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Corporate Finance – Sample 2

  1. The Brazilian economy in 2001 and 2002 had gone up and down. The Brazilian “real” (R$) had also been declining since 1999 (when it was floated). Investors wished to diversify internationally – into U.S. dollars for the most part – to protect themselves against the domestic economy and currency. A large private investor had, in April 2002, invested Brazilian “reais” (plural) R$ 500,000 in Standard & Poor’s 500 Indexes [Standard & Poor’s Depository Receipts or SPiDeRs] which are traded on the American Stock Exchange (AMEX: SPY). The beginning and ending index prices and exchange rates between the Brazilian “real” and the US dollar were as follows:

April 10, 2002    April 10, 2003

Purchase                                Sale

Share price of  “SPIDERS” (US dollars) $               112.60   $                 87.50
Exchange rate (Reais/US $)                               2.27                     3.22

 

a. What was the % return on the index fund for the year to a US-based investor?

Return = Ending Value – Beginning value / Beginning Value * 100

= 87.5 – 112.6 / 112.6 = -22.3%

The U.S investors had a capital loss = 22.3%

 

b.  What was the % return to the Brazilian investor for the one-year holding period?  If the Brazilian investor could have invested locally in Brazil in a 10% interest-bearing account, would that have been better than his/her American investment diversification strategy?

Amount Invested in USD = Amount in Reais / Exchange rate

= 50000 / 2.27 = 22026.43

Value of investment on April 10 2003 = 22026.43 * 87.5/112.6 = 17116.45

Investment converted back to Reias = 17116.45 * 3.22 = 55115

 

Return = Ending Value – Beginning value / Beginning Value * 100

= 55115 – 50000 / 50000 = 10.23%

 

Investment in US is better because he was able to earn .23% more over one year period.

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