Chapte_25_InternationalDiversification Finance

Chapter 25 - International Diversification

25-1

Chapter 25

International Diversification

Multiple Choice Questions

1. Shares of several foreign firms are traded in the U. S. markets in the form of

A. ADRs.

B. ECUs.

C. single-country funds.

D. All of these are correct.

E. None of these is correct.

2. __________ refers to the possibility of expropriation of assets, changes in tax policy, and

the possibility of restrictions on foreign exchange transactions.

A. Default risk

B. Foreign exchange risk

C. Market risk

D. Political risk


3. __________ are mutual funds that invest in one country only.

A. ADRs

B. ECUs

C. Single-country funds



4. The performance of an internationally diversified portfolio may be affected by

A. country selection

B. currency selection

C. stock selection




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5. Over the period 2000–2009, most correlations between the U.S. stock index and stock-

index portfolios of other countries were

A. negative.

B. positive but less than .9.

C. approximately zero.

D. .9 or above.


6. The __________ index is a widely used index of non-U.S. stocks.

A. CBOE

B. Dow Jones

C. EAFE



7. The __________ equity market had the highest average local currency excess return

between 2000 and 2009.

A. Columbian

B. Norwegian

C. U.K.

D. U.S.


8. The developed country with the highest average local-currency equity-market excess return

between 2000 and 2009 is

A. Japan

B. Korea

C. U.K.

D. U.S.



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9. The emerging market country with the highest average local-currency equity-market excess

return between 2000 and 2009 is

A. China

B. Columbia

C. Poland

D. Turkey


10. The __________ equity market had the highest average U.S. dollar excess return between

2000 and 2009.

A. Russian

B. Finnish

C. Columbian

D. U.S.


11. The developed country with the highest average U.S. dollar equity-market excess return


A. Japan

B. Norway

C. Austria

D. U.S.


12. The emerging market country with the highest average U.S. dollar equity-market excess


A. China

B. Columbia

C. Poland

D. Turkey



25-4

13. The __________ equity market had the lowest average local currency excess return


A. Columbian

B. Ireland

C. U.K.

D. U.S.


14. The developed country with the lowest average local-currency equity-market excess


A. Ireland

B. Korea

C. U.K.

D. U.S.


15. The emerging market country with the lowest average local-currency equity-market

excess return between 2000 and 2009 is

A. Taiwan

B. Columbia

C. Poland

D. Turkey


16. The __________ equity market had the lowest average U.S. dollar excess return between

2000 and 2009.

A. Russian

B. Finnish

C. Columbian

D. Irish



25-5

17. The developed country with the lowest average U.S. dollar equity-market excess return


A. Japan

B. Korea

C. Austria

D. Ireland


18. The emerging market country with the lowest average U.S. dollar equity-market excess


A. China

B. Russia

C. Poland

D. Taiwan


19. The __________ equity market had the highest average U.S. dollar standard deviation of

excess returns between 2000 and 2009.

A. Turkish

B. Finnish

C. Indonesian

D. U.S.


20. The __________ equity market had the lowest average U.S. dollar standard deviation of


A. Turkish

B. U.S.

C. Indonesian

D. U.K.



25-6

21. The __________ equity market had the highest average local currency standard deviation

of excess returns between 2000 and 2009.

A. Turkish

B. Finnish

C. Indonesian

D. U.S.


22. The __________ equity market had the lowest average local currency standard deviation


A. Turkish

B. Finnish

C. Indonesian

D. Australia


23. In 2009, the U. S. equity market represented __________ of the world equity market.

A. 19%

B. 60%

C. 43%

D. 33%


24. The straightforward generalization of the simple CAPM to international stocks is

problematic because __________.

A. inflation risk perceptions by different investors in different countries will differ as

consumption baskets differ

B. investors in different countries view exchange rate risk from the perspective of different

domestic currencies

C. taxes, transaction costs and capital barriers across countries make it difficult for investor to

hold a world index portfolio




25-7

25. The yield on a 1-year bill in the U. K. is 8% and the present exchange rate is 1 pound = U.

S. $1.60. If you expect the exchange rate to be 1 pound = U. S. $1.50 a year from now, the

return a U. S. investor can expect to earn by investing in U. K. bills is

A. −6.7%.

B. 0%.

C. 8%.

D. 1.25%.


26. Suppose the 1-year risk-free rate of return in the U. S. is 5%. The current exchange rate is

1 pound = U. S. $1.60. The 1-year forward rate is 1 pound = $1.57. What is the minimum

yield on a 1-year risk-free security in Britain that would induce a U. S. investor to invest in

the British security?

