Exchange rate fluctuations contribute to the risk of foreign investment through three possible channels (i)the volatility of the investment due to the volatility of the exchange rate
(ii)the contribution of the cross-product term
(iii)its covariance with the local market returns
Which of the following contributes and accounts for most of the volatility?
A)(i)and (ii)
B)(ii)and (iii)
C)(i)and (iii)
D)only (ii)

Question

Quizplus · Accepted Answer

The volatility of the investment due to the volatility of the exchange rate (i) and its covariance with the local market returns (iii) are significant contributors to the risk of foreign investment. The exchange rate volatility directly affects the value of the investment when converted back to the investor's home currency. The covariance with local market returns indicates how changes in the exchange rate correlate with local market performance, both of which can significantly impact the overall volatility of the investment.

Exchange Rate Fluctuations Contribute to the Risk of Foreign Investment