If the economies of the world were tightly interconnected, the stock markets of different countries would move together. If they did, there would be no reason for investors to diversify their stock portfolios with stocks from a variety of countries (Sharpe, Alexander, and Bailey, Investments, 1999). The table below lists the correlations of returns on stocks in each of six countries with the returns of US. stocks.

Correlation between Country Foreign and U.S. Stocks Australia .48 Canada .74 France SO Germany .43 Japan .41 U.K. .58 Source: Sharpe, W. E,Alexander, G.J., and Ba~ley. Jeffery V, Inve~tments. Upper Saddle River, N.J.: Prentlce Hall, 1999, p. 887.

a. Interpret the Australia1U.S. correlation. What does it suggest about the linear relationship between the stocks of the two countries?

b. Sketch a scattergram that is roughly consistent with the magnitude of the France1U.S. correlation.

c. Why must we be careful not to conclude from the information in the table that the country which is most tightly integrated with the U.S. is Canada?