Elton, Gruber, Brown, and Goetzmann
Modern Portfolio Theory and Investment Analysis, 7th Edition
Solutions to Text Problems: Chapter 12
Chapter 12: Problem 1
Equation (12.1) in the text can be used to answer this question:
RN RF RUS RF
> N,US
N US
As is explained in the text, if the above inequality holds, then the foreign
investment will be attractive to a U.S. investor. RUS and RN for the foreign
countries are given in the problem's table. From the tables in the text, we have:
N N,US
Austria 24.50 0.281
France 17.76 0.534
Japan 25.70 0.348
U.K. 15.59 0.646
Also, from the text tables, US = 13.59. Given that RF = 6%, we have:
RN RF RUS RF
N,US
N US
Austria 0.327 0.289
France 0.563 0.550
Japan 0.311 0.358
U.K. 0.577 0.665
For Austria and France, the above inequality holds, so a U.S. investor should
consider those foreign markets as attractive investments; for Japan and the U.K.,
the above inequality does not hold, so a U.S. investor should not consider those
foreign markets as attractive investments.
Elton, Gruber, Brown, and Goetzmann 12-1
Modern Portfolio Theory and Investment Analysis, 7th Edition
Solutions To Text Problems: Chapter 12
Chapter 12: Problem 2
To answer this question, use the formula introduced in Chapter 5 for finding the
minimum-risk portfolio of two assets:
22 1 2 12
X1GMV =
12 + 22 2 1 2 12
where X1 is the investment weight for asset 1 and X2 = 1 - X1.
For equities, US = 13.59, N = 16.70 and N,US = 0.423. So the minimum-risk portfolio is:
GMV
X US =
(16.7) (13.59)(16.7)(0.423)
2
(13.59)2 + (16.7)2 (2)(13.59)(16.7)(0.423)
= 0.6734 (67.34% )
X NGMV = 1 X US
GMV
= 0.3266 (32.66% )
For bonds, US = 7.90, N = 9.45 and N,US = 0.527. So the minimum-risk portfolio is:
GMV
X US =
(9.45)2 (7.9)(9.45)(0.527)
(7.9)2 + (9.45)2 (2)(7.9)(9.45)(0.527)
= 0.6841 (68.41% )
X NGMV = 1 X US
GMV
= 0.3159 (31.59% )
For T-bills, US = 0.35, N = 6.77 and N,US = 0.220. So the minimum-risk portfolio is:
GMV
X US =
(6.77)2 (0.35)(6.77)( 0.22)
(0.35)2 + (6.77)2 (2)(0.35)(6.77)( 0.22)
= 0.9863 (98.63% )
X NGMV = 1 X US
GMV
= 0.0137 (1.37% )
Elton, Gruber, Brown, and Goetzmann 12-2
Modern Portfolio Theory and Investment Analysis, 7th Edition
Solutions To Text Problems: Chapter 12
Chapter 12: Problem 3
In the text, the return due to exchange-rate changes (RX) is shown to be equal to
fxt/fxt-1 - 1, where fxt is the foreign exchange rate at time t expressed in terms of the
investor's home currency per unit of foreign currency. Let fxt be the exchange rate
expressed in terms of dollars and fx*t be the exchange rate expressed in terms of
pounds. These two rates are simply reciprocals, i.e., fx*t = 1/fxt. So from the table in
the problem we have:
(1 + RX) (1 + R*X)
Period (for US investor) (for UK investor)
1 2.5/3 = 0.833 3/2.5 = 1.200
2 2.5/2.5 = 1.000 2.5/2.5 = 1.000
3 2/2.5 = 0.800 2.5/2 = 1.250
4 1.5/2 = 0.750 2/1.5 = 1.333
5 2.5/1.5 = 1.667 1.5/2.5 = 0.600
The total return to a U.S. investor from a U.K. investment is (1 + RX)(1 + RUK) 1; the
total return to a U.K. investor from a U.S. investment is(1 + R*X)(1 + RUS) 1. So:
Return to U.S. Investor
From U.S.
