Question: Brazilian Investors Diversify. The Brazilian economy in 2001 and 2002 had gone up and down. The Brazilian reais (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 R$500,000 in Standard and Poor's 500 Indexes, which are traded on the American Stock Exchange (AMSE: SPY). The beginning and ending index prices and exchange rates between the reais and the dollar were as follows:
Element April 10, 2002 Purchase April 10, 2003 Sale
Share price of SPYDERS(U.S. dollars) $112.60 $87.50
Exchange rate (Reals/$) 2.27 3.22
a. What was the return on the index fund for the year to a U.S.-based investor?
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 an interest-bearing account guaranteeing 12%, would that have been better than the American diversification strategy?