Investments, tenth edition

Interest Rates (APR) 90-Day Cash Equivalents

Japanese government

2.52%

Canadian government

6.74%

Exchange Rates Dollars per Unit of Foreign Currency

Spot

90-Day Forward

Japanese yen

.0119

.0120

Canadian dollar

.7284

.7269

   7.  The Windsor Foundation, a U.S.-based, not-for-profit charitable organization, has a diversified 

investment portfolio of $100 million. Windsor’s board of directors is considering an initial invest-

ment in emerging market equities. Robert Houston, treasurer of the foundation, has made the 

following four comments:

     a.   “For an investor holding only developed market equities, the existence of stable emerging 

market currencies is one of several preconditions necessary for that investor to realize strong 

emerging market performance.”  

    b.   “Local currency depreciation against the dollar has been a frequent occurrence for U.S. inves-

tors in emerging markets. U.S. investors have consistently seen large percentages of their 

returns erased by currency depreciation. This is true even for long-term investors.”  

    c.   “Historically, the addition of emerging market stocks to a U.S. equity portfolio such as the 

S&P 500 index has reduced volatility; volatility has also been reduced when emerging market 

stocks are combined with an international portfolio such as the MSCI EAFE index.”  

    d.   “Although correlations among emerging markets can change over the short term, such correla-

tions show evidence of stability over the long term. Thus, an emerging markets portfolio that 

lies on the efficient frontier in one period tends to remain close to the frontier in subsequent 

periods.”    

     Discuss whether  each  of Houston’s four comments is correct or incorrect.  

   8.  After much research on the developing economy and capital markets of the country of Otunia, 

your firm, GAC, has decided to include an investment in the Otunia stock market in its Emerging 

Markets Commingled Fund. However, GAC has not yet decided whether to invest actively or by 

indexing. Your opinion on the active versus indexing decision has been solicited. The following is 

a summary of the research findings:

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P A R T   V I I

  Applied Portfolio Management

  Otunia’s economy is fairly well diversified across agricultural and natural 

resources, manufacturing (both consumer and durable goods), and a grow-

ing finance sector. Transaction costs in securities markets are relatively large in 

Otunia because of high commissions and government “stamp taxes” on securi-

ties trades. Accounting standards and disclosure regulations are quite detailed, 

resulting in wide public availability of reliable information about companies’ 

financial performance. 

 Capital flows into and out of Otunia, and foreign ownership of Otunia secu-

rities is strictly regulated by an agency of the national government. The settle-

ment procedures under these ownership rules often cause long delays in settling 

trades made by nonresidents. Senior finance officials in the government are 

working to deregulate capital flows and foreign ownership, but GAC’s political 

consultant believes that isolationist sentiment may prevent much real progress 

in the short run.  

     a.   Briefly discuss aspects of the Otunia environment that favor investing actively, and aspects 

that favor indexing.  

    b.   Recommend whether GAC should invest in Otunia actively or by indexing. Justify your rec-

ommendation based on the factors identified in part ( a ).       

 E-INVESTMENTS EXERCISES 

 A common misconception is that investors can earn excess returns by investing in foreign 

bonds with higher interest rates than are available in the U.S. Interest rate parity implies 

that any such interest rate differentials will be offset by premiums or discounts in the for-

ward or futures market for foreign currency. 

 Interest rates on government bonds in the U.S., U.K., Japan, Germany, Brazil, and 

Australia can be found at   www.bloomberg.com/markets/rates/index.html   .  

 Spot exchange rates on international currencies can be found at   www.bloomberg.