Deck 13: Global Cost and Availability of Capital

Question 1

Which of the following is NOT a key variable in the equation for the capital asset pricing model?

A) the risk-free rate of interest
B) the expected rate of return on the market portfolio
C) the marginal tax rate
D) All are important components of the CAPM.

Answer 1

the marginal tax rate

Question 2

Beta may be defined as:

A) the measure of systematic risk.
B) a risk measure of a portfolio.
C) the ratio of the variance of the portfolio to the variance of the market.
D) all of the above

Answer 2

all of the above

Question 3

Other things equal, a firm that must obtain its long-term debt and equity in a highly illiquid domestic securities market will probably have a:

A) relatively low cost of capital.
B) relatively high cost of capital.
C) relatively average cost of capital.
D) cost of capital that we cannot estimate from this question.

Answer 3

relatively high cost of capital.

Question 4

Reasons that firms may find themselves with relatively high costs of capital include:

A) The firms reside in emerging countries with undeveloped capital markets.
B) The firms are too small to easily gain access to their own national securities market.
C) The firms are family owned and they choose not to access public markets and lose control of the firm.
D) all of the above

Question 5

The after-tax cost of debt is found by:

A) dividing the before-tax cost of debt by (1 - the corporate tax rate).
B) subtracting (1 - the corporate tax rate) from the before-tax cost of debt.
C) multiplying the before-tax cost of debt by (1 - the corporate tax rate).
D) subtracting the corporate tax rate from the before-tax cost of debt.

Question 6

The capital asset pricing model (CAPM) is an approach:

A) to determine the price of equity capital.
B) used by marketers to determine the price of saleable product.
C) that can be applied only to domestic markets.
D) none of the above

Question 7

Which of the following will NOT affect a firm's beta?

A) the choice of the market portfolio against which to compare the variability of a firm's returns
B) the choice of the risk-free security
C) the choice of the time period used to calculate the firm's beta
D) None of the above, because each of them affects the calculation of a firm's beta.

Question 8

Which of the following is NOT a contributing factor to the segmentation of capital markets?

A) lack of transparency
B) asymmetric availability of information
C) insider trading
D) All of the above are contributing factors.

Question 9

The difference between the expected (or required) return for the market portfolio and the risk-free rate of return is referred to as:

A) beta.
B) the geometric mean.
C) the market risk premium.
D) the arithmetic mean.

Question 10

________ risk is a function of the variability of expected returns of the firm's stock relative to the market index and the measure of correlation between the expected returns of the firm and the market.

A) Systematic
B) Unsystematic
C) Total
D) Diversifiable

Question 11

If a firm lies within a country with ________ or ________ domestic capital markets, it can achieve lower global cost and greater availability of capital with a properly designed and implemented strategy to participate in international capital markets.

A) liquid; segmented
B) liquid; large
C) illiquid; segmented
D) large; illiquid

Question 12

Which of the following statements is NOT true regarding beta?

A) Beta will have a value of less than 1.0 if the firm's returns are less volatile than the market.
B) Beta will have a value of greater than 1.0 if the firm's returns are more volatile than the market.
C) Beta will have a value of equal to 1.0 if the firm's returns are of equal volatility to the market.
D) All of the statements above are true.

Question 13

If a company fails to accurately predict it's cost of equity, then:

A) the firm's WACC will also be inaccurate.
B) the firm may not be using the proper interest rate to estimate NPV.
C) the firm may incorrectly accept or reject projects based on decisions made using the cost of capital computed with an incorrect cost of equity.
D) All of the above are true.

Question 14

________ risk is measured with beta.

A) Systematic
B) Unsystematic
C) International
D) Domestic

Question 15

Which of the following is generally unnecessary in measuring the cost of debt?

A) a forecast of future interest rates
B) the proportions of the various classes of debt a firm proposes to use
C) the corporate income tax rate
D) All of the above are necessary for measuring the cost of debt.

Question 16

Systematic risk:

A) is the standard deviation of a security's return.
B) is measured with beta.
C) is measured with standard deviation.
D) none of the above

Question 17

A firm whose equity has a beta of 1.0:

A) has greater systematic risk than the market portfolio.
B) stands little chance of surviving in the international financial market place.
C) has less systematic risk than the market portfolio.
D) None of the above is true.

