Chapter 17

Fundamentals of Multinational Finance, 4e (Moffett)
Chapter 17 International Portfolio Theory and Diversification
Multiple Choice and True/False Questions
17.1 International Diversification and Risk
1) Portfolio diversification can eliminate 100% of risk.

Answer: FALSE
Diff: 1
Topic: 17.1 International Diversification and Risk
Skill: Conceptual
2) Beta may be defined as

A) the measure of systematic risk.
B) a risk measure of a portfolio.
C) the ratio of the variance of the portfolio to the variance of the market.
D) all of the above.
Answer: D
Diff: 1
Skill: Recognition
3) ________ risk is measured with beta.

A) Systematic
B) Unsystematic
C) International
D) Domestic
Answer: A
Diff: 1
Skill: Recognition
4) A fully diversified domestic portfolio has a beta of

A) 0.0.
B) 1.0.
C) -1.0.
D) Not enough information to answer this question.
Answer: B
Diff: 1
Skill: Conceptual
1
Copyright © 2012 Pearson Education, Inc.
5) Unsystematic risk is
A) the remaining risk in a well-diversified portfolio.
B) measured with beta.
C) diversifiable.
Answer: C
Diff: 1
Skill: Recognition
6) A well-diversified portfolio is only about ________ as risky as the typical individual stock.
A) 8%
B) 19%
C) 27%
D) 52%
Answer: C
Diff: 1
Skill: Recognition
7) Randomly increasing the number of securities in a portfolio reduces the unsystematic risk but not the
systematic risk.
Answer: TRUE
Diff: 1
Skill: Conceptual
8) An internationally diversified portfolio

A) should result in a portfolio with a lower beta than a purely domestic portfolio.
B) has the same overall risk shape as a purely domestic portfolio.
C) is only about 12% as risky as the typical individual stock.
Answer: D
Diff: 1
Skill: Conceptual
9) In some respects, internationally diversified portfolios are the same in principle as a domestic
portfolio because
A) the investor is attempting to combine assets that are perfectly correlated.
B) investors are tying to reduce systematic risk.
C) investors are trying to reduce the total risk of the portfolio.
Answer: C
Diff: 1
Skill: Conceptual
2
10) In some respects, internationally diversified portfolios are different from a domestic portfolio
because
A) investors may also acquire foreign exchange risk.
B) international portfolio diversification increases expected return but does not decrease risk.
C) investors must leave the country to acquire foreign securities.
Answer: A
Diff: 1
Skill: Conceptual
17.2 Internationalizing the Domestic Portfolio
Instruction 17.1:
Use the information to answer the following question(s).
In September 2002 a U.S. investor chooses to invest $500,000 in German equity securities at a then
current spot rate of $1.30/euro. At the end of one year the spot rate is $1.35/euro.
1) Refer to Instruction 17.1. How many euros will the U.S. investor acquire with his initial $500,000
investment?
A) euro 650,000
B) euro 370,370
C) euro 500,000
D) euro 384,615
Answer: D
Diff: 2
Topic: 17.2 Internationalizing the Domestic Portfolio
Skill: Analytical
2) Refer to Instruction 17.1. At an average price of euro 60/share, how many shares of stock will the
investor be able to purchase?
A) 8333 shares
B) 6410 shares
C) 6173 shares
D) 10,833 shares
Answer: B
Diff: 2
Skill: Analytical
3
3) Refer to Instruction 17.1. At the end of the year the investor sells his stock that now has an average
price per share of euro 57. What is the investor's average rate of return before converting the stock back
into dollars?
A) 5.0%
B) -3.0%
C) -5.0%
D) 3.0%
Answer: C
Diff: 2
Skill: Analytical
4) Refer to Instruction 17.1. At the end of the year the investor sells his stock that now has an average
price per share of euro 57. What is the investor's average rate of return after converting the stock back
into dollars?
A) -1.35%
B) 5.0%
C) -5.0%
D) -7.24%
Answer: A
Diff: 2
Skill: Analytical
5) A U.S. investor makes an investment in Britain and earns 14% on the investment while the British
pound appreciates against the U.S. dollar by 8%. What is the investor's total return?
A) 22.00%
B) 23.12%
C) 6.00%
D) 4.88%
Answer: B
Diff: 2
Skill: Analytical
6) Which of the following statements is NOT true?

