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# International Investing (Part II).doc

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### International Investing (Part II).doc

1. 1. FIN 476 Greg MacKinnon Sobey School of Business Saint Mary's University International Investing (Part II) As discussed previously, when someone makes an investment in a foreign stock (or stock market), they are really making an investment in two things; the stock itself and the foreign currency in which it is held. Because of this, there are two components to the return and risk of a foreign investment. Say the return on a foreign stock is R, in foreign currency terms (or “local currency” terms). Let %∆e be the percentage change in the value of the foreign currency. Assume that an investor is concerned with the return on the stock in dollar terms. Let the return in dollar terms be R\$. Then, as seen before: R\$ = (1+R)(1+%∆e)-1 Example: If the S&P 500 goes from 1000 to 1100 over a one year period and over the same period the \$US goes from 1.5 \$Can/\$US to 1.6\$Can/\$US, then the return on the S&P 500 to a US investor is 10%, but the return on an investment to a Canadian investor in \$Can terms can be calculated as: %∆e = (1.6 − 1.5) = 6.7% 1.5 R \$ Can = (1.1)(1.067) − 1 = 17.37% Of course, because both the return on the stock and the return on the currency enter the calculation for return, they will both also affect the calculation for risk. Intuitively, there is an extra source of risk for international investments because the investor has to worry about changes in the exchange rate as well as changes in the value of the stock itself. Variance of returns is a standard measure of risk. From the equation above, an investor worried about the dollar returns on a foreign investment would measure risk by Var[R\$]. R \$ = (1 + R )(1 + %∆e) − 1 = R + %∆e + R (%∆e) ≈ R + %∆e where the last near equality holds since the cross product will tend to be very small. Looking at variance of R\$: Var[ R \$ ] = Var[ R + %∆e] = Var[ R ] + Var[ %∆e] + 2Cov[ R ,%∆e]