Chapter 25 - International Diversification

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
E. None of these is correct.

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

A. ADRs
B. ECUs
C. Single-country funds
D. All of these are correct.
E. None of these is correct.

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

A. country selection
B. currency selection
C. stock selection
D. All of these are correct.
E. None of these is correct.

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Chapter 25 - International Diversification

5. Over the period 20002009, most correlations between the U.S. stock index and stockindex portfolios of other countries were
A. negative.
B. positive but less than .9.
C. approximately zero.
D. .9 or above.
E. None of these is correct.

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

A. CBOE
B. Dow Jones
C. EAFE
D. All of these are correct.
E. None of these is correct.

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.
E. None of these is correct.

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.
E. None of these is correct.

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Chapter 25 - International Diversification

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
E. None of these is correct.

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.
E. None of these is correct.

11. The developed country with the highest average U.S. dollar equity-market excess return
between 2000 and 2009 is
A. Japan
B. Norway
C. Austria
D. U.S.
E. None of these is correct.

12. The emerging market country with the highest average U.S. dollar equity-market excess
return between 2000 and 2009 is
A. China
B. Columbia
C. Poland
D. Turkey
E. None of these is correct.

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Chapter 25 - International Diversification

13. The __________ equity market had the lowest average local currency excess return
between 2000 and 2009.
A. Columbian
B. Ireland
C. U.K.
D. U.S.
E. None of these is correct.

14. The developed country with the lowest average local-currency equity-market excess
return between 2000 and 2009 is
A. Ireland
B. Korea
C. U.K.
D. U.S.
E. None of these is correct.

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
E. None of these is correct.

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
E. None of these is correct.

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Chapter 25 - International Diversification

17. The developed country with the lowest average U.S. dollar equity-market excess return
between 2000 and 2009 is
A. Japan
B. Korea
C. Austria
D. Ireland
E. None of these is correct.

18. The emerging market country with the lowest average U.S. dollar equity-market excess
return between 2000 and 2009 is
A. China
B. Russia
C. Poland
D. Taiwan
E. None of these is correct.

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.
E. None of these is correct.

20. The __________ equity market had the lowest average U.S. dollar standard deviation of
excess returns between 2000 and 2009.
A. Turkish
B. U.S.
C. Indonesian
D. U.K.
E. None of these is correct.

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Chapter 25 - International Diversification

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.
E. None of these is correct.

22. The __________ equity market had the lowest average local currency standard deviation
of excess returns between 2000 and 2009.
A. Turkish
B. Finnish
C. Indonesian
D. Australia
E. None of these is correct.

23. In 2009, the U. S. equity market represented __________ of the world equity market.
A. 19%
B. 60%
C. 43%
D. 33%
E. None of these is correct.

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
D. All of these are correct.
E. None of these is correct.

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Chapter 25 - International Diversification

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%.
E. None of these is correct.

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%
E. None of these is correct.

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%
E. None of these is correct.

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Chapter 25 - International Diversification

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
E. None of these is correct.

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%
E. None of these is correct.

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%
E. None of these is correct.

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Chapter 25 - International Diversification

31. If you invested 50% of your money in the Canadian stock market and 50% in the U. S.
stock market, the standard deviation of return of your portfolio would be __________.
A. 12.53%
B. 15.21%
C. 17.50%
D. 18.75%
E. None of these is correct.

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.
E. None of these is correct.

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%
E. None of these is correct.

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Chapter 25 - International Diversification

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.
E. None of these is correct.

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.
E. None of these is correct.

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Chapter 25 - International Diversification

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.
E. None of these is correct.

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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Chapter 25 - International Diversification

40. Calculate Quantitative's stock selection return contribution.

A. 1.0%
B. 1.0%
C. 3.0%
D. 0.25%
E. None of these is correct.

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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Chapter 25 - International Diversification

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 correcteach 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.

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Chapter 25 - International Diversification

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.
E. None of these is correct.

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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Chapter 25 - International Diversification

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.

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Chapter 25 - International Diversification

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
E. None of these is correct
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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Chapter 25 - International Diversification

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

A. ADRs
B. ECUs
C. Single-country funds
D. All of these are correct
E. None of these is correct
Mutual funds that invest in the stocks of one country only are called single-country funds.

AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: International investing

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

A. country selection
B. currency selection
C. stock selection
D. All of these are correct
E. None of these is correct
All listed factors may affect the performance of an international portfolio.

AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: International investing

25-17

Chapter 25 - International Diversification

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
E. None of these is correct
Correlation coefficients were typically below .9.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

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

A. CBOE
B. Dow Jones
C. EAFE
D. All of these are correct
E. None of these is correct
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
Difficulty: Basic
Topic: International investing

25-18

Chapter 25 - International Diversification

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.
E. None of these is correct
See Table 25.9.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

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.
E. None of these is correct
See Table 25.9.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

25-19

Chapter 25 - International Diversification

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
E. None of these is correct
See Table 25.9.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

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.
E. None of these is correct
See Table 25.9.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

25-20

Chapter 25 - International Diversification

11. The developed country with the highest average U.S. dollar equity-market excess return
between 2000 and 2009 is
A. Japan
B. Norway
C. Austria
D. U. S.
E. None of these is correct
See Table 25.9.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

12. The emerging market country with the highest average U.S. dollar equity-market excess
return between 2000 and 2009 is
A. China
B. Columbia
C. Poland
D. Turkey
E. None of these is correct
See Table 25.9.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

25-21

Chapter 25 - International Diversification

13. The __________ equity market had the lowest average local currency excess return
between 2000 and 2009.
A. Columbian
B. Ireland
C. U. K.
D. U. S.
E. None of these is correct
See Table 25.9.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

