Class 9 (ch 13 & 14) Flashcards
How does a firm find its cost of capital?
By evaluating where and from whom it will raise capital
How does the firm calculate WACC
Combine cost of equity with cost of debt in proportion to the relative weight of each of the firm’s optimal long-term financial structure
What is CAPM
Says that cost of equity is the sum of a risk free interest component and a firm specific spread, above the risk free rate
What is the key component of CAPM?
Beta
What is beta?
Measure of systematic risk
How is beta calculated
As a function of the total variability of expected returns of the firm’s stock relative to the market
If beta is 1, what does that mean
Moves with the market
If beta is less than 1, what does that mean
Less movement compared to the market
If beta is more than 1, what does that mean
More movement compared to the market
What does international CAPM (ICAPM) assume
Assumes that there is a global market where the firms trade
What are the 2 ways of debt?
1) Loans with commercial banks
2) Instruments like notes and bonds
What is needed to calculate cost of debt
Requires a forecast of interest rates for the next few years, the propositions of various classes of debt the firm expects to use and the corporate income tax
What are the potential benefits for companies who raise capital on global markets based on
Based on international portfolio theory
What is international portfolio theory
Benefits of international diversification
What is assumed when managing international portfolio equities?
It is assumed that the international portfolio’s market risk is lower than that of domestic portfolio. This is because returns on the foreign stocks are not perfectly correlated with domestic stocks
When an investor buys a asset or security in a country they are not in, what can be said regarding their assets
It can be said that they acquired two assets:
1) The asset purchased
2) The currency the asset that was purchased
What does international portfolio theory say about risk?
Typically says that adding international securities to a domestic portfolio will reduce the portfolios risk
What can be said about a multinational firms cost of capital? Why?
They have higher cost of capital compared to domestic firms because of agency costs, foreign exchange risk, portfolio risk, asymmetric information and other complexities to foreign operations
What can be said about a multinational firm with regards to debt
It can be said they are in a better position to support higher debt because their cash flows are diversified internationally
What does it mean if you are a big firm in a domiciled country that have illiquid assets
-It means you will rely on internally generated funds and borrowing from the bank
-May not provide sufficient capital growth
-To finance growth, they may need to borrow more money than typically which is bad for capital structure and cost of capital
-Since debt has a fixed repayment and interest rates, it makes it harder for the borrower to repay its dues
What is a private placement?
It is the sale of a security to a small set of qualified institutional buyers
Who is typically the institutional buyer in a private placement
Usually insurance companies and investment companies
What is the policy for private placement buyers? Why is this the policy?
The rule is to buy and hold since the security is not registered for sale to the public
Where are private placements common nowadays?
They exist in most countries and are particularly prevalent in groing emerging countries
If you want to get funds for another country, how do you lower the risk?
Borrow in the location you wish to borrow in
How is beta measured for international firms
Use he world or global index that best suits them. You can also use the S&P 500 cause many of those companies are multinational
