Deck 31: Emerging Markets

Question 1

As long as international investors have access to an emerging market's local investment opportunities,local prices will be based on an international cost of capital.

Answer 1

True

Question 2

In a two-scenario model of an emerging market,it is recommended that the analyst create a base-case set of forecasts and a set of forecasts associated with a period of economic distress.Which of the following best represents the range of probability weights to assign the economic distress scenario?

A)5 to 10 percent.
B)10 to 20 percent.
C)20 to 30 percent.
D)30 to 40 percent.

Answer 2

C

Question 3

In applying the CAPM in estimating the cost of capital in an emerging market,explain the three problems in estimating an appropriate risk-free rate and the recommended solution.

Answer 3

In emerging markets,the risk-free rate is harder to estimate from government bonds than in developed markets.Three main problems arise.First,most of the government debt in emerging markets is not risk free,and often the debt is below investment grade.Second,the long-term government bonds do not actively trade and are relatively illiquid.Finally,the long-term debt that is traded is often in U.S.dollars,a European currency,or the Japanese yen,so it is not appropriate for discounting local nominal cash flows.
The solution is to start with a risk-free rate based on the 10-year U.S.government bond yield and then add to this the projected difference over time between U.S.and local inflation.The result is an estimate of the nominal risk-free rate in local currency.

Question 4

Which of the following are reasons an analyst should allow for changes in cost of capital in an emerging market?
I.Reforms in the tax system.
II.Changes in the cost of debt.
III.Evolving inflation expectations.
IV.Changes in a company's capital structure.

A)I and II only.
B)I,III,and IV only.
C)II and IV only.
D)I,II,III,and IV.

Question 5

For emerging markets,the recommended input for the risk-free rate for computing beta is:

A)The domestic government bond rate.
B)The average of the inflation rates of developed nations.
C)The average of the government bond rates of developed nations.
D)The U.S.Treasury bond rate plus the local inflation rate minus the U.S.inflation rate.

Question 6

Which of the following best represents the relevance of purchasing power parity (PPP )when analyzing companies in emerging markets?

A)PPP does not hold between emerging and developed economies.
B)PPP holds over the long run,and exchange rates will adjust to inflation differentials.
C)PPP holds over the long run,but exchange rates will not adjust to inflation differentials.
D)It is not clear whether PPP holds,because there is not yet enough evidence one way or the other.

Question 7

For emerging markets,the recommended market input for computing beta is:

A)A small-cap index.
B)A median-cap index.
C)A global market index.
D)An index of non-investment-grade bonds.

Question 8

For estimating the cost of capital in emerging markets,other models are superior to the capital asset pricing model (CAPM).

Question 9

Which of the following is NOT an argument against the country risk premium approach?

A)Most country risks,including expropriation,devaluation,and war,are largely diversifiable.
B)Risks apply unequally to companies in a given country.
C)There is no systematic method to calculate a country risk premium.
D)It is bound to be below the growth rate,and that limits its application.

Question 10

Given the following information for a company in a developing market,estimate the value of the company.The cash for the next year is estimated to be either $200 in the business-as-usual scenario or $50 in the distress scenario.The probabilities of the scenarios are 80 percent and 20 percent,respectively.The expected perpetual growth rate in each case is 5 percent per year,and the cost of capital is 11 percent.The value of the company is closest to:

A)$1,654.55
B)$2,500.00
C)$2,833.33
D)$3,333.33

Question 11

Using a scenario approach,an analyst finds that the estimated value of a company is $800.The business-as-usual scenario forecasts a cash flow of $40 starting next year and then growing at 6 percent forever.The cost of capital in that scenario is 10 percent.Given this information,what is the implied risk premium to add to the cost of capital to make the analyst's results consistent with the country risk premium discounted cash flow (DCF )approach?

A)0.80 percent.
B)1.00 percent.
C)1.20 percent.
D)1.25 percent.