14. The developed country with the lowest average local-currency equity-market excess
return between 2000 and 2009 is
A. Ireland
B. Korea
C. U. K.
D. U. S.
E. None of these is correct
See Table 25.9.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

25-22

Chapter 25 - International Diversification

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
E. None of these is correct
See Table 25.9.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

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
E. None of these is correct
See Table 25.9.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

25-23

Chapter 25 - International Diversification

17. The developed country with the lowest average U.S. dollar equity-market excess return
between 2000 and 2009 is
A. Japan
B. Korea
C. Austria
D. Ireland
E. None of these is correct
See Table 25.9.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

18. The emerging market country with the lowest average U.S. dollar equity-market excess
return between 2000 and 2009 is
A. China
B. Russia
C. Poland
D. Taiwan
E. None of these is correct
See Table 25.9.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

25-24

Chapter 25 - International Diversification

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.
E. None of these is correct
See Table 25.9.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

20. The __________ equity market had the lowest average U.S. dollar standard deviation of
excess returns between 2000 and 2009.
A. Turkish
B. U. S.
C. Indonesian
D. U. K.
E. None of these is correct
See Table 25.9.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

25-25

Chapter 25 - International Diversification

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.
E. None of these is correct
See Table 25.9.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

22. The __________ equity market had the lowest average local currency standard deviation
of excess returns between 2000 and 2009.
A. Turkish
B. Finnish
C. Indonesian
D. Australia
E. None of these is correct
See Table 25.9.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

25-26

Chapter 25 - International Diversification

23. In 2009, the U. S. equity market represented __________ of the world equity market.
A. 19%
B. 60%
C. 43%
D. 33%
E. None of these is correct
See Table 25.1.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

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
D. All of these are correct
E. None of these is correct.
All of these factors make a broad generalization of the CAPM to international stocks
problematic.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

25-27

Chapter 25 - International Diversification

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%
E. None of these is correct
r(US) = [1 + r(UK)]F0/E0 1; [1.08][1.50/1.60] 1 = 1.25%.

AACSB: Analytic
Bloom's: Apply
Difficulty: Intermediate
Topic: International investing

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%
E. None of these is correct
1.05 = (1 + r) [1.57/1.60] 1; r = 7.0%.

AACSB: Analytic
Bloom's: Apply
Difficulty: Intermediate
Topic: International investing

25-28

Chapter 25 - International Diversification

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%
E. None of these is correct
1.08[0.76/0.78] = x 1; x = 5.23%.

AACSB: Analytic
Bloom's: Apply
Difficulty: Intermediate
Topic: International investing

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
E. None of these is correct
1.04/1.07 = x/1.65; x = 1.6037.

AACSB: Analytic
Bloom's: Apply
Difficulty: Intermediate
Topic: International investing

25-29

Chapter 25 - International Diversification

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%
E. None of these is correct
1.04 = [($0.76/$0.78)(1 + r)] 1; r = 6.7%.

AACSB: Analytic
Bloom's: Apply
Difficulty: Intermediate
Topic: International investing

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%
E. None of these is correct
18% (0.5) + 13%(0.5) = 15.5%.

AACSB: Analytic
Bloom's: Apply
Difficulty: Intermediate
Topic: International investing

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Chapter 25 - International Diversification

31. If you invested 50% of your money in the Canadian stock market and 50% in the U. S.
stock market, the standard deviation of return of your portfolio would be __________.
A. 12.53%
B. 15.21%
C. 17.50%
D. 18.75%
E. None of these is correct
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
Topic: International investing

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.
E. None of these is correct
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
Difficulty: Intermediate
Topic: International investing

25-31

Chapter 25 - International Diversification

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%
E. None of these is correct
($3,840 $3,000)/$3,000 = 0.28, or 28.0%.

AACSB: Analytic
Bloom's: Apply
Difficulty: Intermediate
Topic: International investing

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.
E. None of these is correct.
U. S. investors can invest as indicated in A, examples of which are given in C.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

25-32

Chapter 25 - International Diversification

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
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

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.
E. None of these is correct.
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
Difficulty: Intermediate
Topic: International investing

25-33

Chapter 25 - International Diversification

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.
E. None of these is correct.
None of these is correct.

AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

The manager of Quantitative International Fund uses EAFE as a benchmark. Last year's
performance for the fund and the benchmark were as follows:

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Chapter 25 - International Diversification

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
Topic: International investing

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

25-35

Chapter 25 - International Diversification

40. Calculate Quantitative's stock selection return contribution.

A. 1.0%
B. -1.0%
C. 3.0%
D. 0.25%
E. None of these is correct.
(9% 10%).25 + (8% 5%).25 + (16% 15%).50 = 1.00%

AACSB: Analytic
Bloom's: Apply
Difficulty: Intermediate
Topic: International investing

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
Difficulty: Basic
Topic: International investing

25-36

Chapter 25 - International Diversification

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
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

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
Difficulty: Basic
Topic: International investing

25-37

Chapter 25 - International Diversification

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
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

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
Difficulty: Basic
Topic: International investing

25-38

Chapter 25 - International Diversification

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
Bloom's: Remember
Difficulty: Intermediate
Topic: International investing

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
Difficulty: Basic
Topic: International investing

25-39

Chapter 25 - International Diversification

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.
E. None of these is correct.
Home bias refers to the tendency to overweight investments in your home country.

AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: International investing

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
Difficulty: Intermediate
Topic: International investing

25-40

Chapter 25 - International Diversification

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.

AACSB: Reflective Thinking

Bloom's: Understand
Difficulty: Intermediate
Topic: International investing

25-41

Chapter 25 - International Diversification

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
Topic: International investing

25-42

Chapter 25 - International Diversification

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.

AACSB: Reflective Thinking

Bloom's: Understand
Difficulty: Intermediate
Topic: International investing

25-43