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Multiple Choice Questions
1. In 2011, U.S. securities represented ______ of the world market for equities.
A. less than 25%
B. more than two-thirds
C. between 30% and 40%
D. a consistent 50%
Answer: C. between 30% and 40%
2. _____ has the highest market capitalization of listed corporations among developed
markets.
A. The United States
B. Japan
C. The United Kingdom
D. Switzerland
Answer: A. The United States
3. Total capitalization of corporate equity in the United States in 2011 was about _______
trillion.
A. $13.9
B. $23.4
C. $30.2
D. $45.5
Answer: A. $13.9
4. If you limit your investment opportunity set to only the largest six countries in the world in
terms of equity capitalization as a percentage of total global equity capital, you will include
about _______ of the world's equity.
A. 34%
B. 44%
C. 54%
D. 64%
Answer: D. 64%
5. Limiting your investments to the top six countries in the world in terms of market
capitalization may make sense for _________ investor but probably does not make sense for
________ investor.
A. an active; a passive
B. a passive; an active
C. a security selection expert; a market timer
D. a fundamental; a technical
Answer: B. a passive; an active
6. WEBS are ____________________.
A. investments in country-specific portfolios
B. traded exactly like mutual funds
C. identical to ADRs
D. designed to give investors foreign currency exposure to multiple countries
Answer: A. investments in country-specific portfolios
7. Which one of the following allows you to purchase the stock of a specific foreign
company?
A. WEBS

B. MSCI
C. ADR
D. EAFE
Answer: C. ADR
8. Generally speaking, countries with ______ capitalization of equities ________.
A. larger; have higher GDP
B. smaller; are wealthier
C. larger; have smaller GDP
D. larger; are higher-growth countries
Answer: A. larger; have higher GDP
9. The 32 "developed" countries with the largest equity capitalization made up about _____ of
the world GDP in 2011.
A. 22%
B. 44%
C. 68%
D. 85%
Answer: C. 68%
10. According to a regression of GDP on market capitalization in 2010, virtually all
developed countries had _______ per capita GDP than (as) predicted by the regression.
A. higher
B. lower
C. the same
D. sometimes lower and sometimes higher
Answer: A. higher
11. If the direct quote for the exchange rate for the U.S. dollar versus the Canadian dollar is
.98, what is the indirect quote?
A. 1.98
B. 1.02
C. .02
D. 1.05
Answer: B. 1.02
The indirect quote is the reciprocal of the direct quote:
1/.98 = 1.02
12. EAFE stands for _______.
A. Equity And Foreign Exchange
B. European, Australian, Far East
C. European, Asian, Foreign Exchange
D. European, American, Far East
Answer: B. European, Australian, Far East
13. Which one of the following country risks includes the possibility of expropriation of
assets, changes in tax policy, and restrictions on foreign exchange transactions?
A. Default risk
B. Foreign exchange risk
C. Market risk
D. Political risk
Answer: D. Political risk

14. The __________ index is a widely used index of non-U.S. stocks.
A. CBOE
B. Dow Jones
C. EAFE
D. Lehman Index
Answer: C. EAFE
15. Suppose that U.S. equity markets represent about 35% of total global equity markets and
that the typical U.S. investor has about 95% of her portfolio invested only in U.S. equities.
This is an example of _________.
A. home-country bias
B. excessive diversification
C. active management
D. passive management
Answer: A. home-country bias
16. The four largest economies in the world in 2010 were ____________.
A. United States, India, China, and Japan
B. United States, China, Canada, and Japan
C. United States, China, Japan, and Germany
D. China, United Kingdom, Canada, and United States
Answer: C. United States, China, Japan, and Germany
17. The proper formula for interest rate parity is ___________.
A. [1 + rf(foreign)]/[1 + rf(US)] = F1/E0
B. [1 + rf(US)]/[1 + rf(foreign)] = E0/F1
C. [1 + rf(US)]/[1 + rf(foreign)] = F0/E0
D. [1 + rf(foreign)]/[1 + rf(foreign)] = F0/E1
Answer: C. [1 + rf(US)]/[1 + rf(foreign)] = F0/E0
18. Research indicates that exchange risk of the major currencies has been _________ so far
in this century.
A. relatively high
B. relatively low
C. declining slightly
D. declining rapidly
Answer: A. relatively high
19. It appears from empirical work that exchange rate risk ____________.
A. has been declining for individual investments in recent years
B. is mostly diversifiable
C. is mostly systematic risk
D. is unimportant for an investment in a single foreign country
Answer: B. is mostly diversifiable
20. Passive investors with well-diversified international portfolios _________.
A. can safely ignore all political risk in emerging markets
B. can expect very large diversification gains from their international investing
C. do not need to be concerned with hedging exposure to foreign currencies
D. can expect returns to be better than the EAFE on a consistent basis
Answer: C. do not need to be concerned with hedging exposure to foreign currencies
21. Which stock market has the largest weight in the EAFE index?

A. Japan
B. Germany
C. United Kingdom
D. Australia
Answer: A. Japan
22. The correlation coefficient between the U.S. stock market index and stock market indexes
of major countries is __________.
A. between -1 and -.5
B. between -.50 and 0
C. between 0 and .5
D. between .5 and 1
Answer: D. between .5 and 1
23. In 2010, the ___ countries with the largest capitalization of equities made up
approximately 60% of the world equity portfolio.
A. 2
B. 4
C. 5
D. 12
Answer: C. 5
24. Investor portfolios are notoriously overweighted in home-country stocks. This is
commonly called ________.
A. local fat
B. nativism
C. home-country bias
D. misleading representation
Answer: C. home-country bias
25. Corruption is _________ risk variable.
A. a firm-specific
B. a political
C. a financial
D. an economic
Answer: B. a political
26. A U.S. hedge fund owns Swiss franc bonds. The fund manager believes that if Swiss
interest rates rise relative to U.S. interest rates, the value of the franc will rise. To limit the
risk to the fund's dollar return, the fund manager should __________.
A. sell the Swiss franc bonds now
B. sell the Swiss franc forward
C. probably do nothing because the franc move will offset the lower bond price
D. enter into an interest rate swap to pay variable and receive fixed
Answer: C. probably do nothing because the franc move will offset the lower bond price
27. The annual inflation rate is ______ risk variable.
A. a firm-specific
B. a political
C. a financial
D. an economic
Answer: D. an economic

28. A U.S. insurance firm must pay €75,000 in 6 months. The spot exchange rate is $1.32 per
euro, and in 6 months the exchange rate is expected to be $1.35. The 6-month forward rate is
currently $1.36 per euro. If the insurer's goal is to limit its risk, should the insurer hedge this
transaction? If so how?
A. The insurer need not hedge because the expected exchange rate move will be favorable.
B. The insurer should hedge by buying the euro forward even though this will cost more than
the expected cost of not hedging.
C. The insurer should hedge by selling the euro forward because this will cost less than the
expected cost of not hedging.
D. The insurer should hedge by buying the euro forward even though this will cost less than
the expected cost of not hedging.
Answer: B. The insurer should hedge by buying the euro forward even though this will cost
more than the expected cost of not hedging.
29. A fund has assets denominated in euros and liabilities in yen due in 6 months. The 6month forward rate for the euro is $1.36 per euro, and the 6-month forward rate for the yen is
121 yen per dollar. The 6-month forward rate for the euro versus the yen should be ________
per euro.
A. ×88.97
B. ×145.34
C. ×154.67
D. ×164.56
Answer: D. ×164.56
($1.36/€)(×121/$) = ×164.56/€
30. You invest in various broadly diversified international mutual funds as well as your U.S.
portfolio. The one risk you probably don't have to worry about affecting your returns is
__________.
A. business-cycle risk
B. beta risk
C. inflation risk
D. currency risk
Answer: D. currency risk
31. According to the International Country Risk Guide in 2011, which of the following
countries was the riskiest according to the current composite risk rating?
A. Japan
B. United States
C. China
D. India
Answer: D. India
32. Suppose the 6-month risk-free rate of return in the United States is 5%. The current
exchange rate is 1 pound = US$2.05. The 6-month forward rate is 1 pound = US$2. The
minimum yield on a 6-month risk-free security in Britain that would induce a U.S. investor to
invest in the British security is ________.
A. 5.06%
B. 6.74%
C. 8.48%
D. 10.13%

Answer: D. 10.13%

33. The quoted interest rate on a 3-month Canadian security is 8%. The current exchange rate
is C$1 = US$.68. The 3-month forward rate is C$1 = US$.70. The APR (denominated in
US$) that a U.S. investor can earn by investing in the Canadian security is __________.
A. 5%
B. 7.25%
C. 20%
D. 22.43%
Answer: C. 20%

34. Suppose the 1-year risk-free rate of return in the United States is 5% and the 1-year riskfree rate of return in Britain is 8%. The current exchange rate is $1 = ₤.50. A 1-year future
exchange rate of __________ would make a U.S. investor indifferent between investing in the
U.S. security and investing in the British security.
A. ₤.5150
B. ₤.5142
C. ₤.5123
D. ₤.4859
Answer: B. ₤.5142
F0 = (1.08/1.05) × .50≤/$ = .5143≤/$
35. The risk-free interest rate in the United States is 4%, while the risk-free interest rate in the
United Kingdom is 9%. If the British pound is worth $2 in the spot market, a 1-year futures
rate on the British pound should be worth __________.
A. $1.83
B. $1.91
C. $2.08
D. $2.18
Answer: B. $1.91

36. The risk-free interest rate in the United States is 8%, while the risk-free interest rate in the
United Kingdom is 15%. If the 1-year futures price on the British pound is $2.40, the spot
market value of the British pound today should be __________.
A. $1.93
B. $2.22
C. $2.56
D. $2.76
Answer: C. $2.56

37. The present exchange rate is C$1 = US$.77. The 1-year futures rate is C$1 = US$.73. The
yield on a 1-year U.S. bill is 4%. A yield of __________ on a 1-year Canadian bill will make
investors indifferent between investing in the U.S. bill and the Canadian bill.
A. 9.7%
B. 2.9%
C. 2.8%
D. 2%
Answer: A. 9.7%

38. The yield on a 1-year bill in the United Kingdom is 6%, and the present exchange rate is 1
pound = US$2. If you expect the exchange rate to be 1 pound = US$1.95 a year from now, the
return a U.S. investor can expect to earn by investing in U.K. bills is approximately
__________.
A. -3%
B. 3%
C. 3.35%
D. 8.72%
Answer: C. 3.35%

39. Assume there is a fixed exchange rate between the Canadian and U.S. dollars. The
expected return and standard deviation of return on the U.S. stock market are 13% and 15%,
respectively. The expected return and standard deviation of return on the Canadian stock
market are 12% and 16%, respectively. The covariance of returns between the U.S. and
Canadian stock markets is 1.2%. If you invested 50% of your money in the Canadian stock
market and 50% in the U.S. stock market, the expected return on your portfolio would be
__________.
A. 12%
B. 12.5%
C. 14%
D. 15.5%
Answer: B. 12.5%

40. Assume there is a fixed exchange rate between the Canadian and U.S. dollars. The
expected return and standard deviation of return on the U.S. stock market are 10% and 15%,
respectively. The expected return and standard deviation of return on the Canadian stock
market are 12% and 16%, respectively. The covariance of returns between the U.S. and
Canadian stock markets is .012. If you invested 50% of your money in the Canadian stock
market and 50% in the U.S. stock market, the standard deviation of return on your portfolio
would be __________.
A. 10.96%
B. 12.25%

C. 13.42%
D. 15.5%
Answer: C. 13.42%

41. Inclusion of international equities in a U.S. investor's portfolio has historically produced
___________________.
A. a substantially reduced portfolio variance
B. a slightly reduced portfolio variance
C. a substantially poorer portfolio variance
D. a slightly poorer portfolio variance
Answer: A. a substantially reduced portfolio variance
42. WEBS are _____________.
A. mutual funds marketed internationally on the Internet
B. synthetic domestic stock indexes
C. equity indexes that replicate the price and yield performance of foreign stock portfolios
D. single stock investments in a foreign security
Answer: C. equity indexes that replicate the price and yield performance of foreign stock
portfolios
43. You are a U.S. investor who purchased British securities for 3,500 pounds 1 year ago
when the British pound cost $1.35. No dividends were paid on the British securities in the
past year. Your total return based on U.S. dollars was __________ if the value of the
securities is now 4,200 pounds and the pound is worth $1.15.
A. -3.8%
B. 2.2%
C. 5.6%
D. 15%
Answer: B. 2.2%

44. Real U.S. interest rates move above Japanese interest rates. If you believe that Japanese
interest rates won't move and that interest rate parity will hold, then ____________.
A. the yen-per-dollar exchange rate should rise
B. the dollar-per-yen exchange rate should rise
C. the exchange rate should stay the same if parity holds
D. The answer cannot be determined from the information given.
Answer: B. the dollar-per-yen exchange rate should rise
45. Suppose a U.S. investor wants to invest in a British firm currently selling for ₤50 per
share. The investor has $7,000 to invest, and the current exchange rate is $1.40/₤.
How many shares can the investor purchase?
A. 140
B. 100
C. 71.43
D. None of these options
Answer: B. 100
$7,000 = 7,000/1.40 = ₤5,000

₤5,000/50 = 100 shares
46. Suppose a U.S. investor wants to invest in a British firm currently selling for ₤50 per
share. The investor has $7,000 to invest, and the current exchange rate is $1.40/₤.
After 1 year, the exchange rate is unchanged and the share price is ₤55. What is the dollardenominated return?
A. 14%
B. 10%
C. 9.3%
D. 7.1%
Answer: B. 10%
₤55 × 100 × 1.40 = $7,700
(7,700/7,000) - 1 = 1.10 - 1 = 10%
47. Suppose a U.S. investor wants to invest in a British firm currently selling for ₤50 per
share. The investor has $7,000 to invest, and the current exchange rate is $1.40/₤.
After 1 year, the exchange rate is unchanged and the share price is ₤55. What is the pounddenominated return?
A. 14%
B. 10%
C. 9.3%
D. 7.1%
Answer: B. 10%
₤55 × 100 = ₤5,500
₤50 × 100 = ₤5,000
(5,500/5,000) - 1 = 1.10 - 1 = 10%
48. Suppose a U.S. investor wants to invest in a British firm currently selling for ₤50 per
share. The investor has $7,000 to invest, and the current exchange rate is $1.40/₤.
After 1 year, the exchange rate is $1.60/₤ and the share price is ₤55. What is the dollardenominated return?
A. 25.7%
B. 16%
C. 14.3%
D. 9.3%
Answer: A. 25.7%
₤55 × 100 × 1.60 = $8,800
(8,800/7,000) - 1 = 1.257 - 1 = 25.7%
49. Suppose a U.S. investor wants to invest in a British firm currently selling for ₤50 per
share. The investor has $7,000 to invest, and the current exchange rate is $1.40/₤.
After 1 year, the exchange rate is $1.50/₤ and the share price is ₤45. How much of your
dollar-denominated return is due to the currency change?
A. 10%
B. 6.43%
C. 4.34%
D. 2.12%
Answer: B. 6.43%

Gain from currency is -3.571% - (-10%) = 6.429%
50. You find that the exchange rate quote for the yen is 121 yen per dollar. This is an example
of ________ quote. You also find that the euro is worth $1.33. This second quote is an
example of _______ quote.
A. a direct; an indirect
B. an indirect; a direct
C. a foreign; a U.S.
D. a U.S.; a foreign
Answer: B. an indirect; a direct
51. Among emerging countries the largest equity market in 2011 was located in
_____________.
A. China
B. India
C. Brazil
D. Russia
Answer: C. Brazil
52. In the PRS country composite risk ratings, a score of ______ represents the least risky and
a score of _____ represents the most risky.
A. 0; 100
B. 0; 50
C. 50; 0
D. 100; 0
Answer: D. 100; 0
53. Which emerging country had the highest percentage growth in market capitalization
during the 2000-2011 period?
A. Brazil
B. China
C. Columbia
D. Turkey
Answer: C. Columbia
54. The dollar-per-euro spot rate is 1.2 when an importer of French wines places an order. Six
months later, when she takes delivery, the spot rate is 1.3 dollars per euro. If her original
invoice was for 30,000 euro, what is her gain or loss due to exchange rate risk?
A. $3,000 gain
B. $3,000 loss
C. $6,000 loss
D. No gain or loss
Answer: B. $3,000 loss
Original cost = €30,000 × 1.2 = $36,000
New cost = €30,000 × 1.3 = $39,000; $36,000 - $39,000 = -$3,000.

55. An importer of televisions from Japan has a contract to purchase a shipment of televisions
for 2 million yen. The spot rate increases from 105 yen per dollar to 108 yen per dollar. What
is the importer's gain or loss?
A. $529 gain
B. $529 loss
C. $619 gain
D. $619 loss
Answer: A. $529 gain
Original cost = 2,000,000/105 = $19,048
New cost = 2,000,000/108 = $18,519
Change = 19,048 - 18,519 = 529
56. A country has a PRS political risk rating of 75, a financial score of 40, and an economic
score of 35. The country's composite rating is _________.
A. 75
B. 50
C. 40
D. 35
Answer: A. 75
PRS = (75 + 40 + 35)/2 = 75
57. The risk-free rate in the United States is 2.5%, and the risk-free rate in Europe is 3.2%. If
the spot rate of dollars per euro is 1.32, what is the likely forward rate in terms of dollars per
euro?
A. 1.30
B. 1.31
C. 1.32
D. 1.33
Answer: B. 1.31
Forward rate = (1.32)(1.025/1.032) = 1.31
58. The risk-free rate in the United States is 4%, and the risk-free rate in Japan is 1.2%. If the
spot rate of yen to dollars is 105, what is the likely yen-per-dollar forward rate?
A. 101
B. 102
C. 105
D. 108
Answer: B. 102
forward rate = (105)(1.012/1.04) = 102.2
59. The yen-per-dollar spot rate is 104. The yen-per-dollar forward rate is 107. If the U.S.
risk-free rate is 2.4%, what is the likely yen risk-free rate?
A. 1.24%
B. 2.35%
C. 3.98%
D. 5.35%
Answer: D. 5.35%
Yen rate = (1.024)(107/104) - 1 = .0535
60. In the PRS financial risk ratings, the United States rates poorly because of the U.S.
________.

I. Large budget deficit
II. Large trade deficit
III. Large amount of total debt
A. I only
B. I and II only
C. I and III only
D. I, II, and III
Answer: D. I, II, and III
61. The major participants who directly purchase securities in the capital markets of other
countries are predominantly ____________.
A. large institutional investors
B. individual investors
C. government agencies
D. central banks
Answer: A. large institutional investors
62. Of the following, which is the most commonly used international index?
A. DJIA
B. EAFE
C. Russell 2000
D. S&P 500
Answer: B. EAFE
63. WEBS differ from mutual funds in that:
I. WEBS can be shorted.
II. WEBS trade continuously on the AMEX.
III. WEBS are passively managed.
A. II only
B. II and III only
C. I and III only
D. I, II, and III
Answer: D. I, II, and III
64. The variation in the betas of emerging markets suggests that ____________.
A. emerging markets are more uniform than developed markets
B. beta does not hold in international markets
C. international diversification may reduce portfolio risk
D. riskier emerging markets have uniformly lower betas
Answer: C. international diversification may reduce portfolio risk
65. One year U.S. interest rates are 5%, and European interest rates are 7%. The spot euro
direct exchange rate quote is 1.32, and the 1-year forward rate direct quote is 1.35. If you can
borrow either $1 million or €1 million to start with, what would be your dollar profits from
interest arbitrage based on these data?
A. $94,322
B. $55,345
C. $44,318
D. $33,595
Answer: C. $44,318
This is called covered interest arbitrage; the steps are outlined below:

According to interest rate parity, the forward rate should be (1.05/1.07 ) × $1.32 = $1.30;
since the rate is $1.35, you should borrow dollars.
1. Borrow $1 million; in 1 year you owe $1 million × 1.05 = $1,050,000.
2. Sell dollars and buy euro spot: $1,000,000/$1.32 = €757,575.76.
3. Invest in euro securities and earn 7.00%: €757,575.76 × 1.07 = €810,606.06.
4. Cover $1,050,000 owed in 1 year by selling euro forward:
€810,606.06 × $1.35 = $1,094,318.18
Repay $1,050,000 and net $1,094,318.18 - $1,050,000 = $44,318.18.
66. One year U.S. interest rates are 7%, and European interest rates are 5%. The spot euro
direct exchange rate quote is 1.30 and the 1-year forward rate direct quote is 1.25. If you can
borrow either $1 million or €1 million to start with, what would be your dollar profits from
interest arbitrage based on these data?
A. $60,384
B. $42,973
C. $68,422
D. $78,500
Answer: D. $78,500
This is called covered interest arbitrage; the steps are outlined below:
According to interest rate parity, the forward rate should be (1.07/1.05) × 1.30 = $1.32; since
the rate is only $1.25, you should borrow euros.
1. Borrow €1 million; in 1 year you owe €1 million × 1.05 = €1,050,000.
2. Sell euros and buy dollars spot: €1,000,000 × $1.30 = $1,300,000.
3. Invest in the United States and earn 7%: $1,300,000 × 1.07 = $1,391,000.
4. Cover €1,050,000 owed in 1 year by buying euros forward; this will require
€1,050,000 × $1.25 = $1,312,500.
This leaves $1,391,000 - $1,312,500 = $78,500 profit in dollars.
67.

All exchange rates are expressed as units of foreign currency that can be purchased with one
U.S. dollar. Answer the following about decomposing the manager's performance.
What is the difference in return of the manager's portfolio due to currency selection?
A. -5%
B. -3%
C. 2%
D. 1%
Answer: C. 2%
Currency Selection
EAFE: EAFE weight × [(E1/E0) - 1] = (.3)(-20%) + (.1)(10%) + (.6)(0%) = -5%
Manager: Manager weight × [(E1/E0) - 1] = (.25)(-20%) + (.2)(10%) + (.55)(0%) = -3%
Gain = -3% - (-5%) = +2%
68.

All exchange rates are expressed as units of foreign currency that can be purchased with one
U.S. dollar. Answer the following about decomposing the manager's performance.
What is the difference in return of the manager's portfolio due to country selection?
A. -.60%
B. -.75%
C. .12%
D. .22%
Answer: B. -.75%
Country Selection
EAFE: (EAFE weight)(return equity index) = (.3)(20%) + (.1)(15%) + (.6)(25%) = 22.5%
Manager: (Manager weight)(return equity index) = (.25)(20%) + (.2)(15%) + (.55)(25%) =
21.75%
Gain = 21.75% - 22.5% = -.75%
69.

All exchange rates are expressed as units of foreign currency that can be purchased with one
U.S. dollar. Answer the following about decomposing the manager's performance.
What is the difference in return of the manager's portfolio due to stock selection?
A. 1.15%
B. 3.25%
C. 5.45%
D. 6.13%
Answer: B. 3.25%
Stock Selection
(Manager weight)(Manager return - Equity index return)
Selection = (.25)(18% - 20%) + (.2)(20% - 15%) + (.55)(30% - 25%) = 3.25%

Test Bank for Essentials of Investments
Zvi Bodie, Alex Kane, Alan Marcus
9780078034695, 9789389957877, 9781264140251, 9781260316148, 9780073382401, 9780078034695, 9781260013924, 9780077835422

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