Deck 16: International Portfolio Theory and Diversification

Question 1

Portfolio theory assumes that investors are risk-averse. This means that investors

A) cannot be induced to make risky investments.
B) prefer more risk to less for a given return.
C) will accept some risk, but not unnecessary risk.
D) All of the above are true.

Answer 1

will accept some risk, but not unnecessary risk.

Question 2

An internationally diversified portfolio

A) should result in a portfolio with a lower beta than a purely domestic portfolio.
B) has the same overall risk shape as a purely domestic portfolio.
C) is only about 12% as risky as the typical individual stock.
D) all of the above.

Answer 2

all of the above.

Question 3

Unsystematic risk is

A) the remaining risk in a well-diversified portfolio.
B) measured with beta.
C) can be diversified away.
D) all of the above.

Answer 3

can be diversified away.

Question 4

A U.S. investor makes an investment in Britain and earns 14% on the investment while the British pound appreciates against the U.S. dollar by 8%. What is the investor's total return?

A) 22.00%
B) 23.12%
C) 6.00%
D) 4.88%

Question 5

The graph for the efficient frontier has beta on the vertical axis and standard deviation of the horizontal axis.

Question 6

The efficient frontier of the domestic portfolio opportunity set

A) runs along the extreme left edge of the opportunity set.
B) represents optimal portfolios of securities that represent minimum risk for a given level of expected portfolio return.
C) contains the portfolio of risky securities that the logical investor would choose to hold.
D) all of the above.

Question 7

Beta may be defined as

A) the measure of systematic risk.
B) a risk measure of a portfolio.
C) the ratio of the variance of the portfolio to the variance of the market.
D) all of the above.

Question 8

Portfolio diversification can eliminate 100% of risk.

Question 9

Instruction 16.1:
Use the information to answer following question(s).
In September 2002 a U.S. investor chooses to invest $500,000 in German equity securities at a then current spot rate of $1.30/euro. At the end of one year the spot rate is $1.35/euro.
Refer to Instruction 16.1. How many euros will the U.S. investor acquire with his initial $500,000 investment?

A) euro 650,000
B) euro 370,370
C) euro 500,000
D) euro 384,615

Question 10

Instruction 16.1:
Use the information to answer following question(s).
In September 2002 a U.S. investor chooses to invest $500,000 in German equity securities at a then current spot rate of $1.30/euro. At the end of one year the spot rate is $1.35/euro.
Refer to Instruction 16.1. At the end of the year the investor sells his stock that now has an average price per share of euro 57. What is the investor's average rate of return before converting the stock back into dollars?

A) 5.0%
B) -3.0%
C) -5.0%
D) 3.0%

Question 11

A well-diversified portfolio is only about ________ as risky as the typical individual stock.

A) 8%
B) 19%
C) 27%
D) 52%

Question 12

A fully diversified domestic portfolio has a beta of

A) 0.0.
B) 1.0.
C) -1.0.
D) Not enough information to answer this question.

Question 13

In some respects, internationally diversified portfolios are the same in principle as a domestic portfolio because

A) the investor is attempting to combine assets that are perfectly correlated.
B) investors are tying to reduce systematic risk.
C) investors are trying to reduce the total risk of the portfolio.
D) all of the above.

Question 14

Instruction 16.1:
Use the information to answer following question(s).
In September 2002 a U.S. investor chooses to invest $500,000 in German equity securities at a then current spot rate of $1.30/euro. At the end of one year the spot rate is $1.35/euro.
Refer to Instruction 16.1. At the end of the year the investor sells his stock that now has an average price per share of euro 57. What is the investor's average rate of return after converting the stock back into dollars?

A) -1.35%
B) 5.0%
C) -5.0%
D) -7.24%

Question 15

________ risk is measured with beta.

A) Systematic
B) Unsystematic
C) International
D) Domestic

Question 16

Which of the following statements is NOT true?

A) International diversification benefits induce investors to demand foreign securities.
B) An international security adds value to a portfolio if it reduces risk without reducing return.
C) Investors will demand a security that adds value.
D) All of the above are true.

Question 17

The portfolio with the least risk among all those possible in the domestic portfolio opportunity set is called the minimum risk domestic portfolio.

Question 18

In some respects, internationally diversified portfolios are different from a domestic portfolio because

A) investors may also acquire foreign exchange risk.
B) international portfolio diversification increases expected return but does not decrease risk.
C) investors must leave the country to acquire foreign securities.
D) all of the above.

Question 19

Increasing the number of securities in a portfolio reduces the unsystematic risk but not the systematic risk.

Question 20

Instruction 16.1:
Use the information to answer following question(s).
In September 2002 a U.S. investor chooses to invest $500,000 in German equity securities at a then current spot rate of $1.30/euro. At the end of one year the spot rate is $1.35/euro.
Refer to Instruction 16.1. At an average price of euro 60/share, how many shares of stock will the investor be able to purchase?

