Chapter 4
International Asset Pricing
1. According to the CAPM, expected return = 3.25 + 1.25(5.5) = 10.125%.
2. The total risk of the asset is 120%. The systematic risk = 0.92(90) = 72.9. Thus, the portion of total
4. a. Current real exchange rate = Can$1.46(1/1.46) = Can$1 per pound.
b. Real exchange rate one year later = Can$1.4308(1.04/1.4892) = Can$1 per pound.
5. a. Current real exchange rate = $1.80(1/3) = $0.60 per pound.
6. a. The current real exchange rate = $0.62(1.5/1) = $0.93 per Swiss franc. The inflation differential
between the United States and Switzerland is 2.5 percent. That is, U.S. inflation minus Swiss
inflation is –2.5 percent. Thus, for real exchange rates to remain the same, the Swiss franc would
20 Solnik/McLeavey • Global Investments, Sixth Edition
7. a. The current real exchange rate = 0.69(1/1.2) = £0.575 per U.S. dollar.
The inflation differential between the United Kingdom and the United States is 2.25 percent.
That is, U.K. inflation minus U.S. inflation is 2.25 percent. Thus, for real exchange rates to
8. a. The forward rate = 0.90(1.0315/1.0478) = $0.886 per euro.
b. The euro is trading at a forward discount = (0.886 − 0.90)/0.90 = −0.0156, or −1.56%.
9. If the U.S. firm invests funds (say, $1) in one-year U.S. bonds, at the end of one year it will have
1(1 + 0.0275) = $1.0275.
10. If the German firm invests funds (say, €1) in one-year euro bonds, at the end of one year it will have
1(1 + 0.0335) = €1.0335.
11. a. The interest rate differential (U.S. minus Swiss) = 0.0425 − 0.0375 = 0.005, or 0.50%. This
implies that the Swiss franc trades at a forward premium of 0.50 percent. That is, the forward
exchange rate is quoted at a premium of 0.50 percent over the spot exchange rate of $0.65 per
Chapter 4 International Asset Pricing 21
12. a. The interest rate differential (Swiss minus U.S.) = 0.0275 − 0.0525 = −0.025, or −2.50%. This
implies that the U.S. dollar trades at a forward discount of 2.50 percent. That is, the forward
13. a. The expected return for each of the stocks is calculated using the following version of the
ICAPM:
Thus, the expected returns for Stocks A, B, C, and D are
14. a. The derivation of the traditional CAPM relies on assumptions about investors’ expectations and
market perfection.
In the international context, tax differentials, high transaction costs, regulations, capital, and
15. a. From a U.S. dollar viewpoint, the currency exposure of a diversified Australian portfolio (similar
to the index) is equal to +0.5. The regression coefficient
A$
measures the sensitivity of the
22 Solnik/McLeavey • Global Investments, Sixth Edition
16. a. For Mega: Assume a sudden and unanticipated depreciation of the euro. Production costs are
unaffected in the short run; they stay constant in euros. Product prices stay constant in dollars and
therefore increase by 20 percent in euros. The earnings are vastly increased in the short run.
For Club: The short-run effect is opposite to that of Mega. The import costs rise while the
17. Because you want an asset whose price will go up if the Australian dollar depreciates, you would
18. a. In general, the short-term appreciation of the won versus the euro would make South Korean
goods more expensive to European buyers and would make European goods cheaper for South
Korean citizens.
The likely effect of a short-term appreciation of the won versus the euro on KoreaCo’s unit sales
margins through manipulation of such variable costs as labor and materials.
b. The traditional trade approach suggests that real exchange rate appreciation tends to reduce the
competitiveness of a domestic economy and, therefore, reduce domestic activity over time.
Worsening economic conditions resulting from reduced competitiveness would be expected to
Chapter 4 International Asset Pricing 23
19. The dollar value of the foreign bonds would rise because the foreign currency appreciates relative to
the dollar. Furthermore, many countries practice a “leaning against the wind” exchange rate policy.
20. The following are some arguments in favor of international bond diversification:
A rise in European inflationary anticipations is bad for European bond prices (increasing nominal
yields), but should not affect foreign bond prices. Because foreign economies are lagging the