30. Assume that you are a U.S. investor who is considering investments in the Ge

Question

30. Assume that you are a U.S. investor who is considering investments in the German (Stocks A) and British (Stocks B) stock markets. The world market risk premium is 4.5%. The currency risk

premium on the euro is 1%, and the currency risk premium on the pound is 1%. In the United States, the interest rate on one-year risk-free bonds is 4%. In addition, you are provided with the following information:

Stock               A             B

Country Germany United Kingdom

w 1.5 1

€                1             0.25

£ 0.25             1.0

Expected return for stock B is: (The U.S. dollar is the base currency).

A. 12%

B. 9.25%

C. 9.75%

D. 7.25%

Explanation / Answer

Answer:

Expected Return for stock B using the version for International CAPM:

E(RB) = Rf + W(RPw)+€ (RP€)+£(RP£)

= 0.04+1(0.045)0.25(0.01)+1(-0.01)

= 0.0325

So the expected return on stock B is 3.25% (Ans)

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