International Corporate Finance

Question 1

What are Internationally Integrated Capital Markets (Conditions)?

Answer 1

• Markets where any amount of currency can be exchanged at current rates (spot / forward)
• Investors can buy or sell any security in any country at market prices
• The value of investments does not depend on the currency used

Question 2

How is the price of a risky foreign asset calculated?

Answer 2

• Price is calculated by discounting expected cash flow by the foreign risk-free rate.
• The formula used is

Question 3

How would a U.S. investor calculate the cost to purchase a risky foreign asset in dollars?

Answer 3

• The cost is calculated using the current spot exchange rate.
• S is the current spot exchange rate in dollars per foreign currency (xUSD = 1 FC

Question 4

How does a U.S. investor value the expected cash flow in one period in dollars?

Answer 4

=> CF multiplied with the forward rate F
*quoted as dollars per foreign currency

Question 5

What formula does a U.S. investor use to calculate the present value of the expected cash flow in dollars?

Answer 5

• It is determined by discounting the expected cash flow **at the U.S. investor’s cost of capital **x multiplied by F

where r*$
is the cost of capital for a U.S. investor.

Question 6

What does the Covered Interest Parity principle state in the context of Internationally Integrated Capital Markets?

Answer 6

= the relationship between the spot exchange rates, forward rates, and interest rates of two countries must be such that there are no arbitrage opportunities (=no use of exchange rates, interest rates or price differences possible)

Question 7

How does the Law of One Price apply to the valuation of a foreign asset by a U.S. investor?

Answer 7

It ensures the value with the spot exchange rate = the value with the forward rate:

Question 8

• What are the two equivalent methods that can be used to value foreign currency cash flows (in an internationally integrated capital market)?

Answer 8

Method 1:
1. Calculate the NPV in the foreign country’s currency.
2. Convert the NPV to the local currency at the current spot rate.

Method 2:
1. Convert the future cash flows of the foreign project into the local currency at the current spot rates.
2. Calculate the NPV of these converted cash flows.

Question 9

Explain the NPV

Answer 9

NPV Explanation:
* NPV is the sum of present values of incoming and outgoing **cash flows **over a period of time.
* A positive NPV = earnings > costs

=> indicates that the projected earnings (in present) exceed the anticipated costs (also in present ).

Question 10

How is the NPV calculated?

Answer 10

Question 11

Is converting the cash flows of a foreign project into local currency and then calculating the NPV equivalent to converting the expected dollar value of the foreign currency cash flows and valuing the project as a domestic one?

Answer 11

Yes, the equivalence is due to the time value of money and the fungibility of currency in financial valuation:
* **Whether you convert future cash flows first or calculate NPV first, the final value should be the same ***due to consistent exchange rates applied in the calculation.
* Converting future cash flows to local currency first aligns with domestic NPV valuation methods, ensuring comparability with other domestic investments.

This method reflects the risk and return of the project as if it were a domestic project, considering the local currency’s perspective.
* It incorporates the local investor’s viewpoint by using the local discount rate, which reflects the opportunity cost of capital for similar-risk investments in the local market.
=> The process assumes that exchange rates remain constant or are correctly predicted by the forward rates, which is an inherent assumption in the internationally integrated capital market theory.

Question 12

What is the Weighted Average Cost of Capital (WACC)?

Answer 12

Theory:
* = rate
* WACC represents a firm’s cost to borrow capital, weighted by the proportion of each capital component (debt and equity).
* It reflects the average rate of return required by investors, taking into account the relative weights of each component of the company’s capital structure.

Question 13

How is the WACC calculated?

Answer 13

• E is the market value of the equity.
• D is the market value of the debt.
• rE is the cost of equity.
• rD is the cost of debt.
• Tc is the corporate tax rate.

The c**ost of equity is typically calculated using models such as the Capital Asset Pricing Model (CAPM), and the cost of debt **is determined by the yield to maturity on existing debt or the current interest rate on new debt.