You are contemplating an investment in China. Your stock broker informs you that

Question

You are contemplating an investment in China. Your stock broker informs you that you could earn as much as 25% by investing in an oil company stock for a year. The standard deviation of the stock return is forecasted to be 14%. The yuan is expected to depreciate 12% vis-a-vis the dollar and the standard deviation of the percentage change in exchange rate is 8%. The correlation between exchange rate change and the stock's return is -0.30.

If you invest in China, what would be your expected return and its standard deviation?

Explanation / Answer

Expected return = (1 + Ri)(1 + ei) – 1

= (1.25)(1-.0.08)-1

= 1.15-1

= 15%

Standard deviation = Var Ri + Var Ei + 2 cov RiEI

= (14*14)+ (8*8)+ 2 *(-0.3)*14*8)

=196+64-67.2

=193

Sd = 193 under root

SD = 13.88

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