International CAPM (ICAPM)

ICAPM (with only one foreign currency)

E(R_i) = R_{f, DC} + B_iw * RP_w + γ_i1 * SRP₁

SRP₁ = expected foreign currency (FC) appreciation - (R_f, DC - R_{f, FC})


E(R_i): company i's expected (or required) return
R_{f, DC}: domestic risk-free rate
R_{f, FC}: foreign risk-free rate
B_iw: sensitivity of i to the world market
RP_w: world market risk premium
γ_i1: sensitivity of i to changes in the (domestic currency / foreign currency) exchange rate
SRP₁: foreign currency risk premium

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(e.g.)
GBP: domestic currency
CAD: foreign currency

E(R_i): company i's expected (or required) return
R_{f, DC} = R_{f, GBP} = 6%
R_{f, FC} = R_f, CAD = 9%
B_iw = 1.2
RP_w = 6%
γ_i1 = sensitivity of i to changes in the GBP/CAD = 1.4

CAD is expected to depreciate against GBP by 2%.
SRP₁ = (-2% - (6%-9%)) = 1%

∴ E(Ri) = 6% + 1.2 * 6% + 1.4 * 1% = 14.6%

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(e.g.)

A U.S. investor invests in a swiss stock.

The Swiss stock:

world beta = 1.2

world market risk premium = 4%

Swiss franc risk premium = 0.5%

currency exposure = 0.5

risk-free rate = 5%

∴ E(Ri) = 5% + 1.2*4% + 0.5 * 0.5% = 10.05%