Exam 16: International Portfolio Theory and Diversification

Good financial advice would suggest that investors should examine returns by the amount of return per unit of risk accepted, rather than in isolation.

The optimal domestic portfolio combines the risk-free asset and a portfolio of domestic securities found on the efficient frontier.

The denominator of the Treynor measure is portfolio risk as measured by the standard deviation of the portfolio.

The graph for the efficient frontier has beta on the vertical axis and standard deviation of the horizontal axis.

The Sharpe and Treynor measures are each measures of return per unit of risk.

In an empirical study on national market returns in the 20th century, Dimson, Marsh, and Staunton (2002)found that just under one-half of the 16 countries in the study had negative average returns in their equity markets.

International diversification benefits may induce investors to demand foreign securities.

Draw the curve representing the Optimal Domestic Efficient Frontier. Be sure to draw and label the following: The vertical axis and the horizontal axis, the risk-free security, the minimum risk portfolio, the domestic portfolio opportunity set, the optimal domestic portfolio, and the capital market line. Choose a point along the domestic portfolio opportunity set between the optimal domestic portfolio and the minimum risk domestic portfolio and explain why that point is not the optimal risky domestic portfolio for investors to hold.

The denominator of the Treynor measure is the portfolio's beta, the systematic risk of the portfolio, as measured against the world market portfolio.

The denominator of the Sharpe measure is the portfolio's beta, the systematic risk of the portfolio, as measured against the world market portfolio.

Unsystematic risk:

The optimal domestic portfolio of risky securities is always the portfolio of minimum risk.

TABLE 16.1 Use the information to answer following question(s). -Refer to Table 16.1. What is the value of the Sharpe Measure for France?

Capital markets around the world are on average less integrated today than they were 20 years ago.

In some respects, internationally diversified portfolios are different from a domestic portfolio because:

________ risk is measured with beta.

Increasing the number of securities in a portfolio reduces the unsystematic risk but not the systematic risk.

Instruction 16.1:Use the information to answer the following question(s). In September 2009 a U.S. investor chooses to invest $500,000 in German equity securities at a then current spot rate of $1.30/euro. At the end of one year the spot rate is $1.35/euro. -Refer to Instruction 16.1. At the end of the year the investor sells his stock that now has an average price per share of €57. What is the investor's average rate of return before converting the stock back into dollars?

Instruction 16.1:Use the information to answer the following question(s). In September 2009 a U.S. investor chooses to invest $500,000 in German equity securities at a then current spot rate of $1.30/euro. At the end of one year the spot rate is $1.35/euro. -Refer to Instruction 16.1. At an average price of €60/share, how many shares of stock will the investor be able to purchase?

Beta may be defined as: