Question

True or False The CAPM is an approach to determine the cost of international equity capital.

17) TRUE or FALSE The MNE can increase its marginal cost of capital by gaining access to markets that

are more liquid and/or less segmented than its own.

14) TRUE or FALSE To minimize the cost of external funds, the MNE should choose to minimize debt

financing.

TRUE or FALSE In theory, the MNE should support lower debt ratios than a purely domestic firm

because their cash flows are less stable due to international diversification.

True or false Other things equal, the price of an option goes up as the volatility of the underlying

increases.

2) Which of the following is NOT an example of a form of political risk that might be avoided or reduced by foreign exchange risk management?

A) Unfavorable legal changes.

B) War.

C) Expropriation of assets.

D) Destruction of raw materials through natural disaster.

Answer 1

• True. The CAPM is an approach to determine the cost of international equity capital.

CAPM explains the relationship between the required rate of return and the non- diversifiable risk i.e. beta (b) of the firm.   

                Where, K_e = Cost of equity capital

                                Rf = Rate of return required on a risk free security

                                b = Beta coefficient

                        R_{mf =} Required rate of return on the market portfolio of assets                               

• FALSE. The MNE can increase its marginal cost of capital by gaining access to markets that are ill- liquid and more segmented than its own.

Here, the Weighted Average cost of capital (WACC) is known as the marginal cost of caplital. The firm should raise funds from both domestic and international market as the firm will be able to take more projects. If the market is segmented, return/ risk trade-off are different in different market, therefore the firm operating in it will have a increase in marginal cost of capital.

• FALSE. In theory, the MNE should support increase debt ratios than a purely domestic firm

because MNE’s access to the international market may allow it to obtain funds at lower cost than that paid by the domestic firm which will result in the lower cost of capital.

• True. Other things equal, the price of an option goes up as the volatility of the underlying

increases. Volatility is used to measure the risk of the security, therefore it effects the option pricing.

2) D) Destruction of raw materials through natural disaster. It is not a political risk.