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14) Use of the International CAPM (ICAPM) assures that the WACC will be lower than if a
purely domestic market portfolio had been used in the estimation of the cost of equity.
15) A global portfolio is an index of all the securities in the world, whereas a world portfolio
represents those securities actually available to an investor.
16) The CAPM has now become very widely accepted in global business as the preferred
method of calculating the cost of equity for a firm. As a result of this, there is now little debate
over what numerical values should be used in its application.
17) The geometric mean will, in all but a few extreme circumstances, yield a larger return than
the arithmetic mean return.
18) Portfolio diversification can eliminate 100% of risk.
19) Increasing the number of securities in a portfolio reduces the unsystematic risk but not the
systematic risk.
20) International diversification benefits may induce investors to demand foreign securities.
21) If the addition of a foreign security to the portfolio of the investor aids in the reduction of
risk for a given level of return, then the security adds value to the portfolio.
22) If the addition of a foreign security to the portfolio of the investor decreases the expected
return for a given level of risk, then the security adds value to the portfolio.
23) One of the elegant beauties of international equity markets is that over the last 100 or so
years, the average market risk premium is almost identical across major industrial countries.
24) There are potential benefits and risks from raising capital on global markets. Discuss the pros
and cons in terms of risk of raising capital on global markets.
1) The primary goal of both domestic and international portfolio managers is:
A) to maximize return for a given level of risk, or to minimize risk for a given level of return.
B) to minimize the number of unique securities held in their portfolio.
C) to maximize their WACC.
D) all of the above
2) Which of the following is NOT a portfolio diversification technique used by portfolio
managers?
A) diversify by type of security
B) diversify by the size of capitalization of the securities held
C) diversify by country
D) All of the above are diversification techniques.
3) If all capital markets are fully integrated, securities of comparable expected return and risk
should have the same required rate of return in each national market after adjusting for:
A) time of day and language requirements.
B) political risk and time lags.
C) foreign exchange risk and political risk.
D) foreign exchange risk and the spot rate.
4) Capital market segmentation is a financial market imperfection caused mainly by:
A) government constraints.
B) institutional practices.
C) investor perceptions.
D) all of the above
5) Capital market imperfections leading to financial market segmentation include:
A) asymmetric information between domestic and foreign-based investors.
B) high securities transaction costs.
C) foreign exchange risks.
D) all of the above
6) Capital market imperfections leading to financial market segmentation include:
A) political risks.
B) corporate governance differences.
C) regulatory barriers.
D) all of the above
7) The authors refer to companies that have access to a ________ as MNEs, and firms without
such access are identified as ________.
A) global cost and availability of capital; domestic firms.
B) large domestic capital market; geographically challenged.
C) world financial markets; antiquated.
D) none of the above
8) The MNE can ________ its ________ by gaining access to markets that are more liquid
and/or less segmented than its own.
A) increase; MCC.
B) decrease; MCC.
C) maintain; MRR.
D) none of the above
9) Portfolio theory assumes that investors are risk-averse. This means that investors:
A) cannot be induced to make risky investments.
B) prefer more risk to less for a given return.
C) will accept some risk, but not unnecessary risk.
D) All of the above are true.
10) The optimal capital budget:
A) occurs where the marginal cost of capital equals the marginal rate of return of the opportunity
set of projects.
B) is typically larger for purely domestic firms than for MNEs.
C) is an illusion found only in international finance textbooks.
D) none of the above
11) Internationally diversified portfolios often have a lower rate of return and almost always
have a higher level of portfolio risk than their domestic counterparts.
12) Empirical tests of market efficiency fail to show that most major national markets are
reasonably efficient.
13) A MNEs marginal cost of capital is constant for considerable ranges in its capital budget, but
this statement cannot be made for most domestic firms.
14) Capital market segmentation is a financial market imperfection caused mainly by
government constraints, institutional practices, and investor perceptions.
15) Since the 1980s and 1990s, segmentation in global financial markets has been reduced. As a
result of this, the correlation among securities markets has increased, thereby reducing, but not
eliminating, the benefits of international portfolio diversification.
16) Capital market segmentation is a financial market imperfection caused mainly by
government constraints, institutional practices, and investor perceptions. List and explain three
imperfections.
17) Market imperfections do not necessarily imply that national securities markets are
inefficient. Develop an argument as to why this is possible.
18) Most observers believe that for better or for worse, we have achieved a global market for
securities. Discuss the major changes in the international markets of securities: during the 1980s,
during the 1990s and the current conditions.
13.4 The Cost of Capital for MNEs Compared to Domestic Firms
1) Theoretically, most MNEs should be in a position to support higher ________ than their
domestic counterparts because their cash flows are diversified internationally.
A) equity ratios
B) debt ratios
C) temperatures
D) none of the above
2) According to your authors, diversifying cash flows internationally may help MNEs reduce the
variability of cash flows because:
A) of a lack of competition among international firms.
B) of an offset to cash flow variability caused by exchange rate variability.
C) returns are not perfectly correlated between countries.
D) none of the above
3) Which of the following statements is NOT true regarding MNEs when compared to purely
domestic firms?
A) MNEs tend to rely more on short and intermediate term debt.
B) MNEs have greater foreign exchange risk.
C) MNEs have greater costs of asymmetric information.
D) MNEs have higher agency costs.
4) Empirical research has found that systematic risk for MNEs is greater than that for their
domestic counterparts. This could be due to:
A) the fact that the increase in the correlation of returns between the market and the firm is less
than the increase in the standard deviation of returns of the firm.
B) the fact that the decrease in the correlation of returns between the market and the firm is
greater than the increase in the standard deviation of returns of the firm.
C) the reduction in the correlation of returns between the firm and the market is less than the
increase in the variability of returns caused by factors such as asymmetric information, foreign
exchange risk, and the like.
D) None of the above; systematic risk is less for MNEs than for their domestic counterparts.
5) Empirical studies indicate that MNEs have higher costs of capital than purely domestic firms.
This could be due to higher levels of:
A) political risk.
B) exchange rate risk.
C) agency costs.
D) all of the above
6) Despite the theoretical elegance of this hypothesis, empirical studies have come to the
opposite conclusion.Despite the favorable effect of international diversification of cash flows,
bankruptcy risk was only about the same for MNEs as for domestic firms. However, MNEs
faced higher costs for each of the following EXCEPT:
A) agency costs
B) political risk
C) asymmetric information
D) In fact, each of these costs were higher for the MNE than for the domestic firm.
7) Empirical studies indicate that WACC for an MNE is higher than for their domestic
competitors. Reasons cited for this increased cost include all of the following EXCEPT:
A) agency costs
B) foreign exchange risk
C) political risk
D) All of the above are cited as reasons for an MNE's increased WACC.
8) Because of the international diversification of cash flows, the risk of bankruptcy for MNEs is
significantly lower than that for purely domestic firms.
9) The opportunity set of projects is typically smaller for MNEs than for purely domestic firms
because international markets are typically specialized niches.
10) Surprisingly, empirical studies find that MNEs have a higher level of systematic risk than
their domestic counterparts.
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11) Empirical studies indicate that MNEs have a lower debt/capital ratio than domestic
counterparts, indicating that MNEs have a lower cost of capital.
12) What do theory and empirical evidence say about capital structure and the cost of capital for
MNEs versus their domestic counterparts?
