Question 1

Developed economies seem to exhibit significant differences in the cost of equity due to the relatively high integration of their capital markets in the global capital market.

Accepted Answer

Developed economies often have more integrated capital markets, which can lead to a convergence in the cost of equity across these economies due to the ease of capital movement and investment, reducing significant differences.

Question 2

The interest rate parity theory relates forward or future spot exchange rates to differences in interest rates between two countries adjusted by the spot rate.

Accepted Answer

The interest rate parity theory is based on the idea that the expected return on a foreign currency investment should be equal to the return on a domestic currency investment, when adjusted for the exchange rate. This is expressed in the equation: (1+Rfc)/(1+Rdc) = (1+f)/(1+s), where R is the interest rate, f is the forward rate, and s is the spot rate. The theory is used to explain and predict exchange rate movements.

Question 3

Nominal or real cash flows should give different net present values if the expected rate of inflation used to convert future cash flows to real terms is the same inflation rate used to estimate the real discount rate.

Accepted Answer

The net present value (NPV) should be the same whether using nominal or real cash flows, as long as the inflation rate used to adjust future cash flows is consistent with the inflation rate used to estimate the real discount rate. This is because the adjustment for inflation in both the cash flows and the discount rate should offset each other, leading to the same NPV result.

Question 4

Firms are likely to achieve significant diversification by investing in all of the following except for

Accepted Answer

Investing in different companies within the same industry in the same country does not significantly diversify risk because the companies are likely to be affected by the same economic, industry-specific, and country-specific factors.

Question 5

Due to absence of historical data in many emerging economies, the equity risk premium often is estimated using the prospective method implied in the constant growth valuation model.

Accepted Answer

In the absence of historical data, the equity risk premium can be estimated using the prospective method implied in the constant growth valuation model, which assumes that the stock price will grow at a constant rate indefinitely into the future. This method uses forward-looking assumptions to estimate the required rate of return on equity, including the equity risk premium.

Question 6

Whenever the target firm's projected cash flows are in local currency, the risk free rate is the local country's government bond rate.

Accepted Answer

When the projected cash flows are in local currency, it is appropriate to use the local country's risk-free rate, which is usually represented by the government bond rate. This is because the government bond rate reflects the risk-free rate for investments denominated in the local currency.

Question 7

Which of the following is generally not a motive for firms to expand internationally?

Accepted Answer

It is not a common motive for firms to expand internationally as it may lead to negative public perception and potential legal issues. The other options are generally common motives for firms to expand internationally.

Question 8

The purchasing power parity theory states that one currency will appreciate (depreciate) with respect to another currency according to the expected relative rates of inflation between the two countries.

Accepted Answer

The statement accurately represents the theory of purchasing power parity.

Question 9

M&A practitioners utilize nominal cash flows except in circumstances of high rates of inflation, when real cash flows are preferable.

Accepted Answer

Nominal cash flows are cash flows that are not adjusted for inflation, while real cash flows are adjusted for inflation. M&A practitioners typically use nominal cash flows, except in situations with high rates of inflation, where real cash flows are more suitable.

Question 10

In general, the appropriate marginal tax rate used in calculating cash flows and the discount rate should be that applicable to the country in which the cash flows are produced.

Accepted Answer

The appropriate marginal tax rate and discount rate for a cash flow should be based on the country in which the cash flow is being produced. This is because tax rates and economic conditions vary across different countries and can significantly impact the cash flows and discount rates used for investing and financial decision-making.

Question 11

Which of the following is true about segmented capital markets?

Accepted Answer

Segmented capital markets refer to situations where identical assets in terms of risk and maturity may have different prices in different geographic areas. This is because of factors such as differences in local market conditions, supply and demand, and investor behavior. Therefore, option A is the correct answer as it correctly describes the nature of segmented capital markets.

Question 12

Interest rates and expected inflation in one country compared to another country seldom affect exchange rates between the two countries.

