Assume that a country has a negative trade balance. In the traditional model of the impact of currency appreciation on domestic economic activities, what is the likely short-run impact of currency depreciation? A) The cost of imports decreases narrowing the trade balance. B) The cost of imports increases widening the trade balance. C) Domestic industry becomes more competitive narrowing the trade balance. D) Domestic industry becomes less competitive widening the trade balance. Which of the following factors are least likely to affect the formulation of an investment policy statement for a university’s endowment fund? A) Legal and regulatory factors. B) Multi-stage time horizons. C) Social considerations. D) Tax considerations. 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) 12.2%. B) 10.2%. C) 14.2%. D) 9.2%.
D, D, A Reasoning: 1. appreciating domestic currency, makes imports cheaper, and exports more expensive (to others), thus imports increase, exports decrease, creating a negative trade balance 2. universities are tax exempt? no? 3. 5+ (0.8*6) + (1.2*2) = 12.2 made an error on 1 - i see its asking for depreciating impact. so it should benefit the trade balance… C
C neg trade balance, I > X. currency goes down, you’re not going to import as much b/c they’re more expensive to you. cost of I up, domestic becomes more competitive. D pensions i want to say are tax free or something like that- they wouldn’t worry taxes A 0.05 + (.8x.06) + (1.2x0.02) = 12.2 basic ICAPM- hope there’s no trick there.
- C 2. C 3. B
1-B 2-D 3-C
c, d, don’t have a calc with me, so can’t answer number 3!
B short run cost of imports increase D for endowments, taxes are not an issue. C 5 + (.8*6) + (1+1.2)(2)
1-B 2-D 3-A
C, D, A
dinesh is telling me I’m wrong on the third one apparently you need to add one to the sensitivity.
Answers are B, D and A. Congrats to Olivier! FIRST ONE Your answer: C was incorrect. The correct answer was B) The cost of imports increases widening the trade balance. In the short run, if a country’s currency depreciates in real terms, the cost of imports increases causing a widening in the trade balance (exports – imports) and an increase in domestic inflation. Currency depreciation tends to reduce economic activity in the short run. SECOND ONE Your answer: C was incorrect. The correct answer was D) Tax considerations. An endowment would receive tax-exempt status, and therefore would not have to include tax considerations when formulating an investment policy statement. THIRD ONE Your answer: C was incorrect. The correct answer was A) 12.2%. In a single foreign currency world, the ICAPM simplifies to: E(Ri) = R0 + Biw × RPw + γi1 x FCRP1. Substituting in the numbers from the problem, we get: E(Ri) = 5% + 0.8 × (6%) + 1.2 × (2%) = 12.2%. Remember to use the domestic risk-free rate. “Lee has measured the sensitivity of Stockco to changes in the value of the U.S. dollar to be 1.2” --> this is LC sensitivity, right? So why do we take it in the calculation instead of 1+1.2?
can you please send me the question number? thank you
Questions are 8476, 46524 and 8455
What is the reason for using 1.2 as the sensitivity factor? And why did I use 1.2+1 = 2.2 and got to the wrong answer of C? Could somebody make this distinction clear of when to add 1 and when not to? I am asking a sure shot 3-pointer here!!
I am still getting to grips with the ICAPM stuff. So let me give it a shot. You add 1 , to reflect the sensitivity of the stock to its own currency. Since the question says that “Stockco is only sensitive to changes in the value of the U.S. dollar.” , you get 0+1.2= 1.2
I made the same mistake as Dinesh and I still don’t get why I am wrong. Even if Stocko is only sensitive to changes in the value of the USD, for a Korean investor the following relationship must apply: Sensitivity (Korean investmt to USD changes) = 1 + Sensitivity (US investmt to USD changes) What am I missing?
good questions. so easy to mess up …
nicolargol Wrote: ------------------------------------------------------- > I made the same mistake as Dinesh and I still > don’t get why I am wrong. > > Even if Stocko is only sensitive to changes in the > value of the USD, for a Korean investor the > following relationship must apply: > > Sensitivity (Korean investmt to USD changes) = 1 + > Sensitivity (US investmt to USD changes) nicolargol - I completely agree, this equation should apply here. For people who chose A as the answer to the 3rd question, can you tell us why 1.2 should be used and not 2.2.
Lee’s in Korea. If he’s measured the sensitivity as 1.2, then that includes the whole 1+issue. Bit of a fudge but best I can think of.
I think this might help “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” there is no local sensitivity to the KRW hence the sensitivity equation : Sensitivity (Korean investmt to USD changes) = 1 + Sensitivity (US investmt to USD changes) Does not fit this problem, it should be 0 + Sensitivity (US investmt to USD changes) which is the only exposure we will experience. just my, dos centavos.