A. 2.44%

B. 2.50%

C. 7.00%

D. 7.62%


27. The interest rate on a 1-year Canadian security is 8%. The current exchange rate is C$ =

US $0.78. The 1-year forward rate is C$ = US $0.76. The return (denominated in U. S. $) that

a U. S. investor can earn by investing in the Canadian security is __________.

A. 3.59%

B. 4.00%

C. 5.23%

D. 8.46%



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28. Suppose the 1-year risk-free rate of return in the U. S. is 4% and the 1-year risk-free rate

of return in Britain is 7%. The current exchange rate is 1 pound = U. S. $1.65. A 1-year future

exchange rate of __________ for the pound would make a U. S. investor indifferent between

investing in the U. S. security and investing the British security.

A. 1.6037

B. 2.0411

C. 1.7500

D. 2.3369


29. The present exchange rate is C$ = U. S. $0.78. The one year future rate is C$ = U. S.

$0.76. The yield on a 1-year U. S. bill is 4%. A yield of __________ on a 1-year Canadian

bill will make investor indifferent between investing in the U. S. bill and the Canadian bill.

A. 2.4%

B. 1.3%

C. 6.4%

D. 6.7%


Assume there is a fixed exchange rate between the Canadian and U. S. dollar. The expected

return and standard deviation of return on the U. S. stock market are 18% and 15%,

respectively. The expected return and standard deviation on the Canadian stock market are

13% and 20%, respectively. The covariance of returns between the U. S. and Canadian stock

markets is 1.5%.

30. If you invested 50% of your money in the Canadian stock market and 50% in the U. S.

stock market, the expected return on your portfolio would be __________.

A. 12.0%

B. 12.5%

C. 13.0%

D. 15.5%



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stock market, the standard deviation of return of your portfolio would be __________.

A. 12.53%

B. 15.21%

C. 17.50%

D. 18.75%


32. The major concern that has been raised with respect to the weighting of countries within

the EAFE index is

A. currency volatilities are not considered in the weighting.

B. cross-correlations are not considered in the weighting.

C. inflation is not represented in the weighting.

D. the weights are not proportional to the asset bases of the respective countries.


33. You are a U. S. investor who purchased British securities for 2,000 pounds one year ago

when the British pound cost $1.50. No dividends were paid on the British securities in the

past year. Your total return based on U. S. dollars was __________ if the value of the

securities is now 2,400 pounds and the pound is worth $1.60.

A. 16.7%

B. 20.0%

C. 28.0%

D. 40.0%



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34. U. S. investors

A. can trade derivative securities based on prices in foreign security markets.

B. cannot trade foreign derivative securities.

C. can trade options and futures on the Nikkei stock index of 225 stocks traded on the Tokyo

stock exchange and on FTSE (Financial Times Share Exchange) indexes of U. K. and

European stocks.

D. can trade derivative securities based on prices in foreign security markets and can trade

options and futures on the Nikkei stock index of 225 stocks traded on the Tokyo stock

exchange and on FTSE (Financial Times Share Exchange) indexes of U. K. and European

stocks.


35. Exchange rate risk

A. results from changes in the exchange rates between the currency of the investor and the

country in which the investment is made.

B. can be hedged by using a forward or futures contract in foreign exchange.

C. cannot be eliminated.

D. results from changes in the exchange rates between the currency of the investor and the

country in which the investment is made and cannot be eliminated.

E. results from changes in the exchange rates between the currency of the investor and the

country in which the investment is made and can be hedged by using a forward or futures

contract in foreign exchange.

36. International investing

A. cannot be measured against a passive benchmark, such as the S&P 500.

B. can be measured against a widely used index of non-U. S. stocks, the EAFE index (Europe,

Australia, Far East).

C. can be measured against international indexes.

D. can be measured against a widely used index of non-U. S. stocks, the EAFE index (Europe,

Australia, Far East) and can be measured against international indexes.



25-11

37. Investors looking for effective international diversification should

A. invest about 60% of their money in foreign stocks.

B. invest the same percentage of their money in foreign stocks that foreign equities represent

in the world equity market.

C. frequently hedge currency exposure.

D. invest about 60% of their money in foreign stocks and invest the same percentage of their

money in foreign stocks that foreign equities represent in the world equity market.


The manager of Quantitative International Fund uses EAFE as a benchmark. Last year's

performance for the fund and the benchmark were as follows:

38. Calculate Quantitative's currency selection return contribution.

A. +20%

B. −5%

C. +15%

D. +5%

E. −10%

39. Calculate Quantitative's country selection return contribution.

A. 12.5%

B. −12.5%

C. 11.25%

D. −1.25%

E. 1.25%


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40. Calculate Quantitative's stock selection return contribution.

A. 1.0%

B. −1.0%

C. 3.0%

D. 0.25%


41. Using the S&P500 portfolio as a proxy of the market portfolio

A. is appropriate because U.S. securities represent more than 60% of world equities.

B. is appropriate because most U.S. investors are primarily interested in U.S. securities.

C. is appropriate because most U.S. and non-U.S. investors are primarily interested in U.S.

securities.

D. is inappropriate because U.S. securities make up less than 40% of world equities.

E. is inappropriate because the average U.S. investor has less than 20% of her portfolio in

non-U.S. equities.

42. The average country equity market share is

A. less than 2%.

B. between 3% and 4%.

C. between 5% and 7%.

D. between 7% and 8%.

E. greater than 8%.

43. When an investor adds international stocks to her U. S. stock portfolio,

A. it will raise her risk relative to the risk she would face just holding U.S. stocks.

B. she can reduce the risk of her portfolio.

C. she will increase her expected return, but must also take on more risk.

D. it will have no impact on either the risk or the return of her portfolio.

E. she needs to seek professional management because she doesn't have access to

international investments on her own.


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44. Which of the following countries has an equity index that lies on the efficient frontier

generated by allowing international diversification?

A. The United States

B. The United Kingdom

C. Japan

D. Norway

E. None of these is correct—each of these countries' indexes fall inside the efficient frontier.

45. "ADRs" stands for ___________ and "WEBS" stands for ____________.

A. Additional Dollar Returns; Weekly Equity and Bond Survey

B. Additional Daily Returns; World Equity and Bond Survey

C. American Dollar Returns; World Equity and Bond Statistics

D. American Depository Receipts; World Equity Benchmark Shares

E. Adjusted Dollar Returns; Weighted Equity Benchmark Shares

46. WEBS portfolios

A. are passively managed.

B. are shares that can be sold by investors.

C. are free from brokerage commissions.

D. are passively managed and are shares that can be sold by investors.

E. are passively managed, are shares that can be sold by investors, and are free from

brokerage commissions.

47. The EAFE is

A. the East Asia Foreign Equity index.

B. the Economic Advisor's Foreign Estimator index.

C. the European and Asian Foreign Equity index.

D. the European, Asian, French Equity index.

E. the European, Australian, Far East index.


25-14

48. Home bias refers to

A. the tendency to vacation in your home country instead of traveling abroad.

B. the tendency to believe that your home country is better than other countries.

C. the tendency to give preferential treatment to people from your home country.

D. the tendency to overweight investments in your home country.


Short Answer Questions

49. Discuss performance evaluation of international portfolio managers in terms of potential

sources of abnormal returns.

50. Discuss some of the factors that might be included in a multifactor model of security

returns in an international application of arbitrage pricing theory (APT).


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51. Marla holds her portfolio 100% in U.S. securities. She tells you that she believes foreign

investing can be extremely hazardous to her portfolio. She's not sure about the details, but has

"heard some things". Discuss this idea with Marla by listing three objections you have heard

from your clients who have similar fears. Explain each of the objections is subject to faulty

reasoning.

52. You are managing a portfolio that consists of U.S. equities. You have prepared a

presentation to use when you discuss the possibility of adding international stocks to your

client's portfolio.

- Draw a graph that shows the risk of the portfolio relative to the number of stocks held in the

portfolio.

- When your client arrives, he is surprised at your suggestion that he add international stocks,

but is willing to listen to your statements to justify your recommendations. State two reasons

for why he should consider the international stocks and briefly explain each.


25-16

Chapter 25 International Diversification Answer Key

Multiple Choice Questions

1. Shares of several foreign firms are traded in the U. S. markets in the form of

A. ADRs

B. ECUs

C. single-country funds

D. All of these are correct

E. None of these is correct

American Depository Receipts (ADRs) allow U.S. investors to invest in foreign stocks via

transactions on the U.S. stock exchanges.

AACSB: Analytic

Bloom's: Remember

Difficulty: Basic Topic: International investing

2. __________ refers to the possibility of expropriation of assets, changes in tax policy, and

the possibility of restrictions on foreign exchange transactions.

A. Default risk

B. Foreign exchange risk

C. Market risk

D. Political risk


All of these factors are political in nature, and thus are examples of political risk.

AACSB: Analytic Bloom's: Remember

Difficulty: Basic

Topic: International investing


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3. __________ are mutual funds that invest in one country only.

A. ADRs

B. ECUs

C. Single-country funds



Mutual funds that invest in the stocks of one country only are called single-country funds.

AACSB: Analytic

Bloom's: Remember Difficulty: Basic


4. The performance of an internationally diversified portfolio may be affected by

A. country selection

B. currency selection

C. stock selection



All listed factors may affect the performance of an international portfolio.

AACSB: Analytic

Bloom's: Remember



25-18

5. Over the period 2000-2009, most correlations between the U.S. stock index and stock-index

portfolios of other countries were

A. negative

B. positive but less than .9

C. approximately zero

D. .9 or above


Correlation coefficients were typically below .9.

AACSB: Analytic

Bloom's: Remember Difficulty: Intermediate


6. The __________ index is a widely used index of non-U. S. stocks.

A. CBOE

B. Dow Jones

C. EAFE



The Europe, Australia, Far East (EAFE) index computed by Morgan Stanley is a widely used

index of non-U.S. stocks.

AACSB: Analytic

Bloom's: Remember



25-19

7. The __________ equity market had the highest average local currency excess return


A. Columbian

B. Norwegian

C. U. K.

D. U. S.


See Table 25.9.

AACSB: Analytic



8. The developed country with the highest average local-currency equity-market excess return


A. Japan

B. Korea

C. U. K.

D. U. S.


See Table 25.9.

AACSB: Analytic

Bloom's: Remember

Difficulty: Intermediate Topic: International investing


25-20

9. The emerging market country with the highest average local-currency equity-market excess


A. China

B. Columbia

C. Poland

D. Turkey


See Table 25.9.

AACSB: Analytic



10. The __________ equity market had the highest average U.S. dollar excess return between

2000 and 2009.

A. Russian

B. Finnish

C. Columbian

D. U. S.


See Table 25.9.

AACSB: Analytic

Bloom's: Remember



25-21

11. The developed country with the highest average U.S. dollar equity-market excess return


A. Japan

B. Norway

C. Austria

D. U. S.


See Table 25.9.

AACSB: Analytic



12. The emerging market country with the highest average U.S. dollar equity-market excess


A. China

B. Columbia

C. Poland

D. Turkey


See Table 25.9.

AACSB: Analytic

Bloom's: Remember



25-22

13. The __________ equity market had the lowest average local currency excess return


A. Columbian

B. Ireland

C. U. K.

D. U. S.


See Table 25.9.

AACSB: Analytic



14. The developed country with the lowest average local-currency equity-market excess


A. Ireland

B. Korea

C. U. K.

D. U. S.


See Table 25.9.

AACSB: Analytic

Bloom's: Remember



25-23

15. The emerging market country with the lowest average local-currency equity-market

excess return between 2000 and 2009 is

A. Taiwan

B. Columbia

C. Poland

D. Turkey


See Table 25.9.

AACSB: Analytic



16. The __________ equity market had the lowest average U.S. dollar excess return between

2000 and 2009.

A. Russian

B. Finnish

C. Columbian

D. Irish


See Table 25.9.

AACSB: Analytic

Bloom's: Remember



25-24

17. The developed country with the lowest average U.S. dollar equity-market excess return


A. Japan

B. Korea

C. Austria

D. Ireland


See Table 25.9.

AACSB: Analytic



18. The emerging market country with the lowest average U.S. dollar equity-market excess


A. China

B. Russia

C. Poland

D. Taiwan


See Table 25.9.

AACSB: Analytic

Bloom's: Remember



25-25

19. The __________ equity market had the highest average U.S. dollar standard deviation of


A. Turkish

B. Finnish

C. Indonesian

D. U. S.


See Table 25.9.

AACSB: Analytic



20. The __________ equity market had the lowest average U.S. dollar standard deviation of


A. Turkish

B. U. S.

C. Indonesian

D. U. K.


See Table 25.9.

AACSB: Analytic

Bloom's: Remember



25-26

21. The __________ equity market had the highest average local currency standard deviation


A. Turkish

B. Finnish

C. Indonesian

D. U. S.


See Table 25.9.

AACSB: Analytic



22. The __________ equity market had the lowest average local currency standard deviation


A. Turkish

B. Finnish

C. Indonesian

D. Australia


See Table 25.9.

AACSB: Analytic

Bloom's: Remember



25-27

23. In 2009, the U. S. equity market represented __________ of the world equity market.

A. 19%

B. 60%

C. 43%

D. 33%


See Table 25.1.

AACSB: Analytic



24. The straightforward generalization of the simple CAPM to international stocks is

problematic because __________.

A. inflation risk perceptions by different investors in different countries will differ as

consumption baskets differ

B. investors in different countries view exchange rate risk from the perspective of different

domestic currencies

C. taxes, transaction costs and capital barriers across countries make it difficult for investor to

hold a world index portfolio



All of these factors make a broad generalization of the CAPM to international stocks

problematic.

AACSB: Analytic

Bloom's: Remember



25-28

25. The yield on a 1-year bill in the U. K. is 8% and the present exchange rate is 1 pound = U.

S. $1.60. If you expect the exchange rate to be 1 pound = U. S. $1.50 a year from now, the

return a U. S. investor can expect to earn by investing in U. K. bills is

A. -6.7%

B. 0%

C. 8%

D. 1.25%


r(US) = [1 + r(UK)]F0/E0 − 1; [1.08][1.50/1.60] − 1 = 1.25%.

AACSB: Analytic

Bloom's: Apply Difficulty: Intermediate


26. Suppose the 1-year risk-free rate of return in the U. S. is 5%. The current exchange rate is

1 pound = U. S. $1.60. The 1-year forward rate is 1 pound = $1.57. What is the minimum

yield on a 1-year risk-free security in Britain that would induce a U. S. investor to invest in

the British security?

A. 2.44%

B. 2.50%

C. 7.00%

D. 7.62%


1.05 = (1 + r) × [1.57/1.60] − 1; r = 7.0%.

AACSB: Analytic

Bloom's: Apply



25-29

27. The interest rate on a 1-year Canadian security is 8%. The current exchange rate is C$ =

US $0.78. The 1-year forward rate is C$ = US $0.76. The return (denominated in U. S. $) that

a U. S. investor can earn by investing in the Canadian security is __________.

A. 3.59%

B. 4.00%

C. 5.23%

D. 8.46%


1.08[0.76/0.78] = x − 1; x = 5.23%.

AACSB: Analytic



28. Suppose the 1-year risk-free rate of return in the U. S. is 4% and the 1-year risk-free rate

of return in Britain is 7%. The current exchange rate is 1 pound = U. S. $1.65. A 1-year future

exchange rate of __________ for the pound would make a U. S. investor indifferent between

investing in the U. S. security and investing the British security.

A. 1.6037

B. 2.0411

C. 1.7500

D. 2.3369


1.04/1.07 = x/1.65; x = 1.6037.

AACSB: Analytic

Bloom's: Apply



25-30

29. The present exchange rate is C$ = U. S. $0.78. The one year future rate is C$ = U. S.

$0.76. The yield on a 1-year U. S. bill is 4%. A yield of __________ on a 1-year Canadian

bill will make investor indifferent between investing in the U. S. bill and the Canadian bill.

A. 2.4%

B. 1.3%

C. 6.4%

D. 6.7%


1.04 = [($0.76/$0.78)(1 + r)] − 1; r = 6.7%.

