Question

Foreign financial markets

1. A US investor purchased stock in a Canadian company on May 1, 2018 for C$82.15. The investor sold the stock on June 29 for C$88.75. What is the investor’s percentage return on the investment in Canadian dollars?

2. If the exchange rate for the Canadian dollar wat 1.2940 on May 1 and 1.2268 on June 29, what is the investor’s percentage return on the investment in US dollars?

3. How should an investor whose investment portfolio consists solely of domestic investments expect the risk of the portfolio to change if the investor adds foreign investments to the portfolio? Explain.

4. Name two ways a US investors can include foreign investments in their investment portfolios without the need to buy or sell investments in foreign securities markets.

Answer 1

1. Purchase price of stock in Canadian Co. = C$ 82.15

Sales price of stock in Canadian Co. = C$ 88.75

Investor's percentage return on investment in Canadian dollars = (Sales price - Purchase price) / Purchase price * 100 = (88.75-82.15)/82.15 * 100 = 1.32%

2. Exchange rate for Canadian dollar was 1.2940 (1st May) and exchange rate for Canadian dollar on 29th June was 1.2268 , in that case there would be no gain , rather loss incurred to the investor making investment in US Dollars because the USD has depreciated as against C$

Percentage loss to the investor = (Exchange rate in June - Exchange rate in May) / Exchange rate in May * 100

Percentage loss to the investor = (1.2268 - 1.2940)/1.2940 * 100 = -5.19%

3. The investor whose portfolio earlier consisted of only domestic investments will observe the total portfolio risk going up due to the foreign investments added to the portfolio because foreign investments are characterised by foreign exchange risk and country risk apart from all other risks that domestic investments have. Foreign exchange risk is the risk that the exchange rate might become unfavourable to the extent that the value of investment may decline. Country risk arises from the political, economic and other country specific factors.

4. Investing in a mutual fund or ETF (exchange traded fund) which holds investments in foreign securities is an effective way of investing in foreign securities without actually having to buy or sell investments in foreign security markets. Another way of investing in foreign securities without buying/ selling in foreign security market is to purchase foreign stocks using ADR i.e. American Depository Receipts. ADRs are traded in US itself but they represent ownership in foreign securities.