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922
P A R T V I I
Applied Portfolio Management
8. If you were to invest $10,000 in the British bills of Problem 7, how would you lock in the dollar-
denominated return?
9. M uch of this chapter was written from the perspective of a U.S. investor. But suppose you are
advising an investor living in a small country (choose one to be concrete). How might the lessons
of this chapter need to be modified for such an investor?
Challenge
1. You are a U.S. investor who purchased British securities for £2,000 one year ago when the British
pound cost U.S.$1.50. What is your total return (based on U.S. dollars) if the value of the securities
is now £2,400 and the pound is worth $1.75? No dividends or interest were paid during this period.
2. The correlation coefficient between the returns on a broad index of U.S. stocks and the returns on
indexes of the stocks of other industrialized countries is mostly _____ , and the correlation coef-
ficient between the returns on various diversified portfolios of U.S. stocks is mostly _____ .
a. less than .8; greater than .8.
b. greater than .8; less than .8.
c. less than 0; greater than 0.
d. greater than 0; less than 0.
3. An investor in the common stock of companies in a foreign country may wish to hedge against
the _____ of the investor’s home currency and can do so by _____ the foreign currency in the
forward market.
a. depreciation; selling.
b. appreciation; purchasing.
c. appreciation; selling.
d. depreciation; purchasing.
4. John Irish, CFA, is an independent investment adviser who is assisting Alfred Darwin, the head of
the Investment Committee of General Technology Corporation, to establish a new pension fund.
Darwin asks Irish about international equities and whether the Investment Committee should
consider them as an additional asset for the pension fund.
a. Explain the rationale for including international equities in General’s equity portfolio. Identify
and describe three relevant considerations in formulating your answer.
b. List three possible arguments against international equity investment and briefly discuss the
significance of each.
c. To illustrate several aspects of the performance of international securities over time, Irish
shows Darwin the accompanying graph of investment results experienced by a U.S. pension
fund in the recent past. Compare the performance of the U.S. dollar and non-U.S. dollar equity
and fixed-income asset categories, and explain the significance of the result of the account
performance index relative to the results of the four individual asset class indexes.
10
20
30
40
6
0
1
2
3
4
5
Annualized Historical Performance Data
(%)
Variability
(standard
deviation)
U.S. $ Bonds
Non-U.S. $ Bonds
EAFE Index
Account Performance Index
S&P Index
Real Returns (%)
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bod61671_ch25_882-925.indd 922
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C H A P T E R
2 5
International Diversification
923
5. You are a U.S. investor considering purchase of one of the following securities. Assume that the
currency risk of the Canadian government bond will be hedged, and the 6-month discount on
Canadian dollar forward contracts is 2 .75% versus the U.S. dollar.
Bond
Maturity
Coupon
Price
U.S. government
6 months
6.50%
100.00
Canadian government
6 months
7.50%
100.00
Calculate the expected price change required in the Canadian government bond that would result
in the two bonds having equal total returns in U.S. dollars over a 6-month horizon. Assume that
the yield on the U.S. bond is expected to remain unchanged.
6. A global manager plans to invest $1 million in U.S. government cash equivalents for the next
90 days. However, she is also authorized to use non-U.S. government cash equivalents, as long as
the currency risk is hedged to U.S. dollars using forward currency contracts.
a. What rate of return will the manager earn if she invests in money market instruments in either
Canada or Japan and hedges the dollar value of her investment? Use the data in the following
tables.
b. What must be the approximate value of the 90-day interest rate available on U.S. government
securities?
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