Accepted Answer

Interest rates and expected inflation are important factors that can affect exchange rates between two countries. When a country has higher interest rates or expected inflation compared to another country, its currency tends to appreciate against the other country's currency as investors seek higher returns. This can lead to changes in exchange rates between the two countries.

Question 13

For developed countries, such as Western Europe, the interest rate parity theory provides a useful framework for estimating forward currency exchange rates (i.e., future spot exchange rates).

Accepted Answer

The interest rate parity theory is widely used to estimate forward currency exchange rates for developed countries such as Western Europe. Under this theory, the forward exchange rate should reflect the interest rate differential between two currencies, providing a useful framework for predicting future spot exchange rates.

Question 14

If cash flows are in terms of local currency and the U.S. Treasury bond rate is used to estimate the risk free rate, the analyst should add the expected inflation rate in the local country relative to that in the U.S. to convert the U.S. Treasury bond rate to a local country nominal rate.

Accepted Answer

This is true as the U.S. Treasury bond rate is in U.S. dollar terms and does not reflect the expected inflation rate in the local country. By adding the expected inflation rate in the local country, the analyst can estimate the local country nominal rate.

Question 15

The methodology for valuing cross-border transactions using discounted cash flow analysis is substantially different from that employed when both the acquiring and target firms are within the same country. True of False

Accepted Answer

The fundamental methodology for valuing cross-border transactions using discounted cash flow (DCF) analysis is not substantially different from that employed when both the acquiring and target firms are within the same country. The core principles of DCF, including forecasting future cash flows and discounting them to their present value, apply universally. However, adjustments may be made to account for factors like exchange rates, country risk, and tax implications, but these adjustments do not change the underlying methodology.

Question 16

An analyst can determine if a country's equity market is likely to be segmented from the global equity market if the ß derived by regressing returns in the foreign market with returns on the global equity market is significantly different from one.

Accepted Answer

An ß value that is significantly different from one indicates that the country's equity market is not closely correlated with the global equity market and may be segmented.

Question 17

The basic differences between within-country and cross-border valuation methods is that the latter involves converting cash flows from one currency into another and adjusting the discount rate for risks not generally found when the acquirer and target firms are within the same country.

Accepted Answer

Within-country valuation methods do not involve converting cash flows from one currency into another or adjusting the discount rate for cross-border risks. Cross-border valuation methods, on the other hand, require these adjustments to account for differences in currencies and risks between countries.

Question 18

If individual country's capital markets are segmented, the global capital asset pricing model must not be adjusted to reflect the tendency of investors in individual countries to hold local country rather than globally diversified equity portfolios.

Accepted Answer

If individual country's capital markets are segmented, the global capital asset pricing model must be adjusted to reflect the tendency of investors in individual countries to hold local country rather than globally diversified equity portfolios. This is because the segmentation of capital markets results in greater home bias in investment portfolios, which affects the correlation between market returns and global variables used in the global CAPM.

Question 19

In globally integrated markets, it makes little difference whether the ß is calculated by regressing the target firm's (or a similar firm's) historical returns against the returns for a broadly defined global index, U.S. equity market index, or a broadly defined equity index in the target's country.

Accepted Answer

In globally integrated markets, the correlation between returns of different markets is high, making it less important which benchmark index is used to calculate beta. Therefore, it makes little difference whether the beta is calculated using a global index, U.S. equity market index, or a local equity index.

Question 20

Which of the following factors contribute to the integration of the global capital markets?

Accepted Answer

All of the factors mentioned contribute to the integration of the global capital markets. The reduction in trade barriers and the removal of capital controls allow for easier movement of capital across borders. Harmonization of tax laws helps to reduce regulatory arbitrage and encourages foreign investment. Floating exchange rates enable market forces to determine exchange rates, which leads to greater coordination of monetary policies and increases the global reach of financial markets.

Quiz 18: Cross-Border Mergers and Acquisitions: