International Finance: Putting Theory Into Practice

728 CHAPTER 19. SETTING THE COST OF INTERNATIONAL CAPITAL

Figure 19.4:Relative exposures (γ) of various assets

USD T-bill

US exporters US importers

gamma

0 1

Canadian importers Canadian exporters

CAD T-bill

bad news for this company, because its competitive position has deteriorated.

Thus, the price of the stock measured inusdtypically drops when theusd

appreciates. This drop in theusdvalue of the stock weakens the effect of the

exchange rate itself, and will lead to a relative exposure that is below unity.

Example 19.10

Suppose that, empirically, the stock price inusdof ausfirm goes down by,

on average, 0.25 percent for a 1 percent increase in thecad/usdrate. This

then implies that the return, incad, on the stock will go up by about 0.75

percent for a one percent rise in thecad/usdrate. That is, the Canadian

investor on average suffers a 0.25 percent capital loss inusdterms, which is

to be subtracted from the 1 percent gain on theusditself.

• Lastly, consider ausimporter. An appreciation of theusdrelative to thecad
  is good news for thisusfirm, because its costs have gone down. Thus, for a
  usimporter, we would typically see a rise of theusdstock price, reinforcing
  the effect that the exchange rate itself has on the asset’scadvalue. Thus, the
  gamma would exceed unity.

We conclude that exchange rate covariance risks can be very different for different
assets. The relative exposure of a foreign T-bill is unity, but the relative exposure of
a foreign stock could be higher, or lower. Notably, there is a whole group of foreign
firms with gamma’s below 1, and a bunch of domestic firms with gamma’s above 0.
We’d probably better speak of all of these as internationally competing firms that
do not fundamentally differ from each other. In short, unlike T-bills, their stocks
have no clear-cut economic nationality.