Question

A US investor had purchased a condominium in Israel a year ago for ILS 400,000 when the
spot rate for the Shekel was $0.32/ILS. She just sold the condo for ILS 500,000. The exchange rate
today is $0.29/ILS. What rate of return did the investor earn? What portion of
the rate of return is due to exchange rate changes?
What should she have sold the condo for to generate a return of 8% given the current exchange rate?
b. Explain the relationship below.
Var(Ri$) = Var(Ri) + Var(ei) + 2Cov(Ri,ei) + DVar

Answer 1

SORRY ONLY ONE ALLOWED

ANSWERING PART B

The risk for a U.S. resident investing in a foreign market will depend not only on the risk in the foreign market but also on the risk in the exchange rate between the U.S. dollar and the foreign currency.

Equation Var(Ri$) = Var(Ri) + Var(ei) + 2Cov(Ri,ei) + DVar

The above equation demonstrates that exchange rate fluctuations contribute to the risk of foreign investment through three channels:

Through their own volatility Var(Ri)

Covariance with local market returns (Cov(Ri, ei))

Contribution of cross product term, Riei, to the risk of foreign investment (DVar)