Explain how exchange rate fluctuations influence the return from a foreign market measured in dollar terms. Discuss the empirical proof on the effect of exchange rate doubt on the risk of foreign investment.
Answer: Exchange rate fluctuations mainly give to the risk of foreign investment through its own volatility also its covariance with the local market returns. The covariance is apt to be positive in most of the cases, involving that exchange rate changes tend to add to exchange risk, in place of offset it. Exchange risk is found to be much more important in bond investments as compared to in stock investments.