A firm is considering establishing a subsidiary in either the US or the UK and will invest 40% of the firms total invested funds. The annual expected return of the prevailing business is 10% and the standard deviation of these returns is 1.10. The firm has collected the following information

If located in US If located in UK

Mean Expected Annual Return 10% 8%

Standard Deviation of Returns 20% 18%

Correlation of Expected Returns on

investment with returns of prevailing business 0.85 0.05

Required:

i. Calculate the overall expected return and risk if the new subsidiary is established

in US.

ii. Calculate the overall expected return and risk if the new subsidiary is established in UK.

iii. On the basis of your calculations which place you recommend the firm to establish a new subsidiary.

iv. Discuss the importance of country risk analysis in establishing a new subsidiary and explain its common forms.