Question 18

Relatively high costs of capital are more likely to occur in:

A) highly illiquid domestic securities markets.
B) highly liquid domestic securities markets.
C) unsegmented domestic securities markets.
D) none of the above

Question 19

The weighted average cost of capital (WACC) is:

A) the required rate of return for all of a firm's capital investment projects.
B) the required rate of return for a firm's average risk projects.
C) not applicable for use by MNE.
D) equal to 13%.

Question 20

Which of the following is NOT a contributing factor to the segmentation of capital markets?

A) excessive regulatory control
B) perceived political risk
C) anticipated foreign exchange risk
D) All of the above are contributing factors.

Question 21

Use the information to answer the following question(s).
In September 2009 a U.S. investor chooses to invest $500,000 in German equity securities at a then current spot rate of $1.30/euro. At the end of one year the spot rate is $1.35/euro.
Refer to Instruction 13.1. At the end of the year the investor sells his stock that now has an average price per share of €57. What is the investor's average rate of return after converting the stock back into dollars?

A) -1.35%
B) 5.0%
C) -5.0%
D) -7.24%

Question 22

The beginning share price for a security over a three-year period was $50. Subsequent year-end prices were $62, $58 and $64. The arithmetic average annual rate of return and the geometric average annual rate of return for this stock were:

A) 9.30% and 8.58% respectively.
B) 9.30% and 7.89% respectively.
C) 9.30% and 7.03% respectively.
D) 9.30% and 6.37% respectively.

Question 23

In some respects, internationally diversified portfolios are different from a domestic portfolio because:

A) investors may also acquire foreign exchange risk.
B) international portfolio diversification increases expected return but does not decrease risk.
C) investors must leave the country to acquire foreign securities.
D) all of the above

Question 24

When estimating an average corporate after-tax cost of capital, the component cost of equity is multiplied by (1-t) to allow for the tax-deductibility of dividend payments.

Question 25

Other things equal, an increase in the firm's tax rate will increase the WACC for a firm that has both debt and equity financing.

Question 26

An internationally diversified portfolio:

A) should result in a portfolio with a lower beta than a purely domestic portfolio.
B) has the same overall risk shape as a purely domestic portfolio.
C) is only about 12% as risky as the typical individual stock.
D) all of the above

Question 27

Use the information to answer the following question(s).
In September 2009 a U.S. investor chooses to invest $500,000 in German equity securities at a then current spot rate of $1.30/euro. At the end of one year the spot rate is $1.35/euro.
Refer to Instruction 13.1. At the end of the year the investor sells his stock that now has an average price per share of €57. What is the investor's average rate of return before converting the stock back into dollars?

A) 5.0%
B) -3.0%
C) -5.0%
D) 3.0%

Question 28

Use the information to answer the following question(s).
In September 2009 a U.S. investor chooses to invest $500,000 in German equity securities at a then current spot rate of $1.30/euro. At the end of one year the spot rate is $1.35/euro.
Refer to Instruction 13.1. At an average price of €60/share, how many shares of stock will the investor be able to purchase?

A) 8333 shares
B) 6410 shares
C) 6173 shares
D) 10,833 shares

Question 29

A fully diversified domestic portfolio has a beta of:

A) 0.0.
B) 1.0.
C) -1.0.
D) There is not enough information to answer this question.

Question 30

In general, the geometric mean will be ________ the arithmetic mean for a series of returns.

A) less than
B) greater than
C) equal to
D) greater than or equal to

Question 31

If a firm's expected returns are more volatile than the expected return for the market portfolio, it will have a beta less than 1.0.

Question 32

A national securities market is segmented if the required rate of return on securities in that market differs from comparable securities traded in other, unsegmented markets.

Question 33

What are the components of the weighted average cost of capital (WACC) and how do they differ for an MNE compared to a purely domestic firm?

Question 34

Use the information to answer the following question(s).
In September 2009 a U.S. investor chooses to invest $500,000 in German equity securities at a then current spot rate of $1.30/euro. At the end of one year the spot rate is $1.35/euro.
Refer to Instruction 13.1. How many euros will the U.S. investor acquire with his initial $500,000 investment?

A) €650,000
B) €370,370
C) €500,000
D) €384,615

Question 35

The WACC is usually used as the risk-adjusted required rate of return for new projects that are of the same average risk as the firm's existing projects.