AACSB: Analytic



Assume there is a fixed exchange rate between the Canadian and U. S. dollar. The expected

return and standard deviation of return on the U. S. stock market are 18% and 15%,

respectively. The expected return and standard deviation on the Canadian stock market are

13% and 20%, respectively. The covariance of returns between the U. S. and Canadian stock

markets is 1.5%.


stock market, the expected return on your portfolio would be __________.

A. 12.0%

B. 12.5%

C. 13.0%

D. 15.5%


18% (0.5) + 13%(0.5) = 15.5%.

AACSB: Analytic

Bloom's: Apply



25-31


stock market, the standard deviation of return of your portfolio would be __________.

A. 12.53%

B. 15.21%

C. 17.50%

D. 18.75%


sP = [(0.5)2(15%)2 + (0.5)2(20%)2 + 2(0.5)(0.5)(1.5)]1/2 = 12.53%.

AACSB: Analytic

Bloom's: Apply Difficulty: Challenge


32. The major concern that has been raised with respect to the weighting of countries within

the EAFE index is

A. currency volatilities are not considered in the weighting.

B. cross-correlations are not considered in the weighting.

C. inflation is not represented in the weighting.

D. the weights are not proportional to the asset bases of the respective countries.


Some argue that countries should be weighted in proportion to their GDP to properly adjust

for the true size of their corporate sectors, since many firms are not publicly traded.

AACSB: Analytic

Bloom's: Remember



25-32

33. You are a U. S. investor who purchased British securities for 2,000 pounds one year ago

when the British pound cost $1.50. No dividends were paid on the British securities in the

past year. Your total return based on U. S. dollars was __________ if the value of the

securities is now 2,400 pounds and the pound is worth $1.60.

A. 16.7%

B. 20.0%

C. 28.0%

D. 40.0%


($3,840 − $3,000)/$3,000 = 0.28, or 28.0%.

AACSB: Analytic



34. U. S. investors

A. can trade derivative securities based on prices in foreign security markets.

B. cannot trade foreign derivative securities.

C. can trade options and futures on the Nikkei stock index of 225 stocks traded on the Tokyo

stock exchange and on FTSE (Financial Times Share Exchange) indexes of U. K. and

European stocks.

D. can trade derivative securities based on prices in foreign security markets and can trade

options and futures on the Nikkei stock index of 225 stocks traded on the Tokyo stock

exchange and on FTSE (Financial Times Share Exchange) indexes of U. K. and European

stocks.


U. S. investors can invest as indicated in A, examples of which are given in C.

AACSB: Analytic

Bloom's: Remember



25-33

35. Exchange rate risk

A. results from changes in the exchange rates between the currency of the investor and the

country in which the investment is made.

B. can be hedged by using a forward or futures contract in foreign exchange.

C. cannot be eliminated.

D. results from changes in the exchange rates between the currency of the investor and the

country in which the investment is made and cannot be eliminated.

E. results from changes in the exchange rates between the currency of the investor and the

country in which the investment is made and can be hedged by using a forward or futures

contract in foreign exchange.

Although international investing involves risk resulting from the changing exchange rates

between currencies, this risk can be hedged by using a forward or futures contract in foreign

exchange.

AACSB: Analytic



36. International investing

A. cannot be measured against a passive benchmark, such as the S&P 500.

B. can be measured against a widely used index of non-U. S. stocks, the EAFE index (Europe,

Australia, Far East).

C. can be measured against international indexes.

D. can be measured against a widely used index of non-U. S. stocks, the EAFE index (Europe,

Australia, Far East) and can be measured against international indexes.


International investments can be evaluated against an international index, such as EAFE,

created by Morgan Stanley, and others that have become available in recent years.

AACSB: Analytic

Bloom's: Remember



25-34

37. Investors looking for effective international diversification should

A. invest about 60% of their money in foreign stocks.

B. invest the same percentage of their money in foreign stocks that foreign equities represent

in the world equity market.

C. frequently hedge currency exposure.

D. invest about 60% of their money in foreign stocks and invest the same percentage of their

money in foreign stocks that foreign equities represent in the world equity market.


None of these is correct.

