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CHAPTER 25: INTERNATIONAL DIVERSIFICATION
CHAPTER 25: INTERNATIONAL DIVERSIFICATION
PROBLEM SETS
1. “International Investing Raises Questions” was published in The Wall Street
Journal in 1997. Some of the arguments presented in the article may no longer be
compelling more than a decade later. For example, the following statement from the
article is no longer true for many U.S. multinationals: “When you look at these
multinationals, the factor that drives their performance is their home market.” The
2. Which of the returns is more relevant to an investor depends on whether the
investor hedges the local currency. If the foreign exchange risk has been hedged,
b. To fill in the table, we use the relation:
1
0
E
E
Price per Pound-Denominated
Dollar-Denominated Return (%)
for Year-End Exchange Rate
Share (£)
Return (%)
$1.80/£
$2.00/£
$2.20/£
£35
-12.5%
-21.25%
-12.5%
-3.75%
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CHAPTER 25: INTERNATIONAL DIVERSIFICATION
c. The dollar-denominated return equals the pound-denominated return when the
exchange rate is unchanged over the year.
4. The standard deviation of the pound-denominated return (using 3 degrees of
5. a. First we calculate the dollar value of the 125 shares of stock in each scenario.
Then we add the profits from the forward contract in each scenario.
Price per
Dollar Value of Stock
at Given Exchange Rate
Share (£)
Exchange Rate:
$1.80/£
$2.00/£
$2.20/£
£35
7,875
8,750
9,625
Price per
Total Dollar Proceeds
at Given Exchange Rate
Share (£)
Exchange Rate:
$1.80/£
$2.00/£
$2.20/£
£35
9,375
9,250
9,125
Finally, calculate the dollar-denominated rate of return, recalling that the initial
investment was $10,000:
Price per
Rate of return (%)
at Given Exchange Rate
Share (£)
Exchange Rate:
$1.80/£
$2.00/£
$2.20/£
£35
-6.25%
-7.50%
-8.75%
b. The standard deviation is now 10.24%. This is lower than the unhedged
6. Currency Selection
Country Selection
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CHAPTER 25: INTERNATIONAL DIVERSIFICATION
Stock Selection
9. A naïve investment by an investor who resides in Foreign Country A might include
only a small fraction of the portfolio invested in the home country, and a relatively
greater weight invested in U.S. securities. This might not be an appropriate
approach for a foreign investor who is likely to be comfortable with a home bias,
CFA PROBLEMS
1. Initial investment = 2,000 $1.50 = $3,000
4. a. The primary rationale is the opportunity for diversification. Factors that
contribute to low correlations of stock returns across national boundaries are
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CHAPTER 25: INTERNATIONAL DIVERSIFICATION
b. Obstacles to international investing are
i. Availability of information, including insufficient data on which to base
investment decisions. Interpreting and evaluating data that is different in form
ii. Liquidity, in terms of the ability to buy or sell, in size and in a timely manner,
without affecting the market price. Most foreign exchanges offer (relative to
iii. Transaction costs, particularly when viewed as a combination of commission
c. The asset-class performance data for this particular period reveal that non-U.S.
dollar bonds provided a small incremental return advantage over U.S. dollar
bonds, but at a considerably higher level of risk. Each category of fixed income
Concerning the Account Performance Index, its position on the graph reveals an
aggregate outcome that is superior to the sum of its component parts. To some
5. The return on the Canadian bond is equal to the sum of
Coupon income +
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CHAPTER 25: INTERNATIONAL DIVERSIFICATION
Over the six-month period, the return is
Coupon + Forward premium/Discount + Capital gain =
%)75.0(
2
%50.7
Price change in % = 3.00% + % capital gain
The expected semiannual return on the U.S. bond is 3.25%. Since the U.S. bond is
selling at par and its yield is expected to remain unchanged, there is no expected capital
6. a. We exchange $1 million for foreign currency at the current exchange rate and sell
forward the amount of foreign currency we will accumulate 90 days from now. For
the yen investment, we initially receive:
Invest for 90 days to accumulate:
(Note that we divide the quoted 90-day rate by 4 because quoted money
If we sell this number of yen forward at the forward exchange rate of
Similarly, the dollar proceeds from the 90-day Canadian dollar investment will be
0148.1$7269.0
4
0674.0
1
7284.0
million 1$
million
The 90-day dollar interest rate is 1.48%, the same as that in the yen investment.
b. The dollar-hedged rate of return on default-free government securities in both
Japan and Canada is 1.48%. Therefore, the 90-day interest rate available on
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CHAPTER 25: INTERNATIONAL DIVERSIFICATION
7. a. Incorrect. There have been periods of strong performance despite weak
8. a. The following arguments could be made in favor of active management:
Economic diversity: the diversity of the Otunian economy across various sectors
High transaction costs: very high transaction costs may discourage trading activity
Good financial disclosure and detailed accounting standards: good financial
Capital restrictions: restrictions on capital flows may discourage foreign investor
Developing economy and securities market: developing economies and markets are
Settlement problems: long delays in settling trades by nonresidents may serve to
Economic diversity: economic diversity across a broad sector of industries implies
High transaction costs: indexing would be favored by the implied lower levels of
Settlement problems: indexing would be favored by the implied lower levels of
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CHAPTER 25: INTERNATIONAL DIVERSIFICATION
Financial disclosure and accounting standards: wide public availability of reliable
Restrictions of capital flows: indexing would be favored by the implied lower
b. A recommendation for active management would focus on short-term
A recommendation for indexing would focus on the factors of economic diversity,
25-7
