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The J-Curve – Impact of Exchange Rate Changes on National Economies

The domestic activity in an economy is related to its exchange rate movements. In the traditional theory to explain this, there are two components: long-run and short-run. In the long-run an economy’s competitiveness increases with a decline in the country’s currency value. In the short-run, the country’s trade balance widens, and inflation increases if the

ICAPM vs. Domestic CAPM

Both assume unlimited borrowing and lending at the risk free rate. ICAPM becomes Extended CAPM when international capital markets are integrated and Purchasing Power Parity holds. ICAPM can be used to value any security in the world if all national markets are integrated. ICAPM indicates that if global markets are integrated and efficient, then the

Company Stock Value Responses to Changes in Real Exchange Rates

The stock value of a company will be affected by the changes in the real value of its local currency based on how much exchange rate exposure it has. The response of a company’s stock value in different scenarios is discussed below: Company earns material revenues in foreign countries or faces international competition domestically and

Measuring Currency Exposure

Currency exposures measure, in the investor’s domestic currency, an asset return’s sensitivity to returns on the ith/LC exchange rates. Currency exposure risk must be captured this way when the ICAPM is used to determine the domestic currency returns for a domestic investor purchasing a foreign asset. For example, if a Canadian investor wants to determine

International CAPM (ICAPM) – Beyond Extended CAPM

The ICAPM attempts to explain the required return on a risky asset, measured in its own local currency. ICAPM assumption divergences from Extended CAPM The market basket for goods used in calculating CPI does not need to be the same goods, in the same percentages. Purchasing Power Parity does not always prevail. Theoretically, the ICAPM

Changes in Real Exchange Rates

Nominal Exchange Rates represent how many units of one currency can be exchanged for one unit of another currency. Nominal exchange rates are the rates quoted in the global markets for foreign currency exchange. Real Exchange Rates represent the amount of purchasing power in one currency can be exchanged for one unit of another currency.

Domestic CAPM and Extended CAPM

Domestic CAPM An efficient market allows investors to diversify away company/security specific risk and have exposure solely to the market risk. The Capital Asset Pricing Model (CAPM) as previously discussed was considered purely from an investor’s domestic point of view. Domestic CAPM: Theoretic technique for an investor that can be used to price market/systemic risk

International Capital Market Integration

An efficient market is one, which is able to absorb new information into the security prices instantly. In the context of international markets, efficiency is not just about the individual markets but also about the pricing of these individual markets relative to the world index. The issue of international market efficiency revolves around international capital

Markowitz, MPT, and Market Efficiency

Modern Portfolio Theory (MPT) is rooted in the mean-variance analysis research performed by Harry Markowitz conducted to allocate assets through a portfolio optimization process. The portfolio concepts presented in section I trace their roots to Markowitz groundbreaking work. The Efficient Market Hypothesis (EMH) contents that the market correctly prices all securities. MPT argues that all

Risk Factors and Tracking Portfolios

Tracking portfolios Tracking Portfolio: A portfolio assembled with securities that will replicate a specific risk profile. Tracking portfolios commonly mirror an expected benchmark index, such as an index of global large capitalization stocks. The theoretical construction of a tracking portfolio done through multifactor modeling is done by setting each factor sensitivities equal to the factor