Chapter 5
Equity: Markets and Instruments
Note: In the sixth edition of Global Investments, the exchange rate quotation symbols differ from previous
editions. We adopted the convention that the first currency is the quoted currency in terms of units
of the second currency.
For example, €:$ = 1.4 indicates that one euro is priced at 1.4 dollars. In previous editions we used
the reversed convention $/€ = 1.4, meaning 1.4 dollars per euro.
All problems in this test bank still use the old convention and have not been adapted to reflect the
new quotation symbols used in the 6th edition.
◼ Questions and Problems
1. You are a French institutional investor and wish to buy 1,000 shares of General Motors. Your U.S.
broker quotes 45–45 ¼, with a commission of 0.20% of the transaction value. Your bank quotes the
$/€ rate at 1.1000–1.1100 net. What would be your total cost in euros?
2. A Swedish investor bought 100 shares of IBM on January 1 on the New York Stock Exchange at
$120. The exchange rate was SEK/USD = 7.00. Over the year, the investor has received a gross
dividend of $4 per share; the net dividend received is $3.4 because of a 15% withholding tax levied
by the United States. The exchange rate at the time of dividend payment was SEK/USD = 7.1.
By December 31, the investor resells the IBM shares at $140, but the exchange rate has dropped
suddenly to SEK/USD = 6.8. Ignoring commissions, what is the rate of return on the investment, in
dollars and kronas, gross and net of taxes? The Swedish investor is taxed at 50% on income and 15%
on capital gains; the U.S. withholding tax can be used as a tax credit in Sweden.
36 Solnik/McLeavey • Global Investments, Sixth Edition
3. You are the manager of an American pension fund and decide, on January 5, to buy 10,000 shares
of British Airways (BA) listed in London. You sell them on February 5. Here are the quotes that
you can use:
January 5
February 5
British Airways (£)
3.50–3.52
3.81–3.83
$/£
1.5000–1.5040
1.4500–1.4540
You must pay the U.K. broker a commission of 0.2% of the transaction value (on the purchase and on
the sale). There is a 0.5% U.K. securities transaction tax on purchase (but not on the sale); this tax
cannot be recovered. Foreign exchange rates are the net of commissions and taxes.
a. What is your dollar rate of return on the operation?
b. Would the rate of return be the same for a British investor using the British pound as a reference
currency?
4. You hold some shares of BMW listed in Frankfurt. The share price is €750, and a gross dividend
of €30 is paid. The current exchange rate is 1.15 $/€. The German government imposes a 15%
withholding tax on dividends paid to U.S. investors. Your marginal tax rate is 30%.
a. What dividend per share will you receive in U.S. dollars?
b. What tax will you have to pay to the U.S. government on the dividend received?
Solution
Chapter 5 Equity: Markets and Instruments 37
5. Your pension fund decides to invest in many national stock markets in a passive way. The objective
is to try to match the performance of the local market capitalization–weighted index in each country.
You do not buy national index funds but invest directly in companies listed on each market. Because
of the limited size of your portfolios, you can buy only a few issues in each market. In which national
markets are you likely to track the index well or poorly?
6. You are a U.S. investor and wish to buy 10,000 shares of Club Méditerranée (“Club Med”). You can
buy them on the Paris Bourse or on SEAQ International in London. You ask the brokers to quote you
net prices (no commissions paid). There are no taxes on foreign shares listed in London. Here are the
quotes:
London (in £)
31
44
56 57−
Paris (in €)
3
124
78 78−
$/£ (dollars per pound) 1.5000−1.5040
€/$ (euros per dollar) 0.91100−0.91200
a. What is your total dollar cost if you buy the Club Med shares at the cheaper place?
b. Are there arbitrage opportunities between London and Paris?
7. UBS AG is listed as an ADR on the New York Stock Exchange (NYSE) in dollars (USD). It is also
listed in Zurich in Swiss francs (CHF). Here are some quotes:
NYSE (in $)
3
128
107 108−
Zurich (in CHF) 187−188
CHF/$ (Swiss francs per dollar) 1.7360−1.7380
In addition, you have to pay a commission of 0.3% in New York or 0.5% in Zurich.
a. Where should you buy UBS shares if you are an American investor?
b. Where should you sell UBS shares if you are an American investor?
c. If all commissions were waived for a large transaction, would your answer be the same?
d. Answer the same questions for a Swiss investor.
38 Solnik/McLeavey • Global Investments, Sixth Edition
8. Which of the following characteristics of financial markets are good for investors?
I. Availability of timely and accurate information.
II. Liquidity.
III. Large bid–ask spreads.
IV. Rapid price adjustment to new information.
Chapter 5 Equity: Markets and Instruments 39
a. I and IV only.
b. II and III only.
c. I, II, and IV only.
d. I, II, III, and IV.
