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c. The dollar-hedged rate of return on default-free government securities in Japan is
1.5793% and in Switzerland is 1.5643%. Therefore, the 90-day interest rate
available on U.S. government securities must be between 1.5643% and 1.5793%.
This corresponds to an annual rate between 6.2572% and 6.3172%, which is less
than the APR in Japan or Switzerland. (For consistency with our earlier
calculations, we annualize the 90-day rate using the convention of the money
market, assuming a 360-day year and simple interest). The lower interest rate in
the U.S. makes sense, as the relationship between forward and spot exchange rates
indicates that the U.S. dollar is expected to appreciate against both the Japanese
yen and the Swiss franc.
CFA 2
a. The primary rationale is the opportunity for diversification. Factors that contribute
to low correlations of stock returns across national boundaries are:
i. imperfect correlation of business cycles
ii. imperfect correlation of interest rates
iii. imperfect correlation of inflation rates
iv. exchange rate volatility
b. Obstacles to international investing are:
i. Availability of information, including insufficient data on which to base
investment decisions. It is difficult to interpret and evaluate data that is
different in form and/or content than the routinely available and widely
understood U.S. data. Also, much foreign data is reported with a
considerable lag.
ii. Liquidity, in terms of the ability to buy or sell, in size and in a timely
manner, without affecting the market price. Most foreign exchanges offer
(relative to U.S. norms) limited trading, and experience greater price
volatility. Moreover, only a (relatively) small number of individual foreign
stocks enjoy liquidity comparable to that in the U.S., although this situation
is improving steadily.
iii. Transaction costs, particularly when viewed as a combination of
commission plus spread plus market impact costs, are well above U.S. levels
in most foreign markets. This, of course, adversely affects return
realization.
iv. Political risk.
v. Foreign currency risk, although to a great extent, this can be hedged.
c. The asset-class performance data for this particular period reveal that non-U.S. dollar
bonds provided a small incremental return advantage over U.S. dollar bonds, but at a
considerably higher level of risk. Each category of fixed income assets outperformed
the S&P 500 Index measure of U.S. equity results with regard to both risk and return,
which is certainly an unexpected outcome. Within the equity area, non-U.S. stocks,
represented by the EAFE Index, outperformed U.S. stocks by a considerable margin
with only slightly more risk. In contrast to U.S. equities, this asset category