International Asset Pricing

Question 0

What are integrated worked markets

Answer 0

Capital can flow freely across borders

Law of one price applies

Allows investors to seek most efficient portfolio

Question 1

Market efficiency: what happens if investors can’t short sell risk free asset?

Answer 1

Market portfolio may not be efficient
Changing portfolio beta may not appropriately adjust desired portfolio risk
Investors construct portfolios differently - risk averse will heavily diversify

Question 2

Expect markets to be integrated because these participants move capital between markets:

Answer 2

Institutional investors
Multinational corporations
Governments

Question 3

If markets segmented, these impediments restrict international flow:

Answer 3

Psychological barriers 
Legal restrictions
Transaction costs 
Discriminatory taxation
Political risks
Foreign currency risk

Question 4

Calculate real exchange rate

Answer 4

Real spot = nom spot*FC price level
—————-
DC price level

Use to calc at two points in time; if same, all nominal changes completely explained by inflation

Question 5

% change in real exchange spot

Answer 5

= % change in nominal spot - (DC inflation - FC inflation)

Question 6

Foreign currency risk premium

Answer 6

FCRP = E(S1) - S0 - (rD-rF)
———–
S0

S0 quoted foreign:domestic

Question 7

If interest rate parity holds, calc foreign currency risk premium (FCRP)

Answer 7

FCRP = E(S1) - F
———-
S0

Question 8

Domestic currency return (compared to foreign bond)

Two ways

Answer 8

DC return = rFC + FC appreciation

DC return = rDC + FCRP

Question 9

International CAPM

Answer 9

E(R) = Rf + B*world market risk premium + sum (sensitivity of domestic to foreign * foreign currency risk premium)

Question 10

Currency exposure to itself = 1; thus domestic currency sensitivity of an asset Y is:

Answer 10

Y = Y(local currency sensitivity) + 1

Question 11

Traditional model of equity exposure:

Domestic currency deprecation causes ___________ which causes ________ which results in ______

Answer 11

Increased long run economic activity

Higher equity prices

Negative long run domestic currency exposure

Question 12

Money demand model of equity exposure: increased long run economic activity results in ______ and _______ which leads to ______

Answer 12

Domestic currency to appreciate

Higher equity prices

Positive domestic currency exposure