International finance

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Assignment ; INTERNATIONAL FINANCE ; iseg

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1) You have two stocks with the Expected Return (ER), Standard Deviation (SD), and Correlation Coefficient in the attached list.

a) Show how you can create a portfolio with these two stocks which would have an ER of 8%. What is the SD of this portfolio?

b) Now you also have a Risk-Free Asset with a return of 2.5%. Show how you can combine it with Stock A in order to create a portfolio with a SD of 3%. What is the ER of this portfolio?

c) Now you want to create a portfolio with just the Risk-Free Asset and Stock B. Show how you can create a portfolio with these two securities that has an ER of 13%. What do you need to do to create this portfolio?

d) Explain the concept of Efficient Markets Hypothesis and what the difference is between the Weak, Semi-Strong, and Strong forms of it. Do you agree with it?

2) You put €15,000 into a group of French stocks on January 1. On June 30, your portfolio's value was the amount listed in the attached list. The next day you added another €3000 to the portfolio.

a) Calculate your annual return on the portfolio, if no other money was added or removed, and the value on December 31 was €18,360.

b) Inflation was the amount in the attached list. What was your real annual return on your portfolio? What does this mean?

c) During the same year the CAC40 started at 2500 on January 1. It ended the year with the value in the attached list. Considering this, do you think your stock portfolio did well or did badly? Explain.

d) Explain what the CAC40 is and how its value is calculated. (You may need to do a little outside research to answer this question.)

3) You have purchased stock for $35/share. You want to sell the stock once you have made the acceptable profit in the attached list. However, you do not want to lose any more than the acceptable loss in the attached list.

a) Which order (market, limit, or stop-loss) should you make, and at what price, to ensure your stock is sold once you have earned your acceptable profit? Which order (market, limit, or stop-loss) should you make, and at what price, to ensure your stock is sold to ensure you do not lose any more than your acceptable loss?

b) Assume that you have bought the stock on margin, and borrowed 40% of the purchase price. You purchased 100 shares. The maintenance margin requirement is in the attached list. If the price of the stock falls to $22/share, will you receive a margin call - i.e. will you have to add more money to your account? Explain your calculation.

c) Assume the price falls to $20/share and you sell your shares, which you purchased on margin at the interest rate in the attached list. Calculate your percentage return on this investment?

d) Explain what short sales are and why they are dangerous for investors. Also explain why governments often restrict their use.

4) You have decided to buy stock options. You have purchased a call option on Stock A with the exercise price and premium per share in the attached list. You have also purchased a put option on Stock B with the exercise price and premium in the attached list.

a) Calculate the breakeven price of each of the options, i.e. at what price would the stock have to be so that you have not gained or lost any money by buying each option.

b) On the day you purchase the options, the two stocks sell for the prices per share on the attached list. Calculate the time value of each option.

c) On the expiration date of the options, Stock A sells for $53/share and Stock B sells for $97/share. Calculate the combined total net profit you have earned by buying the two options (after subtracting the premiums paid).

d) Explain the five factors discussed in class that affect the premiums of put and call options. (e.g. time to maturity).

Extraits

[...] No dividends are paid. Use the beginning and ending year spot exchange rates from the attached list. Calculate the return to an American investor. (He invests dollars and receives dollars). Spot rate beginning of year: $ 1.35 /€ Spot rate end of year: $ 1.25 /€ Return: 120 – 100 / 100 = 0.2 = 20% So the return of the American investor (he invests dollars and receives dollars) will be 20% With the information in above, calculate the return to a French investor who invests €15,000. [...]

[...] Translation exposure is the risk that a company's equities, assets, liabilities or income will change in value as a result of exchange rate changes. This occurs when a firm denominates a portion of its equities, assets, liabilities or income in a foreign currency. The difference between translation, transaction and operation exposure are: Translation exposure will impact the balance sheet assets liabilities and income statement Operation exposure will have an impact on revenue and cost which are related to future sales Transaction exposure will have an impact on exchange rate. INTERNATIONAL PROFITS Assume an investor buys stock in Apple, an American company, for $100/share. [...]

[...] Recalculate these prices at the end of year. Which competitor has benefited? We have that data: American: $130/printers French: €100/Printers Today's spot $ 1.30 /€ Expected spot rate in one year $ 1.15 /€ US$ price of the French Printer at the beginning of the year: French: €100/Printers Today's spot $ 1.30 /€ €100 x $ 1.30 /€ = $130 € price of the American Printer at the beginning of the year: American: $130/printers Today's spot $ 1.30 /€ $130 x $ 1.30 /€ = $130 / $ 1.30 /€ = €100 US$ price of the French Printer at the end of the year: French: €100/Printers Expected spot rate in one year $ 1.15 /€ €100 x $ 1.15 /€ = $115 € price of the American Printer at the end of the year American: $130/printers Expected spot rate in one year $ 1.15 /€ $130 x $ 1.15 /€ = $130 / $ 1.15 /€ = € 113.04 To resume, we have: At the end of the Year French Printer American printer Difference € price: €100 € price € 113.04 + € 13.04 for the American Exporter $ price: $115 $ price: $130 + $15 for the American Exporter We notice that the French Exporter will have more benefit than the American because he is cheaper than the American at the end of the year. [...]

[...] So, it is more risky than the arbitrage because there are no low margins or safety. The investor always hope that the price will go up, but he is not sure that will happened. As we saw in class, the financial crisis is the consequence of the speculation. In fact, investors prefer have a safety and secure investment thanks to the arbitrage than a speculation which is base on “chance”. You work at a British firm and are expecting to receive €1,000,000 in 6 months. [...]

[...] The exchange rate of the currency of a country will depend on the demand for and supply of foreign exchange. It is the difference between exports and imports for a country and the country need a positive balance of payment (Export > Import) in order to have a well and healthy financial situation. We have two parts which are the current account and the capital account. In the current account we have 4 parts: Goods, Services, Income and Unilateral transfers. In the capital account we have 2 parts: Direct investment and Portfolio Investment. [...]