Question 36

A well-diversified portfolio has about ________ of the risk of the typical individual stock.

A) 8%
B) 19%
C) 27%
D) 52%

Question 37

Firms acquire debt in either the form of loans from commercial banks, or by selling new common stock.

Question 38

In some respects, internationally diversified portfolios are the same in principle as a domestic portfolio because:

A) the investor is attempting to combine assets that are perfectly correlated.
B) investors are trying to reduce systematic risk.
C) investors are trying to reduce the total risk of the portfolio.
D) all of the above

Question 39

Unsystematic risk:

A) is the remaining risk in a well-diversified portfolio.
B) is measured with beta.
C) can be diversified away.
D) all of the above

Question 40

A U.S. investor makes an investment in Britain and earns 14% on the investment while the British pound appreciates against the U.S. dollar by 8%. What is the investor's total return?

A) 22.00%
B) 23.12%
C) 6.00%
D) 4.88%

Question 41

Increasing the number of securities in a portfolio reduces the unsystematic risk but not the systematic risk.

Question 42

One of the elegant beauties of international equity markets is that over the last 100 or so years, the average market risk premium is almost identical across major industrial countries.

Question 43

Portfolio diversification can eliminate 100% of risk.

Question 44

International diversification benefits may induce investors to demand foreign securities.

Question 45

The CAPM has now become very widely accepted in global business as the preferred method of calculating the cost of equity for a firm. As a result of this, there is now little debate over what numerical values should be used in its application.

Question 46

The authors refer to companies that have access to a ________ as MNEs, and firms without such access are identified as ________.

A) global cost and availability of capital; domestic firms
B) large domestic capital market; geographically challenged
C) world financial markets; antiquated
D) none of the above

Question 47

If the addition of a foreign security to the portfolio of the investor decreases the expected return for a given level of risk, then the security adds value to the portfolio.

Question 48

Use of the International CAPM (ICAPM) assures that the WACC will be lower than if a purely domestic market portfolio had been used in the estimation of the cost of equity.

Question 49

A global portfolio is an index of all the securities in the world, whereas a world portfolio represents those securities actually available to an investor.

Question 50

Which of the following is NOT a portfolio diversification technique used by portfolio managers?

A) diversify by type of security
B) diversify by the size of capitalization of the securities held
C) diversify by country
D) All of the above are diversification techniques.

Question 51

Capital market segmentation is a financial market imperfection caused mainly by:

A) government constraints.
B) institutional practices.
C) investor perceptions.
D) all of the above

Question 52

The geometric mean will, in all but a few extreme circumstances, yield a larger return than the arithmetic mean return.

Question 53

If the addition of a foreign security to the portfolio of the investor aids in the reduction of risk for a given level of return, then the security adds value to the portfolio.

Question 54

If all capital markets are fully integrated, securities of comparable expected return and risk should have the same required rate of return in each national market after adjusting for:

A) time of day and language requirements.
B) political risk and time lags.
C) foreign exchange risk and political risk.
D) foreign exchange risk and the spot rate.

Question 55

Capital market imperfections leading to financial market segmentation include:

A) political risks.
B) corporate governance differences.
C) regulatory barriers.
D) all of the above

Question 56

International CAPM (ICAPM) assumes that there is a global market in which the firm's equity trades, and estimates of the firm's beta, and the market risk premium, must then reflect this global portfolio.

Question 57

The primary goal of both domestic and international portfolio managers is:

A) to maximize return for a given level of risk, or to minimize risk for a given level of return.
B) to minimize the number of unique securities held in their portfolio.
C) to maximize their WACC.
D) all of the above

Question 58

Which of the following statements is NOT true?

A) International diversification benefits induce investors to demand foreign securities.
B) An international security adds value to a portfolio if it reduces risk without reducing return.
C) Investors will demand a security that adds value.
D) All of the above are true.

Question 59

There are potential benefits and risks from raising capital on global markets. Discuss the pros and cons in terms of risk of raising capital on global markets.

Question 60

Capital market imperfections leading to financial market segmentation include:

A) asymmetric information between domestic and foreign-based investors.
B) high securities transaction costs.
C) foreign exchange risks.
D) all of the above

Question 61

Internationally diversified portfolios often have a lower rate of return and almost always have a higher level of portfolio risk than their domestic counterparts.

