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1、CHAPTER 3SELECTING INVESTMENTS IN A GLOBAL MARKETAnswers to Questions 1.The major advantage of investing in common stocks is that generally an investor would earn a higher rate of return than on corporate bonds. Also, while the return on bonds is pre-specified and fixed, the return on common stocks
2、can be substantially higher if the investor can pick a “winner” - i.e., if the companys performance turns out to be better than current market expectations. The main disadvantage of common stock ownership is the higher risk. While the income on bonds is certain (except in the extreme case of bankrup
3、tcy), the return on stocks will vary depending upon the future performance of the company and could well be negative. 2. The three factors are: (1) Limiting oneself to the U.S. securities market would imply effectively ignoring more than 50% of the world securities market. While U.S. markets are sti
4、ll the largest single sector, foreign markets have been growing in absolute and relative size since 1969. (2) The rates of return available on non-U.S. securities often have substantially exceeded those of U.S. securities. (3) Diversification with foreign securities reduces portfolio risk.3.Internat
5、ional diversification reduces portfolio risk because of the low correlation of returns among the securities from different countries. This is due to differing international trade patterns, economic growth, fiscal policies, and monetary policies among countries.4.There are different correlations of r
6、eturns between securities from the U.S. and alternate countries because there are substantial differences in the economies of the various countries (at a given time) in terms of inflation, international trade, monetary and fiscal policies and economic growth. 5.The correlations between U.S. stocks a
7、nd stocks for different countries should change over time because each country has a fairly independent set of economic policies. Factors influencing the correlations include international trade, economic growth, fiscal policy and monetary policy. A change in any of these variables will cause a chan
8、ge in how the economies are related. For example, the correlation between U.S. and Japanese stock will change as the balance of trade shifts between the two countries.6.The major risks that an investor must consider when investing in any bond issue are business risk, financial risk and liquidity ris
9、k. Additional risk associated with foreign bonds, such as Japanese or German bonds, are exchange rate risk and country risk. Country risk is not a major concern for Japanese or German securities. Exchange rate risk is the uncertainty that arises from floating exchange rates between the U.S. dollar a
10、nd the Japanese yen or Deutsch mark.7.The additional risks that some investors believe international investing introduces include foreign exchange risk and country risk. For example, the domestic return on Canada bonds of 10.36% exceeded the U.S. return of 9.78%. The exchange rate effect of -2.19% l
11、owered the Canadian dollar return after conversion to U.S. dollars to 8.17%. (Exhibit 3.2).8. There are four alternatives to direct investment in foreign stocks available to investors: (1) purchase American Depository Receipts (ADRs) (2) purchase of American shares (issued by a transfer agent)(3) di
12、rect purchase of foreign shares listed on a foreign or U.S. exchange(4) purchase of international mutual funds.9.Unlike corporate bonds, interest on municipal bonds is exempt from taxation by the federal government and by the state that issued the bond, provided the investor is a resident of that st
13、ate. For instance, a marginal tax rate of 35 percent means that a regular bond with an interest rate of 8 percent yields a net return after taxes of only 5.20 percent .08 x (1 -.35). A tax-free bond with a 6 percent yield would be preferable.10.The convertible bond of the growth company would have t
14、he lower yield. This is intuitive because there is a greater potential for the price of the growth company stock to increase, which would make the conversion feature of the bond extremely attractive. Thus, the investor would be willing to trade off the higher upside potential resulting from conversi
15、on for the lower yield.11.Liquidity is the ability to buy or sell an asset quickly at a price similar to the prior price assuming no new information has entered the market. Common stocks have the advantage of liquidity since it is very easy to buy or sell a small position (there being a large number
16、 of potential buyers) at a price not substantially different from the current market price. Raw land is relatively illiquid since it is often difficult to find a buyer immediately and often the prospective buyer will offer a price that is substantially different from what the owner considers to be t
17、he true market value. A reason for this difference is that while common stock data are regularly reported in a large number of daily newspapers and several magazines and closely watched by a large number of individuals, raw land simply lacks this kind of interest. Further, the speculative nature of
18、raw land investment calls for high risk and longer maturity before profits can be realized. Finally, the initial investment on a plot of raw land would be substantially greater than a round lot in most securities. As a result, the small investor is generally precluded from this kind of investment.12
19、.A stock warrant is an option issued by a corporation to buy a number of shares of the corporations common stock at a specified price. Warrants typically have a life of several years and could even by perpetual.A call option is similar to a stock warrant with two essential differences. One is that t
20、he call option is not issued by the corporation but by an individual who “writes” it and stands behind it. The second difference is that a call option generally has a maturity of less than a year.13.Art and antiques are considered illiquid investments because in most cases they are sold at auctions.
21、 The implication of being traded at auctions rather than on a developed exchange is that there is tremendous uncertainty regarding the price to be received and it takes a long time to contact a buyer who offers the “right” price. Besides, many buyers of art and antiques are accumulators rather than
22、traders and this further reduces trading.Coins and stamps are more liquid than art and antiques because an investor can determine the “correct” market price from several weekly or monthly publications. There is no such publication of current market prices of the numerous unique pieces of art and ant
23、iques and owners are forced to rely on dealer estimates. Further, while a coin or stamp can be readily disposed of to a dealer at a commission of about 10-15 percent, the commissions on paintings range from 30-50 percent.To sell a portfolio of stocks that are listed on the New York Stock Exchange, a
24、n investor simply contacts his/her broker to sell the shares. Cost of trading stocks varies depending on whether the trade is handled by a full service broker or a discount broker.14.The results of Exhibit 3.13 would tend to support adding some stocks from emerging markets to your portfolio. The tab
25、le indicates a low positive correlation with U.S. stocks (0.347 with the S&P 500), which implies reasonably good diversification opportunities. However, such markets tend to be less liquid than markets of developed countries. 15.Exhibit 3.14 indicates that an investment in American paintings during
26、this period was a good investment. The geometric mean for American paintings (16.20%) was higher than that of U.S. common stocks, measured by the S&P 500 index (14.92%). In addition, risk as measured by standard deviation, was lower for American paintings (16.07%) than for the S&P 500 Index (17.57%)
27、. 16. CFA Examination I (1993)16(a).International stocks versus U.S. stocks Problems:1. Information about foreign firms is often difficult to obtain on a timely basis and once obtained, can be difficult to interpret and analyze due to language and presentation differences.2. Financial statements are
28、 comparable from country to country. Different countries use different accounting principles. Even when similar accounting methods are used, cultural, institutional, political and tax differences can make cross-country comparisons hazardous and misleading.3. Stock valuation techniques useful in the
29、United States may be less useful in other countries. Stock markets in different countries value different attributes.4. Smith must consider currency risk in selecting non-U.S. stocks for his portfolio.5. Increased costs: custody, management fees, and transactions expenses are usually higher outside
30、the United States.17. CFA Examination III (1993)17(a).Arguments in favor of adding international securities include:1. Benefits gained from broader diversification, including economic, political and/or geographic sources.2. Expected higher returns at the same or lower (if properly diversified) level
31、 of portfolio risk.3. Advantages accruing from improved correlation and covariance relationships across the portfolios exposures.4. Improved asset allocation flexibility, including the ability to match or hedge non-U.S. liabilities.5. Wider range of industry and company choices for portfolio constru
32、ction purposes.6. Wider range of managers through whom to implement investment decisions.7. Diversification benefits are realizable despite the absence of non-U.S. pension liabilities.At the same time, there are a number of potential problems associated with moving away from a domestic-securities-on
33、ly orientation:1. Possible higher costs, including those for custody, transactions, and management fees.2. Possibly reduced liquidity, especially when transacting in size.3. Possible unsatisfactory levels of information availability, reliability, scope, timeliness and understand-ability.4. Risks ass
34、ociated with currency management, convertibility and regulations/controls.5. Risks associated with possible instability/volatility in both markets and governments.6. Possible tax consequences or complications.7. Recognition that EAFE has underperformed since 1989.17(b).A policy decision to include i