Period Investment From U.K. Investment
1 10% (0.833)(1.05) 1 = 12.5%
2 15% (1)(0.95) 1 = 5.0%
3 5% (0.8)(1.15) 1 = 8.0%
4 12% (0.75)(1.08) 1 = 19.0%
5 6% (1.667)(1.1) 1 = 83.3%
Average 7.6% 7.76%
Return to U.K. Investor
From U.K.
Period Investment From U.S. Investment
1 5% (1.2)(1.1) 1 = 32.0%
2 5% (1)(1.15) 1 = 15.0%
3 15% (1.25)(0.95) 1 = 18.75%
4 8% (1.333)(1.12) 1 = 49.3%
5 10% (0.6)(1.06) 1 = 36.4%
Average 6.6% 15.73%
Elton, Gruber, Brown, and Goetzmann 12-3
Modern Portfolio Theory and Investment Analysis, 7th Edition
Solutions To Text Problems: Chapter 12
Chapter 12: Problem 4
Using the data and averages from Problem 3 we have:
For U.S. Investor
US =
(10 7.6)2 + (15 7.6)2 + ( 5 7.6)2 + (12 7.6)2 + (6 7.6)2
5
= 6.95%
UK =
( 12.5 7.76)2 + ( 5 7.76)2 + ( 8 7.76)2 + ( 19 7.76)2 + (83.3 7.76)2
5
= 38.06%
For U.K. Investor
UK =
(5 6.6)2 + ( 5 6.6)2 + (15 6.6)2 + (8 6.6)2 + (10 6.6)2
5
= 6.65%
US =
(32 15.73)2 + (15 15.73)2 + (18.75 15.73)2 + (49.3 15.73)2 + ( 36.4 15.73)2
5
= 28.70%
Chapter 12: Problem 5
This problem is essentially the same as Problem 3, except that the exchange rate is
given in indirect (yen/$) terms rather than direct ($/yen) terms. From the table in
the problem we have:
(1 + RX) (1 + R*X)
Period (for US investor) (for Japanese investor)
1 200/180 = 1.111 180/200 = 0.900
2 180/190 = 0.947 190/180 = 1.056
3 190/150 = 1.267 150/190 = 0.789
4 150/170 = 0.882 170/150 = 1.133
5 170/180 = 0.944 180/170 = 1.059
Elton, Gruber, Brown, and Goetzmann 12-4
Modern Portfolio Theory and Investment Analysis, 7th Edition
Solutions To Text Problems: Chapter 12
The total return to a U.S. investor from a Japan investment is (1 + RX)(1 + RJ) 1; the
total return to a Japanese investor from a U.S. investment is(1 + R*X)(1 + RUS) 1. So:
Return to U.S. Investor
From U.S.
Period Investment From Japan Investment
1 12% (1.111)(1.18) 1 = 31.10%
2 15% (0.947)(1.12) 1 = 6.06%
3 5% (1.267)(1.1) 1 = 39.37%
4 10% (0.882)(1.12) 1 = 1.22%
5 6% (0.944)(1.07) 1 = 1.01%
Average 9.6% 15.26%
Return to Japanese Investor
From Japan
Period Investment From U.S. Investment
1 18% (0.9)(1.12) 1 = 0.80%
2 12% (1.056)(1.15) 1 = 21.44%
3 10% (0.789)(1.05) 1 = 17.16%
4 12% (1.133)(1.1) 1 = 24.63%
5 7% (1.059)(1.06) 1 = 12.25%
Average 11.8% 8.39%
Chapter 12: Problem 6
The answers to this problem are found in the same way as those to Problem 4.
For the U.S. investor: US = 3.72%; J = 16.68%
For the Japanese investor: J = 3.6%; US = 15.227%
Elton, Gruber, Brown, and Goetzmann 12-5
Modern Portfolio Theory and Investment Analysis, 7th Edition
Solutions To Text Problems: Chapter 12
Chapter 12: Problem 7
Use the formula for the sample correlation coefficient with five observations:
(R )( )
5
USt RUS R Jt R J
= t =1
(R ) (R )
5 5
2 2
USt RUS Jt RJ
t =1 t =1
For the U.S. investor, = 0.251.
For the Japanese investor, = 0.050.
Elton, Gruber, Brown, and Goetzmann 12-6
Modern Portfolio Theory and Investment Analysis, 7th Edition
Solutions To Text Problems: Chapter 12