Question 62

Empirical research has found that systematic risk for MNEs is greater than that for their domestic counterparts. This could be due to:

A) the fact that the increase in the correlation of returns between the market and the firm is less than the increase in the standard deviation of returns of the firm.
B) the fact that the decrease in the correlation of returns between the market and the firm is greater than the increase in the standard deviation of returns of the firm.
C) the reduction in the correlation of returns between the firm and the market is less than the increase in the variability of returns caused by factors such as asymmetric information, foreign exchange risk, and the like.
D) None of the above; systematic risk is less for MNEs than for their domestic counterparts.

Question 63

Despite the theoretical elegance of this hypothesis, empirical studies have come to the opposite conclusion. Despite the favorable effect of international diversification of cash flows, bankruptcy risk was only about the same for MNEs as for domestic firms. However, MNEs faced higher costs for each of the following EXCEPT:

A) agency costs.
B) political risk.
C) asymmetric information.
D) In fact, each of these costs were higher for the MNE than for the domestic firm.

Question 64

The opportunity set of projects is typically smaller for MNEs than for purely domestic firms because international markets are typically specialized niches.

Question 65

A MNE's marginal cost of capital is constant for considerable ranges in its capital budget, but this statement cannot be made for most domestic firms.

Question 66

The optimal capital budget:

A) occurs where the marginal cost of capital equals the marginal rate of return of the opportunity set of projects.
B) is typically larger for purely domestic firms than for MNEs.
C) is an illusion found only in international finance textbooks.
D) none of the above

Question 67

Which of the following statements is NOT true regarding MNEs when compared to purely domestic firms?

A) MNEs tend to rely more on short and intermediate term debt.
B) MNEs have greater foreign exchange risk.
C) MNEs have greater costs of asymmetric information.
D) MNEs have higher agency costs.

Question 68

Empirical tests of market efficiency fail to show that most major national markets are reasonably efficient.

Question 69

Market imperfections do not necessarily imply that national securities markets are inefficient. Develop an argument as to why this is possible.

Question 70

Capital market segmentation is a financial market imperfection caused mainly by government constraints, institutional practices, and investor perceptions.

Question 71

Empirical studies indicate that MNEs have higher costs of capital than purely domestic firms. This could be due to higher levels of:

A) political risk.
B) exchange rate risk.
C) agency costs.
D) all of the above

Question 72

Most observers believe that for better or for worse, we have achieved a global market for securities. Discuss the major changes in the international markets of securities: during the 1980s, during the 1990s and the current conditions.

Question 73

Portfolio theory assumes that investors are risk-averse. This means that investors:

A) cannot be induced to make risky investments.
B) prefer more risk to less for a given return.
C) will accept some risk, but not unnecessary risk.
D) All of the above are true.

Question 74

According to your authors, diversifying cash flows internationally may help MNEs reduce the variability of cash flows because:

A) of a lack of competition among international firms.
B) of an offset to cash flow variability caused by exchange rate variability.
C) returns are not perfectly correlated between countries.
D) none of the above

Question 75

Since the 1980s and 1990s, segmentation in global financial markets has been reduced. As a result of this, the correlation among securities markets has increased, thereby reducing, but not eliminating, the benefits of international portfolio diversification.

Question 76

The MNE can ________ its ________ by gaining access to markets that are more liquid and/or less segmented than its own.

A) increase; MCC
B) decrease; MCC
C) maintain; MRR
D) none of the above

Question 77

Empirical studies indicate that WACC for an MNE is higher than for their domestic competitors. Reasons cited for this increased cost include all of the following EXCEPT:

A) agency costs.
B) foreign exchange risk.
C) political risk.
D) All of the above are cited as reasons for an MNE's increased WACC.

Question 78

Capital market segmentation is a financial market imperfection caused mainly by government constraints, institutional practices, and investor perceptions. List and explain three imperfections.

Question 79

Because of the international diversification of cash flows, the risk of bankruptcy for MNEs is significantly lower than that for purely domestic firms.

Question 80

Theoretically, most MNEs should be in a position to support higher ________ than their domestic counterparts because their cash flows are diversified internationally.

A) equity ratios
B) debt ratios
C) temperatures
D) none of the above