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Covariance = Cov(ri, rM) = 420/4 = 105

Correlation = Corr(ri, rM) = 105/(16.43 Ã— 15.94) = .40

Beta = Î² = .40 Ã— (16.43/15.94) = .41

Notice that the securityâ€™ beta is only .41 even though its return was higher over this

s

period. This tells us that the security experienced some unexpected high returns due to

positive unsystematic events.

B-70 CORRADO AND JORDAN

Chapter 19

International Finance and Investments

Answers to Questions and Problems

Core Questions

1. a. The most recent exchange rate shown is 1730.8215, so $100 will get you Lit

173,082.

b. One lira is worth 1/1730.8125 = $.00058.

c. You have 5 million/1730.8215 = $2,888.80.

2. a. A New Zealand dollar is worth 1/1.8442 = $.542. A Singapore dollar is worth

1/1.7067 = $.59, or a few cents more.

b. There are two rates for the Chilean dollar, but both are much larger than the

exchange rate for the Mexican peso, so the Mexican peso is worth more.

c. The least valuable is the Turkish lira at almost 348,000 per dollar. The most

valuable is Kuwaiti dinar at about .3 per dollar.

3. a. Â£100 is worth about $163.45 (notice that the UK exchange rate quote is in terms

of dollars per pound).

b. French francs are quoted at about FF 6. So, 100 francs are worth about $17,

whereas from just above, Â£100 is worth about $163.

c. From part b., a franc is worth $17/$163 = .1043 pounds. A pound is worth

$163/$17 = 9.6 francs.

4. Interest rate parity requires that:

F ($ / Â¥)

(1 + r ($)) (1 + r ( Â¥)) S ($ / Â¥)

T TT

=

Noting that T = 1 and filling in the other numbers, we get:

104 = (1 + r ( Â¥))Ã—

.0078

.

.008

Solving for the Japanese interest rate, r(Â¥), we get 1.04 Ã— (.008/.0078) - 1 = 6.67%.

5. If the exchange rate, expressed in won per dollar, rises, your return measured in dollars

will be diminished because each won will convert to fewer dollars and vice versa.

FUNDAMENTALS OF INVESTMENTS B-71

6. Suppose the U.S. dollar strengthens relative to the Canadian dollar. This means a U.S.

dollar is worth more Canadian dollars. In other words, Canadian dollars become cheaper

to buy. If the exchange rate is expressed as Canadian dollars per U.S. dollar, the exchange

rate will rise because it takes more Canadian dollars to buy a U.S. dollar.

7. It takes fewer yen to buy a dollar, so the yen has appreciated.

8. The primary benefit is diversification. Because stock markets are not perfectly correlated,

there is a theoretical benefit to diversifying among them.

9. Exchange rate changes can amplify or dampen gains and losses from international

investing. Unfavorable exchange rate movements can convert gains to losses, and vice

versa. As a result, exchange rates may act to increase or decrease risk, depending on the

correlation between the exchange rate and market returns. Whether this risk is

diversifiable or systematic appears to be an open question.

10. Interest rate parity requires that:

F ($ / DM)

(1 + r ($)) (1 + r ( DM)) S ($ / DM)

T TT

=

Noting that T = 1 and filling in the other numbers, we get:

F ($ / DM)

= 104 Ã—

105

. .

.5

Solving for the forward rate, we get 1.05 Ã— (.5/1.04) = .505 $/DM.

Intermediate Questions

11. The exchange rate for the drachma rose from about 286.5 to about 286.9, so the drachma

weakened (it takes more drachma to buy one dollar). The exchange rate for the pound

increased from 1.6259 to 1.6345. Remembering that the pound is quoted as dollars per

pound, the pound strengthened (it takes more dollars to purchase a pound).

12. The cross rate moved from 283/(1/1.6705) = 472.75 drachma per pound to

287/(1/1.6662) = 478.20, so it takes more drachma to buy a pound. The drachma

depreciated relative to the pound.

B-72 CORRADO AND JORDAN

13. There is definitely an arbitrage. The cross rate should be 6/1.5 = 4, or four French francs

per Swiss franc. Now, the cross rate is quoted at FF 5 = SF 1, so we want to use Swiss

francs to buy French francs because we get 5 instead of 4. So, we first convert $100 to SF

150. We then convert SF 150 to FF 750 at the quoted cross rate. Finally, we convert FF

750 to $125. Not bad!

14. Interest rate parity requires that:

F ($ / Â¥)

(1 + r ($)) (1 + r ( Â¥)) S ($ / Â¥)

T TT

=

Noting that T = 90/365, or about .25, and filling in the other numbers, we get:

(1 + r ( Â¥ )) Ã—

.25 .0071

104.25 =

.

.007

Solving for the Japanese interest rate, r(Â¥), we get [1.06.25 Ã— (.007/.00705)]4 - 1 = 3.02%.

15. Your $10,000 converts to 1 million won. Your won investment grows to 1.6 million won.

When you exchange back to dollars, each won is worth $.008, so you get $12,800. Your

return was thus 28 percent measured in dollars.

16. Your $200,000 converts to 8 million francs. Your franc investment grows to 8.8 million

francs. When you exchange back to dollars, you get 8.8 million/42 = $209,523.81. Your

return was thus 4.76 percent measured in dollars.

17. If two countries have different inflation rates, then the nominal risk-free rates in the two

countries are likely to be different. They may have different real rates as well, but the

difference is not likely to be very large.

18. The Canadian rate of inflation is higher, so we expect the Canadian dollar to lose value

relative to the U.S. dollar. More precisely, because the inflation differential is 2 percent,

the value of a Canadian dollar should decline by 2 percent relative to the U.S. dollar. The

exchange rate, which is expressed as U.S. dollars per Canadian dollar should fall because

the Canadian dollar will get cheaper.

19. In any diversified portfolio, some sector(s) will typically perform well while others do not.

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