A) 8333 shares
B) 6410 shares
C) 6173 shares
D) 10,833 shares

Question 21

According to the capital asset pricing model (CAPM), which of the following is true?

A) The expected return on an asset is equal to the risk-free rate plus the amount of risk, beta, multiplied by the market risk premium.
B) The expected return on an asset is equal to the market rate plus the amount of risk, beta, multiplied by the market risk premium.
C) The expected return on an asset is equal to the risk-free rate plus the amount of risk, standard deviation, multiplied by the market risk premium.
D) None of the above.

Question 22

Which of the following portfolios could not possibly be located on the efficient frontier of risky portfolios?

A) Portfolio 1 with an expected return of 6% and a standard deviation of 6%.
B) Portfolio 2 with an expected return of 10% and a standard deviation of 12%.
C) Portfolio 3 with an expected return of 10% and a standard deviation of 8%.
D) Portfolio 4 with an expected return of 12% and a standard deviation of 20%.

Question 23

TABLE 16.1
Use the information to answer following question(s).

Refer to Table 16.1. What is the value of the Treynor Measure for the Netherlands?

A) 0.197
B) 0.0109
C) Either A or B
D) Neither A nor B

Question 24

Instruction 16.2:
Use the information to answer the following question(s).
A U.S. investor is considering a portfolio consisting of 60% invested in the U.S. equity index fund and 40% invested in the British equity index fund. The expected returns for the funds are 10% for the U.S. and 8% for the British, standard deviations of 20% for the U.S. and 18% for the British, and a correlation coefficient of 0.15 between the U.S. and British equity funds.
Refer to Instruction 16.2. What is the expected return of the proposed portfolio?

A) 9.2%
B) 9.0%
C) 19.2%
D) 19%

Question 25

TABLE 16.1
Use the information to answer following question(s).

Refer to Table 16.1. What is the value of the Sharpe Measure for France?

A) 0.113
B) 0.0071
C) Either A or B
D) Neither A nor B

Question 26

The Sharpe and Treynor Measures tend to be consistent in their ranking of portfolios when the portfolios

A) are poorly diversified.
B) are properly diversified.
C) contain only U.S. equity investments.
D) none of the above.

Question 27

TABLE 16.1
Use the information to answer following question(s).

Refer to Table 16.1. ________ appears to have the greatest amount of risk as measured by monthly standard deviation, but ________ has the best return per unit of risk according to the Sharpe Measure.

A) United States; Austria
B) France; Austria
C) United States; Netherlands
D) France; Netherlands

Question 28

The standard deviation of a portfolio is the weighted average standard deviations of the individual assets.

Question 29

The Sharpe measure uses ________ as the measure of risk and the Treynor measure uses ________ as the measure of risk.

A) standard deviation; variance
B) beta; variance
C) standard deviation; beta
D) beta; standard deviation

Question 30

Relative to the efficient frontier of risky portfolios, it is impossible to hold a portfolio that is located ________ the efficient frontier.

A) to the left of
B) to the right of
C) on
D) to the right or left of

Question 31

The correlation of returns of the U.S. equity market index with the indexes of equity markets in seventeen other countries over the period 1977-1996 is between

A) -1 and -0.50.
B) 1 and 0.50.
C) -0.50 and 0.0.
D) 0.0 and 0.50.

Question 32

Which of the following is NOT an important question regarding the validity of a global version of the capital asset pricing model (CAPM)?

A) barriers to the free and open movement of capital across boundaries
B) difficulties in estimating a global portfolio, i.e., trading limitations, illiquid markets, and incomplete information
C) the lack of a single true worldwide risk-free security
D) all of the above

Question 33

Instruction 16.2:
Use the information to answer the following question(s).
A U.S. investor is considering a portfolio consisting of 60% invested in the U.S. equity index fund and 40% invested in the British equity index fund. The expected returns for the funds are 10% for the U.S. and 8% for the British, standard deviations of 20% for the U.S. and 18% for the British, and a correlation coefficient of 0.15 between the U.S. and British equity funds.
Refer to Instruction 16.2. What is standard deviation of the proposed portfolio?

A) 38.00
B) 19.20
C) 19.00
D) 14.45

Question 34

Capital markets around the world are on average less integrated today than they were 20 years ago.

Question 35

The addition of foreign securities to the domestic portfolio opportunity set shifts the efficient frontier

A) down and to the left.
B) up and to the right.
C) up and to the left.
D) down and to the right.

Question 36

The ________ connects the risk-free security with the optimal domestic portfolio.

A) security market line
B) capital asset pricing model
C) capital market line
D) none of the above

Question 37

The Sharpe and Treynor measures are each measures of return per unit of risk.