A) International diversification benefits induce investors to demand foreign securities.
B) An international security adds value to a portfolio if it reduces risk without reducing return.
C) Investors will demand a security that adds value.
D) All of the above are true.
Answer: D
Diff: 1
Skill: Conceptual
4
7) Portfolio theory assumes that investors are risk-averse. This means that investors
A) cannot be induced to make risky investments.
B) prefer more risk to less for a given return.
C) will accept some risk, but not unnecessary risk.
D) All of the above are true.
Answer: C
Diff: 1
Skill: Conceptual
8) The efficient frontier of the domestic portfolio opportunity set

A) runs along the extreme left edge of the opportunity set.
B) represents optimal portfolios of securities that represent minimum risk for a given level of expected
portfolio return.
C) contains the portfolio of risky securities that the rational investor would choose to hold.
Answer: D
Diff: 1
Skill: Recognition
9) The graph for the efficient frontier has beta on the vertical axis and standard deviation of the
horizontal axis.
Answer: FALSE
Diff: 1
Skill: Recognition
10) The portfolio with the least risk among all those possible in the domestic portfolio opportunity set is
called the minimum risk domestic portfolio.
Answer: TRUE
Diff: 1
Skill: Recognition
11) The addition of foreign securities to the domestic portfolio opportunity set shifts the efficient
frontier
A) down and to the left.
B) up and to the right.
C) up and to the left.
D) down and to the right.
Answer: C
Diff: 1
Skill: Conceptual
5
12) Relative to the efficient frontier of risky portfolios, it is impossible to hold a portfolio that is located
________ the efficient frontier.
A) to the left of
B) to the right of
C) on
D) to the right or left of
Answer: A
Diff: 1
Skill: Conceptual
13) The optimal domestic portfolio of risky securities is the portfolio of minimum risk.
Answer: FALSE
Diff: 1
Skill: Recognition
14) The ________ connects the risk-free security with the optimal domestic portfolio.
A) security market line
B) capital asset pricing model
C) capital market line
D) none of the above
Answer: C
Diff: 1
Skill: Recognition
15) Which of the following portfolios could not possibly be located on the efficient frontier of risky
portfolios?
A) Portfolio 1 with an expected return of 6% and a standard deviation of 6%.
B) Portfolio 2 with an expected return of 10% and a standard deviation of 12%.
C) Portfolio 3 with an expected return of 10% and a standard deviation of 8%.
D) Portfolio 4 with an expected return of 12% and a standard deviation of 20%.
Answer: B
Diff: 1
Skill: Conceptual
16) The standard deviation of the risk-free security is

A) less than the standard deviation of the optimal risky domestic portfolio.
B) less than the standard deviation of the optimal international portfolio.
C) equal to zero.
Answer: D
Diff: 1
Skill: Conceptual
6
Instruction 17.2:
A U.S. investor is considering a portfolio consisting of 60% invested in the U.S. equity index fund and
40% invested in the British equity index fund. The expected returns for the funds are 10% for the U.S.
and 8% for the British, standard deviations of 20% for the U.S. and 18% for the British, and a
correlation coefficient of 0.15 between the U.S. and British equity funds.
17) Refer to Instruction 17.2. What is the expected return of the proposed portfolio?
A) 9.2%
B) 9.0%
C) 19.2%
D) 19%
Answer: A
Diff: 2
Skill: Analytical
18) Refer to Instruction 17.2. What is standard deviation of the proposed portfolio?
A) 38.00
B) 19.20
C) 19.00
D) 14.45
Answer: D
Diff: 2
Skill: Analytical
19) The correlation coefficient has a range of

A) 0 to 1.
B) 1 to 10.
C) -1 to 1.
D) -1 to 0.
Answer: C
Diff: 1
Skill: Recognition
20) The standard deviation of a portfolio is the weighted average standard deviations of the individual
assets.
Answer: FALSE
Diff: 1
Skill: Recognition
7
21) According to the capital asset pricing model (CAPM), which of the following is true?
A) The expected return on an asset is equal to the risk-free rate plus the amount of risk, beta, multiplied
by the market risk premium.
B) The expected return on an asset is equal to the market rate plus the amount of risk, beta, multiplied by
the market risk premium.
C) The expected return on an asset is equal to the risk-free rate plus the amount of risk, standard
deviation, multiplied by the market risk premium.
D) None of the above.
Answer: A
Diff: 1
Skill: Recognition
22) The international diversification of a portfolio

A) results in lower diversifiable risk of the portfolio.
B) decreases the currency risk component of the portfolio.
C) reduces the systematic risk component of the portfolio.
D) none of the above.
Answer: C
Diff: 1
Skill: Conceptual
23) Portfolio diversification is beneficial to the investor because it

