26 From Appendix 3, compare the return and the risk of investing in the NYSE with investing in the London Stock Exchange for a UK investor. Evaluate the significance of your results.

You will need a FTSE stock exchange index, the Dow Jones index or NASDAQ index and the £:$

exchange rate.

Analysis can be made using Excel. The process is to invest in the US index at the start of the period and convert back at the end of the period. Then work out the percentage change in the value. To

‘buy the index’ you can in effect treat the index as the dollar price of a share, so buy the currency, then buy the share at the beginning of the period, then at the end of the period reverse the process.

Alternatively, you can work out the percentage change in the index over the period and the percentage change in the value of the currency over the year, then use the formula as in the text:

R£ ¼ (1 þ R)(1 þ e)

Note that you can work out the risk in approximate fashion by working out the percentage changes in the value of the currency and index then applying the model for combining variances, as:

VAR(index) þ Var(£:$ rate) þ 2  SD(£:$ rate)

 SD(index)  Corr(£:$ rate, index)

This is not exact but relies on the approximation that at low levels of change i.e. below 10%:

(1 þ R)  (1 þ

e)  1 roughly equals R þ e so the formula is the same as adding two investments as the returns are roughly additive.