Exchange Rate Risk : From a Portfolio Investors Point of View

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Due to globalization investors have increasing opportunities to invest on international markets for diversification purposes. This thesis illustrates the added risks of investing internationally due to volatile exchange rates. The purpose is to analyze how a volatileexchange rate affect the risk and return of a portfolio invested in Sweden, when the investor is located in Japan, United Kingdom or the USA.To analyze the effect of exchange rate volatility the focus is on a portfolio consisting of Swedish stocks from the Stockholm Stock Exchange (SSE) O-list. First the risk and return to a hypothetical Swedish investor not exposed to exchange rate volatility is calculated.Then the effects the exchange rates had on the risk and return if a US investor, UK investor and a Japanese investor invested in the same portfolio is analyzed. For the historical period 2005 the portfolio generated a return of 34.36% and a risk of 7.7%. The empirical work showed that for the international investors the risk was increasedwith between 1.95% – 410.52% and that the actual return decreased due to weakening currencies against the Krona.In an attempt to predict future exchange rate movements the thesis analyses two financial relationships, PPP and IRP, to calculate equilibrium movements. Both PPP and IRP predicted a depreciation of the Dollar and Pound Sterling against the Krona over the nextperiod, but an appreciation of the Yen against the Krona over the same period.The analytical discussion covers the importance of a well functio...