should use local currency sensitivvity of 0.5, why add 1 to it? since Poland investor invest in German .
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Jaro Sumzinski, who lives in Poland, is applying the international capital asset pricing model (ICAPM) to determine the value of a German security. The German currency (Euro) has a risk premium of 1% and the security has a local currency sensitivity of 0.5. The risk-free rate in Poland is 8% and the risk-free rate in Germany is 4%. The world market risk premium is 7% and the securities sensitivity to the world market is 2. What is the required return of the security?
A) 23.5%. B) 18.5%. C) 12.5%.
Your answer: A was correct!
In a single foreign currency world, the ICAPM simplifies to: E(Ri) = R0 + Biw × RPw + γi1 × SRP1. Substituting in the numbers from the problem, we get: E(Ri) = 8% + 2(7%) + (1 + 0.5)(1%) = 23.5%. Remember to use the domestic risk-free rate.