A) reduces expected returns and increases risk.
B) increases expected returns.
C) reduces risk for given levels of return.
Answer: C
Diff: 1
Skill: Conceptual
24) A Canadian-based investor purchases a Standard & Poor's 500 index (SPY) on the American Stock
Exchange, in U.S. dollars. Over the course of the year the U.S. dollar appreciates 8% against the
Canadian dollar, and the S&P Index rises 22%. The total return to the Canadian investor in Canadian
dollar terms is approximately ________.
A) 8%
B) 14%
C) 22%
D) 30%
Answer: D
Diff: 2
Skill: Analytical
8
25) The construction of an internationally diversified portfolio combines
A) currency and asset risk and return.
B) country risk with currency return.
C) credit risk with inflation risk.
D) asset risk with sovereign risk.
Answer: A
Diff: 1
Skill: Conceptual
26) If a portfolio is constructed with only two assets, of equal weights, and the correlation coefficient
between the two assets is exactly 1.0, which of the following is true?
A) The portfolio risk reduction is maximized.
B) The return of the two assets over time are seen to follow different cycles or paths.
C) Risk is not reduced at all because of the positive correlation.
D) None of the above are true.
Answer: C
Diff: 1
Skill: Conceptual
27) Which of the following is a potential obstacle to international diversification of portfolios?

