Deck 19: International Diversification

Question 1

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

A) Euronext.
B) FTSE.
C) Nikkei.
D) Toronto.
E) Hang Seng

Answer 1

B

Question 2

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 1.5%.
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%.

Answer 2

B
Explanation: sP = [(0.5)2(15%)2 + (0.5)2(20%)2 + 2(0.5)(0.5)(1.5)]1/2 = 15.21%.

Question 3

________ 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.

Answer 3

D
Explanation: All of the factors are political in nature and thus are examples of political risk.

Question 4

According to PRS, in 2015, 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 5

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 6

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 7

Which country has the largest stock market compared to GDP?

A) Japan
B) Germany
C) Hong Kong
D) U.S.

Question 8

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 9

In 2015, the U.S. equity market represented ________ of the world equity market.

A) 19%
B) 60%
C) 43%
D) 41%
E) 79%

Question 10

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 11

Over the period 2011-2016, most correlations between the U.S. stock index and stock-index portfolios of other countries were

A) negative.
B) positive but less than .9.
C) approximately zero.
D) )9 or above.
E) None of the options are correct.

Question 12

Shares of several foreign firms are traded in the U.S. markets in the form of

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

Question 13

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 14

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 15

________ 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 16

Which country is the leader in GDP per capita?

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

Question 17

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 18

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 19

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 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 1.5%.
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

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 22

The manager of Quantitative International Fund uses EAFE as a benchmark. Last year's performance for the fund and the benchmark were as follows:

Calculate Quantitative's stock selection return contribution.

A) 1.0%
B) −1.0%
C) 3.0%
D) 0.25%

Question 23

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 24

The manager of Quantitative International Fund uses EAFE as a benchmark. Last year's performance for the fund and the benchmark were as follows:

Calculate Quantitative's currency selection return contribution.

A) +20%
B) −5%
C) +15%
D) +5%
E) −10%

Question 25

As exchange rates change, they

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

Question 26

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 27

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 28

The manager of Quantitative International Fund uses EAFE as a benchmark. Last year's performance for the fund and the benchmark were as follows:

Calculate Quantitative's country selection return contribution.

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

Question 29

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 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

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 32

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

A) Euronext
B) FTSE
C) Nikkei
D) Toronto
E) Shanghai

Question 33

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 34

The average country equity market share is

A) less than 2%.
B) between 3% and 4%.
C) between 5% and 7%.
D) between 7% and 8%.
E) greater than 8%.

Question 35

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 36

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 37

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 38

Investors looking for effective international diversification should

A) invest about 60% of their money in foreign stocks.
B) invest the same percentage of their money in foreign stocks that foreign equities represent in the world equity market.
C) frequently hedge currency exposure.
D) invest about 60% of their money in foreign stocks and invest the same percentage of their money in foreign stocks that foreign equities represent in the world equity market.
E) None of the options.

Question 39

"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 40

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 41

Suppose the 1-year risk-free rate of return in the U.S. is 2% and the 1-year risk-free rate of return in Mexico is 8%. The current exchange rate is 1 peso = U.S. $.051. A 1-year future exchange rate of ________ for the peso would make a U.S. investor indifferent between investing in the U.S. security and investing in the Mexican security.

A) 1.6037
B) 0.02001
C) 1.7500
D) 0.02300
E) 0.01250

Question 42

You are a U.S. investor who purchased British securities for 2,340 pounds one year ago when the British pound cost $1.52. 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 2,440 pounds and the pound is worth $1.61.

A) 16.7%
B) 20.0%
C) 12.5%
D) 10.4%
E) None of the options are correct

Question 43

The present exchange rate is 1 Nigerian Niara (NGN) = U.S. $0.002896. The 1-year future rate is NGN = U.S. $0.002774. The yield on a 1-year U.S. bill is 3.2%. A yield of ________ on a 1-year Nigerian bill will make an investor indifferent between investing in the U.S. bill and the Nigerian bill (NTB).

A) 2.94%
B) 1.73%
C) 6.04%
D) 7.74%
E) None of the options are correct

Question 44

Assume there is a fixed exchange rate between the Euro and U.S. dollar. The expected return and standard deviation of return on the U.S. stock market are 16% and 13%, respectively. The expected return and standard deviation on the DAX stock market are 11% and 18%, respectively. The covariance of returns between the U.S. and German stock market is 1.5%.
If you invested 50% of your money in the German (DAX) 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) 13.5%.

Question 45

The yield on a 1-year bill in the Euro is 6%, and the present exchange rate is 1 Euro = U.S. $1.19. If you expect the exchange rate to be 1 Euro = U.S. $1.14 a year from now, the return a U.S. investor can expect to earn by investing in Euro bills is

A) 1.55%.
B) 0%.
C) 8%.
D) −0.42%.
E) None of the options are correct.

Question 46

Assume there is a fixed exchange rate between the Yen and U.S. dollar. The expected return and standard deviation of return on the U.S. stock market are 21% and 15%, respectively. The expected return and standard deviation on the Japanese stock market are 13% and 12%, respectively. The covariance of returns between the U.S. and Japanese stock market is 2.5%.
If you invested 60% of your money in the Japanese stock market and 40% in the U.S. stock market, the expected return on your portfolio would be

A) 12.0%.
B) 16.2%.
C) 17.4%.
D) 18.5%.

Question 47

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 1.5%.
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 48

Suppose the 1-year risk-free rate of return in the U.S. is 3.5%. The current exchange rate is 1 pound = U.S. $1.70. The 1-year forward rate is 1 pound = $1.65. 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) 2.64%
B) 2.85%
C) 3.34%
D) 6.62%
E) None of the options are correct

Question 49

Assume there is a fixed exchange rate between the Swiss Franc and U.S. dollar. The expected return and standard deviation of return on the U.S. stock market are 14% and 11%, respectively. The expected return and standard deviation on the Swiss Stock Exchange (SIX) are 9% and 14%, respectively. The covariance of returns between the U.S. and the SIX is 1.75%.
If you invested 350% of your money in the Swiss (SIX) stock market and 65% in the U.S. stock market, the expected return on your portfolio would be

A) 12.25%.
B) 12.5%.
C) 13.0%.
D) 13.5%.

Question 50

The yield on a 1-year bill in the U.K. is 6%, and the present exchange rate is 1 pound = U.S. $1.65. If you expect the exchange rate to be 1 pound = U.S. $1.55 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) −0.42%.
E) None of the options are correct.