Solutions for Chapter 3: Questions and Problems
CHAPTER 3
SELECTING INVESTMENTS IN A GLOBAL MARKET
Answers to Questions
1. The major advantage of investing in common stocks is that generally an investor would
earn a higher return than on corporate bonds. Also, while the return on bonds is pre–
specified and fixed, the return on common stocks can be substantially higher if the
2. The three factors are:
(1) Limiting oneself to the Canadian securities market would imply effectively ignoring
more than 60% of the world securities market. Foreign markets have been growing in
3. International diversification reduces portfolio risk because of the low correlation of
4. There are different correlations of returns between securities from the Canadian and other
5. The correlations between Canadian stocks and stocks for different countries should
change over time because each country has a fairly independent set of economic policies.
Factors influencing the correlations include international trade, economic growth, fiscal
Solutions for Chapter 3: Questions and Problems
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6. The major risks that an investor must consider when investing in any bond issue are
business risk, financial risk and liquidity risk. Additional risk associated with foreign
7. The additional risks that some investors believe international investing introduces include
foreign exchange risk and country risk. For example, the Canadian bond returns were just
8. An investor can
9. The convertible bond of the growth company would have the lower yield. This is
intuitive because there is a greater potential for the price of the growth company stock to
10. Liquidity is the ability to buy or sell an asset quickly at a price similar to the prior price
assuming no new information has entered the market. Common stocks have the
advantage of liquidity since it is very easy to buy or sell a small position (there being a
large number of potential buyers) at a price not substantially different from the current
11. A warrant is an option issued by a corporation to buy a number of shares of the
corporation’s common stock at a specified price. Warrants typically have a life of several
years and could even by perpetual.
12. Art and antiques are considered illiquid investments because in most cases they are sold
at auctions. The implication of being traded at auctions rather than on a developed
exchange is that there is tremendous uncertainty regarding the price to be received and it
takes a long time to contact a buyer who offers the “right” price. Besides, many buyers of
13. The results of Exhibit 3.11 would tend to support adding some stocks from emerging
markets to your portfolio. The table indicates a low positive correlation, which implies
Solutions for Chapter 3: Questions and Problems
CHAPTER 3
Answers to Problems
1. Student Exercise
4. If inflation is 3%,
real rate of return = (1 + return)/ (1+ inflation rate) -1