A) high transaction costs
B) higher information costs
C) both A and B
Answer: C
Diff: 1
Skill: Recognition
17.3 National Markets and Asset Performance
1) The correlation of returns of the U.S. equity market index with the indexes of equity markets in
seventeen other countries over the period 1977-1996 is between
A) -1 and -0.50.
B) 1 and 0.50.
C) -0.50 and 0.0.
D) 0.0 and 0.50.
Answer: D
Diff: 1
Topic: 17.3 National Markets and Asset Performance
Skill: Recognition
9
2) The Sharpe and Treynor measures are each measures of return per unit of risk.
Answer: TRUE
Diff: 1
Skill: Recognition
3) The Sharpe measure uses ________ as the measure of risk and the Treynor measure uses ________ as
the measure of risk.
A) standard deviation; variance
B) beta; variance
C) standard deviation; beta
D) beta; standard deviation
Answer: C
Diff: 1
Skill: Recognition
TABLE 17.1
4) Refer to Table 17.1. What is the value of the Sharpe Measure for France?
A) 0.113
B) 0.0071
C) Either A or B
D) Neither A nor B
Answer: A
Diff: 2
Skill: Analytical
5) Refer to Table 17.1. What is the value of the Treynor Measure for the Netherlands?
A) 0.197
B) 0.0109
C) Either A or B
D) Neither A nor B
Answer: B
Diff: 1
Skill: Analytical
10
6) Refer to Table 17.1. ________ appears to have the greatest amount of risk as measured by monthly
standard deviation, but ________ has the best return per unit of risk according to the Sharpe Measure.
A) United States; Austria
B) France; Austria
C) United States; Netherlands
D) France; Netherlands
Answer: D
Diff: 1
Skill: Recognition
7) The Sharpe and Treynor Measures tend to be consistent in their ranking of portfolios when the
portfolios
A) are poorly diversified.
B) are properly diversified.
C) contain only U.S. equity investments.
Answer: B
Diff: 1
Skill: Conceptual
8) Capital markets around the world are on average less integrated today than they were 20 years ago.
Answer: FALSE
Diff: 1
Skill: Recognition
9) Which of the following is NOT an important question regarding the validity of a global version of the
capital asset pricing model (CAPM)?
A) barriers to the free and open movement of capital across boundaries
B) difficulties in estimating a global portfolio, i.e., trading limitations, illiquid markets, and incomplete
information
C) the lack of a single true worldwide risk-free security
D) all of the above
Answer: D
Diff: 1
Skill: Conceptual
11
10) The maximum benefits of portfolio construction are obtained when the correlation between assets is
________.
A) -1.0
B) 0.0
C) +1.0
Answer: A
Diff: 1
Skill: Conceptual
11) The Sharpe Measure of portfolio performance calculates the average return of the portfolio above
that of the ________.
A) market, per unit of portfolio risk.
B) market, per unit of beta risk.
C) risk-free rate, per unit of beta.
D) market, per unit of portfolio risk.
Answer: D
Diff: 1
Skill: Recognition
12) The Treynor Measure of portfolio performance calculates the average return of the portfolio above
that of the
A) market, per unit of portfolio risk.
B) risk-free rate, per unit of beta.
C) market, per unit of portfolio risk.
Answer: B
Diff: 1
Skill: Recognition
13) The largest equity market losses of the last 100 years were primarily related to war and terrorism.
Answer: TRUE
Diff: 1
Skill: Recognition
14) Inter-country correlations among the worlds largest capitalistic economies over the last century
illustrate that the correlation results for the first 50 years were good predictors for correlations for the
next 50 years.
Answer: FALSE
Diff: 1
Skill: Recognition
12
15) It is safe to say that because stock market correlations across countries has increased since 1986, that
there are no longer diversification benefits to be found from international portfolio diversification.
Answer: FALSE
Diff: 1
Skill: Conceptual
16) Meryl Janicky, a mutual fund manager, is evaluating the recent performance of the shares of Thames
Boats International, a publicly traded company in Great Britain. Ms Janicky's firm has $200,000
invested in Thames Boats and she has gathered the information presented in the following table. What
was the return on the security in pounds?
A) 7.47%
B) 10.50%
C) 12.07%
D) 16.66%
Answer: C
Diff: 2
Skill: Analytical
17) Meryl Janicky, a mutual fund manager, is evaluating the recent performance of the shares of Thames
Boats International, a publicly traded company in Great Britain. Ms Janicky's firm has $200,000
invested in Thames Boats and she has gathered the information presented in the following table. What
was the return on the security in dollars?
A) 227.47%
B) 10.50%
C) 12.07%
D) 16.66%
Answer: D
Diff: 2
Skill: Analytical
13
Essay Questions
17.1 International Diversification and Risk
1) Draw the curve representing the Optimal Domestic Efficient Frontier. Be sure to draw and label the
following: The vertical axis and the horizontal axis, the risk-free security, the minimum risk portfolio,
the domestic portfolio opportunity set, the optimal domestic portfolio, and the capital market line.
Choose a point along the domestic portfolio opportunity set between the optimal domestic portfolio and
the minimum risk domestic portfolio and explain why that point is not the optimal risky domestic
portfolio for investors to hold.
Answer: The graph should look like that found on page 19.5. To answer the second part of the question,
the student should draw a straight-line beginning at the point of the risk-free rate of return on the vertical
axis and running through the point he/she just put on the opportunity set between the minimum risk
portfolio and the optimal domestic portfolio. This graphical representation clearly shows that at any
point other than holding 100% in the risk-free security, the expected risk and risk characteristics of the
capital market line clearly dominate the new line just drawn.
Diff: 3
17.2 Internationalizing the Domestic Portfolio
1) Draw the domestic portfolio opportunity set being sure to label each axis. Next illustrate and explain
how the (domestic) capital market line is formed as part of the two-asset model of the risk-free security
plus a portfolio of risky securities.. Illustrate and explain how this model changes as we move from a
domestic-only portfolio to an international portfolio. What to we anticipate will happen to the risk-return
tradeoff?
Answer: The student should create a graph resembling exhibit 17.5. and demonstrate how the
international portfolio of risky assets presents the investor with an opportunity to increase expected
return while reducing the variability of return as compared to the purely domestic opportunities.
Diff: 3
17.3 National Markets and Asset Performance
1) If an investor is able to determine a global beta for his portfolio and holds a portfolio that is well-
diversified with international investments, which performance measure is more appropriate, the Sharpe
Measure or the Treynor Measure? Why? Explain each performance measure.
Answer: The Sharpe Measure is the ratio of excess returns above the risk-free rate of return to the
standard deviation of the portfolio. The Treynor Measure substitutes the beta of the portfolio for the
denominator. Thus Sharpe measures reward per unit of portfolio risk while Treynor measures reward per
unit of systematic risk. In this example, the portfolio risk and systematic risk are equivalent so either
measure is appropriate.
Diff: 3
14

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Fundamentals of Multinational Finance, 4e (Moffett)

Chapter 17 International Portfolio Theory and Diversification

Multiple Choice and True/False Questions

17.1 International Diversification and Risk

1) Portfolio diversification can eliminate 100% of risk.

2) Beta may be defined as

3) ________ risk is measured with beta.

4) A fully diversified domestic portfolio has a beta of

8) An internationally diversified portfolio

17.2 Internationalizing the Domestic Portfolio

6) Which of the following statements is NOT true?

8) The efficient frontier of the domestic portfolio opportunity set

16) The standard deviation of the risk-free security is

19) The correlation coefficient has a range of

22) The international diversification of a portfolio

23) Portfolio diversification is beneficial to the investor because it

27) Which of the following is a potential obstacle to international diversification of portfolios?

17.3 National Markets and Asset Performance

17.1 International Diversification and Risk

17.2 Internationalizing the Domestic Portfolio

17.3 National Markets and Asset Performance

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