Class 9 (ch 13 & 14)

Question 1

How does a firm find its cost of capital?

Answer 1

By evaluating where and from whom it will raise capital

Question 2

How does the firm calculate WACC

Answer 2

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

Question 3

What is CAPM

Answer 3

Says that cost of equity is the sum of a risk free interest component and a firm specific spread, above the risk free rate

Question 4

What is the key component of CAPM?

Answer 4

Beta

Question 5

What is beta?

Answer 5

Measure of systematic risk

Question 6

How is beta calculated

Answer 6

As a function of the total variability of expected returns of the firm’s stock relative to the market

Question 7

If beta is 1, what does that mean

Answer 7

Moves with the market

Question 8

If beta is less than 1, what does that mean

Answer 8

Less movement compared to the market

Question 9

If beta is more than 1, what does that mean

Answer 9

More movement compared to the market

Question 10

What does international CAPM (ICAPM) assume

Answer 10

Assumes that there is a global market where the firms trade

Question 11

What are the 2 ways of debt?

Answer 11

1) Loans with commercial banks
2) Instruments like notes and bonds

Question 12

What is needed to calculate cost of debt

Answer 12

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

Question 13

What are the potential benefits for companies who raise capital on global markets based on

Answer 13

Based on international portfolio theory

Question 14

What is international portfolio theory

Answer 14

Benefits of international diversification

Question 15

What is assumed when managing international portfolio equities?

Answer 15

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

Question 16

When an investor buys a asset or security in a country they are not in, what can be said regarding their assets

Answer 16

It can be said that they acquired two assets:
1) The asset purchased
2) The currency the asset that was purchased

Question 17

What does international portfolio theory say about risk?

Answer 17

Typically says that adding international securities to a domestic portfolio will reduce the portfolios risk

Question 18

What can be said about a multinational firms cost of capital? Why?

Answer 18

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

Question 19

What can be said about a multinational firm with regards to debt

Answer 19

It can be said they are in a better position to support higher debt because their cash flows are diversified internationally

Question 20

What does it mean if you are a big firm in a domiciled country that have illiquid assets

Answer 20

-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

Question 21

What is a private placement?

Answer 21

It is the sale of a security to a small set of qualified institutional buyers

Question 22

Who is typically the institutional buyer in a private placement

Answer 22

Usually insurance companies and investment companies

Question 23

What is the policy for private placement buyers? Why is this the policy?

Answer 23

The rule is to buy and hold since the security is not registered for sale to the public

Question 24

Where are private placements common nowadays?

Answer 24

They exist in most countries and are particularly prevalent in groing emerging countries

Question 25

If you want to get funds for another country, how do you lower the risk?

Answer 25

Borrow in the location you wish to borrow in

Question 26

How is beta measured for international firms

Answer 26

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