Question 38

The standard deviation of the risk-free security is

A) less than the standard deviation of the optimal risky domestic portfolio.
B) less than the standard deviation of the optimal international portfolio.
C) is equal to zero.
D) all of the above.

Question 39

The correlation coefficient has a range of

A) 0 to 1.
B) 1 to 10.
C) -1 to 1.
D) -1 to 0.

Question 40

The optimal domestic portfolio of risky securities is the portfolio of minimum risk.

Question 41

The international diversification of a portfolio

A) results in lower diversifiable risk of the portfolio.
B) decreases the currency risk component of the portfolio.
C) reduces the systematic risk component of the portfolio.
D) none of the above.

Question 42

Which of the following is a potential obstacle to international diversification of portfolios?

A) high transaction costs
B) higher information costs
C) both A and B
D) none of the above

Question 43

The construction of an internationally diversified portfolio combines

A) currency and asset risk and return.
B) country risk with currency return.
C) credit risk with inflation risk.
D) asset risk with sovereign risk.

Question 44

Portfolio diversification is beneficial to the investor because it

A) reduces expected returns and increases risk.
B) increases expected returns.
C) reduces risk for given levels of return.
D) none of the above.

Question 45

A Canadian-based investor purchases a Standard & Poor's 500 index (SPY) on the American Stock Exchange, in U.S. dollars. Over the course of the year the U.S. dollar appreciates 8% against the Canadian dollar, and the S&P Index rises 22%. The total return to the Canadian investor in Canadian dollar terms is approximately ________.

A) 8%
B) 14%
C) 22%
D) 30%

Question 46

Meryl Janicky, a mutual fund manager, is evaluating the recent performance of the shares of Thames Boats International, a publicly traded company in Great Britain. Ms Janicky's firm has $200,000 invested in Thames Boats and she has gathered the information presented in the following table. What was the return on the security in dollars?

A) 7.47%
B) 10.50%
C) 12.07%
D) 16.66%

Question 47

The Sharpe Measure of portfolio performance calculates the average return of the portfolio above that of the

A) market, per unit of portfolio risk.
B) market, per unit of beta risk.
C) risk-free rate, per unit of beta.

Question 48

The Treynor Measure of portfolio performance calculates the average return of the portfolio above that of the

A) market, per unit of portfolio risk.
B) risk-free rate, per unit of beta.
C) none of the above.

Question 49

Inter-country correlations among the worlds largest capitalistic economies over the last century illustrate that the correlation results for the first 50 years were good predictors for correlations for the next 50 years.

Question 50

It is safe to say that because stock market correlations across countries has increased since 1986, that there are no longer diversification benefits to be found from international portfolio diversification.

Question 51

Draw the curve representing the Optimal Domestic Efficient Frontier. Be sure to draw and label the following: The vertical axis and the horizontal axis, the risk-free security, the minimum risk portfolio, the domestic portfolio opportunity set, the optimal domestic portfolio, and the capital market line. Choose a point along the domestic portfolio opportunity set between the optimal domestic portfolio and the minimum risk domestic portfolio and explain why that point is not the optimal risky domestic portfolio for investors to hold.

Question 52

If an investor is able to determine a global beta for his portfolio and holds a portfolio that is well-diversified with international investments, which performance measure is more appropriate, the Sharpe Measure or the Treynor Measure? Why? Explain each performance measure.

Question 53

The efficient frontier for an international investor is

A) not capable of being compared to that of a domestic investor unless currency risk has been eliminated.
B) greater than for a domestic investor.
C) maximized at the expected risk and return of the emerging market assets in the portfolio.
D) all of the above.

Question 54

The maximum benefits of portfolio construction are obtained when the correlation between assets is ________.

A) -1.0
B) 0.0
C) +1.0
D) none of the above

Question 55

Your authors present a table showing mean returns across three classes of securities and across several countries. In general, the mean average annual returns for these classes of securities from highest to lowest are

A) bonds, then equity, and finally bills.
B) bills, then bonds, and finally equity.
C) equity, then bonds, and finally bills.
D) equity, then bills, and finally bonds.

Question 56

Meryl Janicky, a mutual fund manager, is evaluating the recent performance of the shares of Thames Boats International, a publicly traded company in Great Britain. Ms Janicky's firm has $200,000 invested in Thames Boats and she has gathered the information presented in the following table. What was the return on the security in pounds?

A) 7.47%
B) 10.50%
C) 12.07%
D) 16.66%

Question 57

The largest equity market losses of the last 100 years were primarily related to war and terrorism.

Question 58

If a portfolio is constructed with only two assets, of equal weights, and the correlation coefficient between the two assets is exactly 1.0, which of the following is true?

A) The portfolio risk reduction is maximized.
B) The return of the two assets over time are seen to follow different cycles or paths.
C) Risk is not reduced significantly because of the positive correlation.
D) None of the above are true.