Chapter 19 – Globalization and International Investing
CHAPTER 19
GLOBALIZATION AND INTERNATIONAL INVESTING
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
2. Which of the returns is more relevant to an investor depends on whether the investor
3. a. $10,000/$2 = £5,000
£5,000/£40 = 125 shares
The investor can buy 125 shares.
b. To fill in the table, we use the relation:
4. The standard deviation of the pound-denominated return (using 3 degrees of freedom)
5.
d. 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
£40
9,000
10,000
11,000
£45
10,125
11,250
12,375
Profits on Forward Exchange:
[ = 5000 (2.10 – E1)]
1,500
500
–500
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
£40
10,500
10,500
10,500
£45
11,625
11,750
11,875
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%
£40
5.00%
5.00%
5.00%
£45
16.25%
17.50%
18.75%
e. The standard deviation is now 10.24%. This is lower than the unhedged dollar-
denominated standard deviation, and is only slightly higher than the standard
deviation of the pound-denominated return.
6. Currency Selection
Chapter 19 – Globalization and International Investing
Country Selection
EAFE: (0.30 .20) + (0.10 .15) + (0.60 .25) = .225 or 22.50%
Stock Selection
7. 1 + r(US) = [1 + rf (UK)] (F0/E0) = 1.03 × (1.45/1.35) = 1.1063 r(US) = 10.63%
8. You can now purchase: $10,000/$1.35 = £7,407.41
9. Anaïve 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
Chapter 19 – Globalization and International Investing
CFA 1 Initial investment = 2,000 $1.50 = $3,000
CFA 4 a. The primary rationale is the opportunity for diversification. Factors that
contribute to low correlations of stock returns across national boundaries are
i. Imperfect correlation of business cycles.
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 and/or content than
the routinely available and widely understood U.S. data is difficult. Also, much
foreign data is reported with a considerable lag.
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 U.S.
norms) limited trading, and experience greater price volatility. Moreover, only a
(relatively) small number of individual foreign stocks enjoy liquidity comparable to
that in the U.S., although this situation is improving steadily.
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 assets outperformed
the S&P 500 Index measure of U.S. equity results with regard to both risk and return,
which is certainly an unexpected outcome. Within the equity area, non-U.S. stocks,
represented by the EAFE Index, outperformed U.S. stocks by a considerable margin
with only slightly more risk. In contrast to U.S. equities, this asset category performed
as it should relative to fixed income assets, providing more return for the higher risk
involved.
Chapter 19 – Globalization and International Investing
diversification and the differential covariances involved. In this case, the portfolio
CFA 5
The return on the Canadian bond is equal to the sum of
Coupon income +
Gain or loss from the premium or discount in the forward rate relative to the spot
exchange rate +
Capital gain or loss on the bond.
Over the six-month period, the return is
Chapter 19 – Globalization and International Investing
b. The dollar-hedged rate of return on default-free government securities in both Japan
CFA 7
a. Incorrect. There have been periods of strong performance despite weak currencies. It
is also possible that an appreciating currency could enhance performance.
CFA 8 a. The following arguments could be made in favor of active management:
Economic diversity: the diversity of the Otunian economy across various sectors may
offer the opportunity for the active investor to employ “top-down” sector timing
strategies.
Chapter 19 – Globalization and International Investing
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High transaction costs: indexing would be favored by the implied lower levels of trading
activity and costs.
Settlement problems: indexing would be favored by the implied lower levels of trading
activity and settlement requirements.
Financial disclosure and accounting standards: wide public availability of reliable
financial information presumably leads to greater market efficiency, reducing the value of
both fundamental analysis and active management, and favoring indexing.
Restrictions of capital flows: indexing would be favored by the implied lower levels of
trading activity and thus smaller opportunity for regulatory interference.
b. A recommendation for active management would focus on short-term inefficiencies in,
and long-term prospects for, the developing Otunian markets and economy,
inefficiencies and prospects which would not generally be found in more developed
markets.
A recommendation for indexing would focus on the factors of economic diversity, high
transaction costs, settlement delays, capital flow restrictions, and lower management
fees.