor can expect to earn by investing in U.K. bills is

A) −6.7%.
B) 3.2%.
C) 8%.
D) −5.97%.
E) None of the options

Question 37

The possibility of experiencing a drop in revenue or an increase in cost in an international transaction due to a change in foreign exchange rates is called

A) foreign exchange risk.
B) political risk.
C) translation exposure.
D) hedging risk.

Question 38

As exchange rates change, they

A) change the relative purchasing power between countries.
B) can affect imports and exports between countries.
C) will affect the flow of funds between countries.
D) All of the options are true.

Question 39

International investing

A) cannot be measured against a passive benchmark, such as the S&P 500.
B) can be measured against a widely-used index of non-U.S. stocks, the EAFE Index (Europe, Australia, Far East).
C) can be measured against international indexes.
D) can be measured against a widely-used index of non-U.S. stocks, the EAFE Index (Europe, Australia, Far East), and against international indexes.
E) None of the options are correct.

Question 40

The EAFE is

A) the East Asia Foreign Equity index.
B) the Economic Advisor's Foreign Estimator index.
C) the European and Asian Foreign Equity index.
D) the European, Asian, French Equity index.
E) the European, Australian, Far East index.

Question 41

The interest rate on a 1-year Canadian security is 7.8%. The current exchange rate is C$ = US $0.79. The 1-year forward rate is C$ = US $0.77. The return (denominated in U.S. $) that a U.S. investor can earn by investing in the Canadian security is

A) 3.59%.
B) 4.00%.
C) 5.07%.
D) 8.46%.
E) None of the options

Question 42

Suppose the 1-year risk-free rate of return in the U.S. is 4% and the 1-year risk-free rate of return in Britain is 6%. The current exchange rate is 1 pound = U.S. $1.67. A 1-year future exchange rate of __________ for the pound would make a U.S. investor indifferent between investing in the U.S. security and investing in the British security.

A) 1.6385
B) 2.0411
C) 1.7500
D) 2.3369

Question 43

You are a U.S. investor who purchased British securities for 2,200 pounds one year ago when the British pound cost $1.50. No dividends were paid on the British securities in the past year. Your total return based on U.S. dollars was __________ if the value of the securities is now 2,560 pounds and the pound is worth $1.60.

A) 16.7%
B) 20.3%
C) 24.1%
D) 41.4%
E) None of the options

Question 44

An investor invests in a Japanese bond at 5.5% for one year. The equivalent USA investment yields 3.8%. If the spot exchange rate is 110.00 yen per USD, what is the expected forward exchange rate in yen per USD?

A) 111.80
B) 111.49
C) 111.03
D) 110.91

Question 45

An investor invests in a Mexican treasury at 9% for one year. The equivalent USA investment yields 5%. If the spot exchange rate is 13.000 pesos per USD, what is the expected forward exchange rate in pesos per USD?

A) 13.691
B) 13.495
C) 13.150
D) 13.000

Question 46

You are a U.S. investor who purchased British securities for 4,000 pounds one year ago when the British pound cost $1.50. No dividends were paid on the British securities in the past year. Your total return based on U.S. dollars was __________ if the value of the securities is now 4,400 pounds and the pound is worth $1.62.

A) 16.7%
B) 18.8%
C) 28.0%
D) 40.0%
E) None of the options

Question 47

Suppose the 1-year risk-free rate of return in the U.S. is 6%. The current exchange rate is 1 pound = U.S. $1.62. The 1-year forward rate is 1 pound = $1.53. What is the minimum yield on a 1-year risk-free security in Britain that would induce a U.S. investor to invest in the British security?

A) 15.44%
B) 13.50%
C) 12.24%
D) 7.62%
E) None of the options

Question 48

Suppose the 1-year risk-free rate of return in the U.S. is 4.5% and the 1-year risk-free rate of return in Britain is 7.7%. The current exchange rate is 1 pound = U.S. $1.60. A 1-year future exchange rate of __________ for the pound would make a U.S. investor indifferent between investing in the U.S. security and investing in the British security.

A) 1.5525
B) 2.0411
C) 1.7500
D) 2.3369

Question 49

An investor invests in a Japanese bond at 7.0% for one year. If the spot exchange rate is 104.00 yen per USD and the one year forward exchange rate is 99, what return should the investor expect on an equivalent USD investment?

A) 9.60%
B) 10.20%
C) 11.92%
D) 12.40%

Question 50

An investor invests in a Japanese bond at 6% for one year. The equivalent USA investment yields 7%. If the spot exchange rate is 104.00 yen per USD, what is the expected forward exchange rate in yen per USD?

A) 103.61
B) 103.49
C) 103.03
D) 102.31

Question 51

The present exchange rate is C$ = U.S. $0.78. The 1-year future rate is C$ = U.S. $0.75. The yield on a 1-year U.S. bill is 5%. A yield of __________ on a 1-year Canadian bill will make investor indifferent between investing in the U.S. bill and the Canadian bill.

A) 9.2%
B) 8.3%
C) 6.4%
D) 11.3%
E) None of the options

Question 52

An investor invests in a Japanese bond at 6.5% for one year. If the spot exchange rate is 110.00 yen per USD and the one year forward exchange rate is 112, what return should the investor expect on an equivalent USD investment?

A) 4.60%
B) 5.20%
C) 5.92%
D) 6.50%