35、nternational securities in an investment portfolio is a necessary first step to actualization. However, certain other policy level decisions must be made prior to implementation. That set of decisions would include:1. What portion of the portfolio shall be invested internationally, and in what equit
36、y and fixed-income proportions?2. Shall all or a portion of the currency risk be hedged or not?3. Shall management of the portfolio be active or passive?4. Shall the market exposures be country/market-wide (top-down) or company/industry specific (bottom-up)?5. What benchmarks shall results be judged
37、 by?6. How will manager style be incorporated into the process?7. How will the process reflect/resolve the important differences in orientation between the international (non U.S.) major markets and the U.S. emerging markets perspectives?Until decisions on these additional policy-level issues have b
38、een made, implementation of the basic decision to invest internationally cannot begin.CHAPTER 3Answers to Problems1.Student Exercise2.Student Exercise3.Student Exercise4.Student Exercise5. CFA Examination (Adapted)5(a).The arithmetic average assumes the presence of simple interest, while the geometr
39、ic average assumes compounding or interest-on-interest. The geometric mean internal rate of return is a critical concept in security and portfolio selection as well as performance measurement in a multi-period framework.5(b).Ranking is best accomplished by using the coefficient of variation (standar
40、d deviation/ arithmetic mean, multiplied by 100):1 - Real Estate 36.882 - Treasury Bills 48.933 - Long Govt Bonds104.924 - Common Stocks164.375 - Long Corp. Bond166.96The coefficient of variation ranking methodology alternatively may be computed using the geometric mean (standard deviation/geometric
41、 mean multiplied by 100). This method provides a ranking almost identical to the prior method (with the 4th and 5th rankings reversed:1 - Real Estate 37.082 - Treasury Bills 49.313 - Long Govt Bonds108.294 - Long Corp. Bonds179.445 - Common Stocks191.83In both cases, a lower ratio indicates a higher
42、 return for risk. Or, a somewhat different ranking methodology utilizes Sharpes reward for risk-taking measure using the arithmetic mean return minus the risk free rate divided by the standard deviation multiplied by 100. The ranking using this measure would be as follows:1 - Real Estate 84.292 - Co
43、mmon Stocks 22.133 - Treasury Bills 0.004 - Long Govt Bonds -6.885 - Long Corp. Bonds -8.23 Under this reward-for-risk ranking methodology, the higher the ratio, the higher the return per unit of risk. The arithmetic mean was used in this computation; however, the geometric mean also could be used t
44、o calculate this ranking.5(c)(1). Expected mean plus or minus two standard deviations: Arithmetic: 10.28% +/-16.9%(2) = -23.52% to +44.08% Geometric: 8.81% +/-16.9%(2) = -24.99% to +42.61%5(c)(2). Ninety-five percent of the area under the normal curve lies between +/- two standard deviations of the
45、mean. Since the mean minus two standard deviations (9.44 - 7.0 = 2.44) is positive, one may conclude that the probability of breaking even is greater than 95%. 5(d).It seems at first that government bonds offer less return and more risk than real estate. However, real estate and government bonds mig
46、ht provide a good combination if the two do not fluctuate in a similar fashion, so that the variability of the portfolio is less than the variability of the individual investments. If the correlation coefficient applicable to this pair of investments is known and is not highly positive, the combinat
47、ion would be advantageous.6(a).(1) Common Stock Risk Premium= Return Common Stock - Return of U.S. Govt T-bills= 12.50 - 4.50= 8.00%(2) Small Firms Stock Risk Premium = Return of Small Capitalization Common Stock - Return of Total Stocks (S&P 500) = 14.60 - 12.50 = 2.10%待添加的隐藏文字内容2(3) Horizon (Matur
48、ity) Premium = Return on Long-term Govt Bonds - Return on U.S. Govt T-bills = 5.10 - 4.50 = 0.60%(4) Default Premium = Return on Long-term Corporate Bonds - Return on Long-term Govt Bonds = 5.80 - 5.10 = 0.70% 6(b). If Inflation = 4% APPENDIX 3Answers to Problems1.Laurens average returnKayleighs average return_