9. Which of the following statements best characterizes the taxation of returns on international
investments in an investor’s country and/or the country where the investment is made?
a. Capital gains normally are taxed only by the country where the investment is made.
b. Tax-exempt investors normally must pay taxes to the country where the investment is made.
c. Investors in non-U.S. common stock normally avoid double taxation on dividend income by
receiving a tax credit for taxes withheld by the country where the investment is made.
d. The investor’s country normally withholds taxes on dividend payments.
10. Vivendi Universal is a French firm listed on Euronext, the Paris Bourse. You can access the central
limit order book directly on the Internet and find the following information:
Sell Orders
Buy Orders
Quantity
Limit
Limit
Quantity
5,000
17.50
17.35
2,000
3,000
17.45
17.32
4,500
1,000
17.42
17.30
5,000
2,000
17.40
17.28
2,000
1,000
17.38
17.20
10,000
You wish to buy 2,000 shares and enter a market order to buy those shares. A market order has no
limit, so, it will be executed against the best matching order. At what price will you buy the shares?
11. Orders for Vivendi Universal have been entered on a crossing network for European shares. There is
one order from Participant A to buy 100,000 shares, one order from Participant B to buy 200,000 shares,
and one order from Participant C to sell 80,000 shares. Assume that the orders were entered in that
chronological order and that the network gives priority to the oldest orders. At the time specified for
the crossing session, Vivendi Universal is transacted at 17.40 euros on Euronext in Paris, its primary
market.
a. What trades would take place on the crossing network?
b. Assume now that all the orders are AON (all or nothing), meaning that the whole block has to be
traded at the same price. What trades would take place?
40 Solnik/McLeavey • Global Investments, Sixth Edition
12. Four companies belong to a group and are listed on a stock exchange. The cross-holdings of these
companies are as follows.
• Company A owns 30% of Company B and 10% of Company C.
• Company B owns 10% of Company C.
• Company C owns 10% of Company A, 10% of Company B, and 25% of Company D.
• Company D owns 10% of company B.
Each company has a market capitalization of $50 billion. You wish to adjust for cross-holding to
reflect the weights of these companies in a market-capitalization weighted index.
a. What adjustments would you make in the market capitalization of each company to reflect the
free float?
b. What would be the total adjusted market capitalization of the four companies?
13. An asset manager follows an active international asset allocation strategy. The average execution cost
for a buy or a sell order is forecasted at 0.6%. On average, the manager turns over the portfolio once a
year. Various administrative costs include a custodial cost amount of 0.5% per year of assets under
management. The annual management fee is 1% of assets under management. The annual expected
return before costs is 14% compared to an expected return of 10% on a passive global benchmark
(some global index).
a. What is the annual expected return net of execution costs?
b. What is the net annual expected return for the client?
c. Should the client expect the portfolio to outperform the global index used as a benchmark?
Chapter 5 Equity: Markets and Instruments 41
14. Paf is an emerging country with severe foreign investment restrictions but with an active stock market
open mostly to local investors. The exchange rate of the pif, the local currency, with the U.S. dollar
remains fixed at 1 pif/$. A closed-end country fund, called Pafy Country Fund, has been approved
by Paf. Its net asset value per share is $100. It trades in New York with a premium of 20% at $120.
Pafy Country Fund holds a well-diversified portfolio of Paf stocks and you expect the value of the
portfolio of Paf stocks held by the closed-end fund to closely track the local stock market index. A
few weeks later the Paf stock market has gone up by 10%. Media coverage has attracted attention to
the potential of the Paf economy, and the demand of Pafy Country Fund by U.S. investors, especially
pension funds, has been increasing; the premium has risen to 30%.
a. What is the new price of the fund listed in New York and the rate of return for an American
investor?
b. A few weeks later, Paf suffers from bad press coverage because of poor labor practices, such as
employing children. Several pension funds decide to sell their holdings in Pafy Country Fund for
ethical considerations. The premium drops to 10%.
c. Should those sales have an influence on the Paf stock market?
42 Solnik/McLeavey • Global Investments, Sixth Edition
15. Grupo Televisa S.A. is a Mexican firm listed in Mexico, with an American Depository Receipt
(ADR) traded on the NYSE. The stock prices are 300 pesos in Mexico, and 30 dollars in New York;
the exchange rate is 10 pesos per dollar. Suddenly, a political problem in Mexico leads to a
depreciation of the peso and a drop of the Mexican stock market. The new exchange rate is 11 pesos
per dollar, and the new stock price of Grupo Televisa is 275 pesos.
a. What should the price quoted in New York be?
b. Actually the stock price in New York is 20 dollars. Should you buy or sell the stock, and why?