Assume that you buy some shares of Nokia in the United States in dollars. Your friend...

Assume that you buy some shares of Nokia in the United States in dollars. Your friend in France buys some Nokia shares in Europe in euros. Will your rate of return over the next year be the same as your friend’s? Is your market beta risk different from your friend’s risk? Explain.

Expert Solution

Rate of return over the next year may be different. Some of the reasons are:

- Mispricing of security, in theory of efficient market hypothesis EMH by Eugene Fama, an asset price incorporates all the available information and will be trading at fair value. We are not part of perfect market, most of the markets worldwide are semi-strong efficient. What it means is, the new information takes a while to get reflected in the price. whereas in perfect market (strong form of efficiency) stock price reflects as soon as some information is made available. Investors in different stock exchanges may be not aware of the exact information leading to different pricing of same security in two different markets.

- Liquidity: It may also happen that as the prices of a security is derived from actual transactions, availability of buyer and seller also be a reason. A higher liquid market absorbs the information faster than relatively illiquid market.

- Globalization: Because of globalization countries growth especially developed countries like United States and France are highly but not perfectly correlated. For CAPM used to calculate expected return will have different risk-free rates will be different and as such the beta that measures market risk.

- Exchange rate risk also affects company’s cash flow, if the company is exporting. However, the affects only about 10 to 20 percent of stocks

jeff jeffy answered 2 years ago

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