BUS 426 Exam 3 Study Guide

BUS 426 Exam 3 Study Guide - Integrated Markets Diversify...

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Integrated Markets – Diversify internationally. The market portfolio in the CAPM formula will be the world market portfolio comprising all assets in the world. The relevant risk measure should be beta measured against the world market portfolio comprising all assets in the world. The relevant risk measure then should be the beta measured against the world market portfolio. In integrated international financial markets, the same future cash flows will be priced in the same way everywhere. Investors would require, on average, lower expected returns on securities under integration than under segmentation because they can diversify risk better under integration. Segmented Markets – Diversify domestically. The market portfolio (M) would represent the domestic market portfolio, which is often proxied by S&P500 Index in the US. The relevant risk measure in pricing assets will be the beta measured against the domestic market portfolio. In segmented capital markets, the same future cash flows are likely to be priced differently across countries, as they would be viewed as having different systematic risks by investors from different countries. Why do firms list overseas? Because of trade barriers, imperfect labor market, intangible assets, vertical integration, product life cycle, shareholder diversification. International Cost of Capital: WACC K = λi(1-t) + (1-λ)KL (where K=WACC, λ=leverage ratio, i=cost of debt, t=tax rate, KL=cost of equity). The leverage ratio is the proportion of the firm’s capital that is financed by debt (λ=D/D+E). Cost of Equity – CAPM KL=rf + βi(rm-rf) (where rf=risk free rate, rm = expected return on the market, βi = systematic risk associated with asset i. M = the shareholders market holdings. If markets are segmented, m should represent the domestic market. If markets are integrated, m should represent the domestic market. (rm-rf = Market Risk Premium and rf=U.S Treasury Bonds – For both of these, if segmented these are associated with the U.S. stock market). Beta = COVim/ς²m Section I: Multiple Choice 1. The appropriate discount rate for analyzing a project is: c. WACC 2. Webster Inc. is planning on borrowing from a London bank at 5.5%. The spot rate is $1.6550=1£. The one-year forward rate is $1.6647=1£. What is the cost of borrowing in terms of US dollars? Assume the relevant parity conditions hold. e. 6.12% 3. Krannert Industries is a US based firm that receives cash flows from Japan on an ongoing basis. The inflation rate in Japan is 0% and the inflation rate in the United States is 5%. Your Yen cash flows grow at the rate of Japanese inflation (0%). What is the annual growth rate of the cash flows in US dollars? Assume the relevant parity conditions hold. f. 5.00% 4. Every year your French division sends its American parent their profits on April 30. You expect that your French division will generate the following cash flows next year to be distributed today to the parent; revenues of €500,000, operating costs of €250,000, and depreciation of €100,000. The tax rate is 35%.
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BUS 426 Exam 3 Study Guide - Integrated Markets Diversify...

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