One year ago, an American investor bought 2000 shares of London Bridges at a pri

Question

One year ago, an American investor bought 2000 shares of London Bridges at a price of £24 (or 24 UK pounds) per share when the exchange rate was $1.4/1£ (or $1.40 dollars = 1 pound). The investor also invested 4,000,000 Japanese Yen in a money market fund in Japan last year when the exchange rate was 110 Yen = $ 1 US.

(a) Using current exchange rates, what is today’s value of the investor’s portfolio in U.S. dollars if the UK investment decreased 10% (in local currency) and the Japan investment increased 1% (in local currency)?

(b) What is the overall rate of return on the portfolio over the last year?

Explanation / Answer

Part A)

The amount of initial investment is calculated as follows:

Initial Investment = Shares*Price*Exchange Rate Per Pound + Total Investment in Money Market Fund/Exchange Rate (Yen) = 2,000*24*1.40 + 4,000,000/110 = $67,200 = $103,563.64

____________

If the UK investment decreases by 10% in local currency, its total value will be calculated as follows:

Investment Value = Shares*Price*(1-Decrease)*Current Exchange Rate Per Pound = 2,000*24*(1-10%)*1.50640 = $65,076.48

If Japan's investment increases by 1% in local currency, its total value will be calculated as follows:

Investment Value = Total Investment in Money Market Fund*(1+Increase)/Current Exchange Rate (Yen) = 4,000,000*(1+1%)/123.380 = $32,744.37

Portfolio Value = 65,076.48 + 32,744.37 = $97,820.85

__________

Notes:

Current exchange rates have been taken from http://www.xe.com/.

____________

Part B)

The overall rate of return can be calculated with the use of following formula:

Overall Rate of Return = (Portfolio Value - Investment Value)/Investment Value*100

____________

Using the values calculated in Part A above, we get,

Overall Rate of Return = (97,820.85 - 103,563.64)/103,563.64*100 = -5.55%

There has been a decline in the value of the investment by 5.5% over the last year.

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