Song Lee, CFA, is a money manager for a small firm in Seoul. All of Lee’s clients are local. He is considering adding the stock of a U.S. firm, Stockco, to some of his client’s portfolios. Stockco sensitivity to the world index is 0.8 and the risk premium on the index is 6 percent. The risk-free rate is 3 percent in the U.S. and 5 percent in Korea. Stockco is only sensitive to changes in the value of the U.S. dollar. Lee has measured the sensitivity of Stockco to changes in the value of the U.S. dollar to be 1.2. The foreign currency risk premium on the U.S. dollar is 2 percent. Assuming that Lee uses the international capital asset pricing model (ICAPM), what is the required return on Stockco? A) 10.2%. B) 12.2%. C) 14.2%. D) 9.2%. But what is the answer? A Swiss investor’s domestic risk-free rate is 9 percent. Japanese risk-free rates are 2 percent. The investor expects the Swiss Franc (SF) to depreciate by 5 percent. What is the foreign currency risk premium (FCRP)? A) 2%. B) -4%. C) 4%. D) -2%.

For the second one: FCRP = 5 - (9 - 2) = -2?

Nibi, Currency depriciates- so isnt be -5

i’d think it’s -2, no?

SF DOWN by 5% YEN UP by 5% FCRP = 5% - (IRD’s) FCRP = 5% - (IR(DC) - IR(FC)) Investor is SF, therefor DC = DF FCRP = 5% - (9% - 2%) FCRP = -2% = D

i got -2 also

cfaboston28 Wrote: ------------------------------------------------------- > Nibi, > > Currency depreciates- so isnt be -5 The investors domestic currency depreciated so that means the foreign currecny appreciated which is used in calculating the FCRP.

I think -2 also

The answer is -2, I just confirmed it by doing it myself

Your answer: A was incorrect. The correct answer was D) -2%. The FCRP is the expected appreciation of the foreign currency minus the interest rate differential (domestic – foreign). Hence, the FCRP is –2% (= 5% appreciation of the yen minus 7% interest rate differential). The interest rate differential is calculated as: rDC – rFC = 9% – 2% = 7%). I didnt know that we have to take foriegn currency here as +5 in this case.

tricky

I get C and D. For 1: 5% + (.8)(6%) + (2.2)(2%) = 14.20% For 2: He should get 4% on the foreign currency (9% domestic - 5% depreciation). Since he’s only getting 2%, there’s a ‘negative’ premium.

i messed up on the second question because I didn’t realize that since SF was domestic the foreign currency is expected to appreciate by 5% and premium is 5%-7% = -2%,

Oh shite, I was trying to do -5 - int. differential 7 = -12 HAHAHAH So, when we’re looking at FCRP, if they give this thing to us from the perspective of the domestic, we’re calculating what they (Swiss investor) has to be compensated? Or what the hell is the interpretation here, in layman’s terms (clearly, I don’t get this sheet). Thx

for the first one 5% + 0.8(6%)+(1.2+1)(2%) = 14.2% I get C, is that the answer?

many people think answer is 14.2 but schweser says answer is 12.2. Nobody is sure

“Lee has measured the sensitivity of Stockco to changes in the value of the U.S. dollar to be 1.2.” This should be interpreted to mean the local currency sensitivity… 1.2 + 1 = 2.2 = domestic currency sensitivity Now I’m getting confused

12.2 makes sense: 5% (Rf LC) + .80(6%) + 1.2(2%) = 12.2%

N.Van can you explain why 1.2 makes sense?