AACSB: Analytic



The manager of Quantitative International Fund uses EAFE as a benchmark. Last year's

performance for the fund and the benchmark were as follows:


25-35

38. Calculate Quantitative's currency selection return contribution.

A. +20%

B. -5%

C. +15%

D. +5%

E. -10%

EAFE: (.30)(10%) + (.10)(−10%) + (.60)(30%) = 20% appreciation; Diversified: (.25)(10%) +

(.25)(−10%) + (.50)(30%) = 15% appreciation; Loss of 5% relative to EAFE.

AACSB: Analytic Bloom's: Apply

Difficulty: Challenge


39. Calculate Quantitative's country selection return contribution.

A. 12.5%

B. -12.5%

C. 11.25%

D. -1.25%

E. 1.25%

EAFE: (.30)(10%) + (.10)(5%) + (.60)(15%) = 12.5%; Diversified: (.25)(10%) + (.25)(5%) +

(.50)(15%) = 11.25%; Loss of 1.25% relative to EAFE.

AACSB: Analytic

Bloom's: Apply

Difficulty: Challenge Topic: International investing


25-36

40. Calculate Quantitative's stock selection return contribution.

A. 1.0%

B. -1.0%

C. 3.0%

D. 0.25%


(9% − 10%).25 + (8% − 5%).25 + (16% − 15%).50 = 1.00%

AACSB: Analytic



41. Using the S&P500 portfolio as a proxy of the market portfolio

A. is appropriate because U.S. securities represent more than 60% of world equities.

B. is appropriate because most U.S. investors are primarily interested in U.S. securities.

C. is appropriate because most U.S. and non-U.S. investors are primarily interested in U.S.

securities.

D. is inappropriate because U.S. securities make up less than 40% of world equities.

E. is inappropriate because the average U.S. investor has less than 20% of her portfolio in

non-U.S. equities.

It is important to take a global perspective when making investment decisions. The S&P500 is

increasingly inappropriate.

AACSB: Analytic

Bloom's: Remember



25-37

42. The average country equity market share is

A. less than 2%

B. between 3% and 4%

C. between 5% and 7%

D. between 7% and 8%

E. greater than 8%

This is stated in the text and confirmed by Table 25.1.

AACSB: Analytic



43. When an investor adds international stocks to her U. S. stock portfolio

A. it will raise her risk relative to the risk she would face just holding U.S. stocks.

B. she can reduce the risk of her portfolio.

C. she will increase her expected return, but must also take on more risk.

D. it will have no impact on either the risk or the return of her portfolio.

E. she needs to seek professional management because she doesn't have access to

international investments on her own.

See Figure 25.1.

AACSB: Analytic

Bloom's: Remember



25-38

44. Which of the following countries has an equity index that lies on the efficient frontier

generated by allowing international diversification?

A. The United States

B. The United Kingdom

C. Japan

D. Norway

E. None of these is correct - each of these countries' indexes fall inside the efficient frontier.

See Figure 25.8. To get to the efficient frontier you would need to combine the countries'

indexes.

AACSB: Analytic



45. "ADRs" stands for ___________ and "WEBS" stands for ____________.

A. Additional Dollar Returns; Weekly Equity and Bond Survey

B. Additional Daily Returns; World Equity and Bond Survey

C. American Dollar Returns; World Equity and Bond Statistics

D. American Depository Receipts; World Equity Benchmark Shares

E. Adjusted Dollar Returns; Weighted Equity Benchmark Shares

The student should be familiar with these basic terms that relate to international investing.

AACSB: Analytic

Bloom's: Remember



25-39

46. WEBS portfolios

A. are passively managed.

B. are shares that can be sold by investors.

C. are free from brokerage commissions.

D. are passively managed and are shares that can be sold by investors

E. are passively managed, are shares that can be sold by investors, and are free from

brokerage commissions

They are passively managed and when holders want to divest their shares they sell them rather

than redeeming them with the company that issued them. There are brokerage commissions,

however.

AACSB: Analytic



47. The EAFE is

A. the East Asia Foreign Equity index.

B. the Economic Advisor's Foreign Estimator index.

C. the European and Asian Foreign Equity index.

D. the European, Asian, French Equity index.

E. the European, Australian, Far East index.

The index is one of several world equity indices that exist. It is computed by Morgan Stanley.

AACSB: Analytic

Bloom's: Remember



25-40

48. Home bias refers to

A. the tendency to vacation in your home country instead of traveling abroad.

B. the tendency to believe that your home country is better than other countries.

C. the tendency to give preferential treatment to people from your home country.

D. the tendency to overweight investments in your home country.


Home bias refers to the tendency to overweight investments in your home country.

AACSB: Analytic

Bloom's: Remember Difficulty: Basic


Short Answer Questions

49. Discuss performance evaluation of international portfolio managers in terms of potential

sources of abnormal returns.

The following factors may be measured to determine the performance of an international

portfolio manager.

(A) Currency selection: a benchmark might be the weighted average of the currency

appreciation of the currencies represented in the EAFE portfolio.

(B) Country selection measures the contribution to performance attributable to investing in

the better-performing stock markets of the world. Country selection can be measured as the

weighted average of the equity index returns of each country using as weights the share of the

manager's portfolio in each country.

(C) Stock selection ability may be measured as the weighted average of equity returns in

excess of the equity index in each country.

(D) Cash/bond selection may be measured as the excess return derived from weighting bonds

and bills differently from some benchmark weights.

Feedback: The rationale for this question is to determine the student's understanding of

evaluating the various components of potential abnormal returns resulting from actively

managing an international portfolio.

AACSB: Reflective Thinking

Bloom's: Understand



25-41

50. Discuss some of the factors that might be included in a multifactor model of security

returns in an international application of arbitrage pricing theory (APT).

Some of the factors that might be considered in a multifactor international APT model are:

(A) A world stock index

(B) A national (domestic) stock index

(C) Industrial/sector indexes

(D) Currency movements.

Studies have indicated that domestic factors appear to be the dominant influence on stock

returns. However, there is clear evidence of a world market factor during the market crash of

October 1987.

Feedback: The rationale for this question is to determine the student's understanding of the

possible effects of various factors on an international portfolio.


Bloom's: Understand Difficulty: Intermediate



25-42

51. Marla holds her portfolio 100% in U.S. securities. She tells you that she believes foreign

investing can be extremely hazardous to her portfolio. She's not sure about the details, but has

"heard some things". Discuss this idea with Marla by listing three objections you have heard

from your clients who have similar fears. Explain each of the objections is subject to faulty

reasoning.

A few of the factors students may mention are

- Client: "The U.S. markets have done extremely well in the past few years, so I should stay

100% invested in them." Your Reply: You can explain that there are other times when foreign

markets have beat the U.S. substantially in performance. You can't tell easily beforehand what

markets will do the best. It is important to consider that there are many times when countries'

markets move in different directions and you can buffer your risk to some extent by investing

globally.

- Client: "You should keep your money at home." Your Reply: Don't confuse familiarity with

good portfolio management. Even though there is a lot of information available on U.S.

companies, it can be difficult to use the information to make good forecasts. Most

professional managers aren't even good at this.

- Client: "There's too much currency risk." Your Reply: It is true that there may be times

when both a security's value and the currency exchange rate may lead to poor returns. But the

opposite is also true. And there are cases when security price movements and currency

movements will have opposite impacts on your portfolio's return. This may have a smoothing

effect on your portfolio.

- Client: "Invest with the best." Your Reply: Even if U.S. markets have been the best

performers in recent periods there is no guarantee that things will stay that way. If you

diversify internationally you will benefit when other markets take the lead.

Feedback: This question tests the student's knowledge of the importance of international

diversification.

AACSB: Reflective Thinking Bloom's: Understand

Difficulty: Intermediate



25-43

52. You are managing a portfolio that consists of U.S. equities. You have prepared a

presentation to use when you discuss the possibility of adding international stocks to your

client's portfolio.

- Draw a graph that shows the risk of the portfolio relative to the number of stocks held in the

portfolio.

- When your client arrives, he is surprised at your suggestion that he add international stocks,

but is willing to listen to your statements to justify your recommendations. State two reasons

for why he should consider the international stocks and briefly explain each.

The graph should look like the one that is shown in figure 25.6ww.

- Two important reasons for adding international securities are the favorable diversification

effects due to the less than perfect positive correlations among countries' returns and the

possible benefit from currency risk.

Feedback: This question tests the student's knowledge of the basic ideas behind investing in

international stocks and other classes of equities.


Bloom's: Understand Difficulty: Intermediate


Chapte_25_InternationalDiversification Finance

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