Chapter: Chapter 31: Emerging Markets
Multiple Choice
1. For emerging markets, the recommended market input for computing beta is:
a) A small-cap index.
b) A median-cap index.
c) A global market index.
d) An index of non-investment-grade bonds.
2. For emerging markets, the recommended input for the risk-free rate for computing beta is:
a) The domestic government bond rate.
b) The average of the inflation rates of developed nations.
c) The average of the government bond rates of developed nations.
d) The U.S. Treasury bond rate plus the local inflation rate minus the U.S. inflation rate.
3. Which of the following are reasons an analyst should allow for changes in cost of capital in an
emerging market?
I. Reforms in the tax system.
II. Changes in the cost of debt.
III. Evolving inflation expectations.
IV. Changes in a company’s capital structure.
a) I and II only.
b) I, III, and IV only.
c) II and IV only.
d) I, II, III, and IV.
4. Which of the following best represents the relevance of purchasing power parity (PPP) when
analyzing companies in emerging markets?
a) PPP does not hold between emerging and developed economies.
b) PPP holds over the long run, and exchange rates will adjust to inflation differentials.
c) PPP holds over the long run, but exchange rates will not adjust to inflation differentials.
d) It is not clear whether PPP holds, because there is not yet enough evidence one way or the
other.
5. Given the following information for a company in a developing market, estimate the value of
the company. The cash for the next year is estimated to be either $200 in the business-as-usual
scenario or $50 in the distress scenario. The probabilities of the scenarios are 80 percent and 20
percent, respectively. The expected perpetual growth rate in each case is 5 percent per year,
and the cost of capital is 11 percent. The value of the company is closest to:
a) $1,654.55
b) $2,500.00
c) $2,833.33
d) $3,333.33
6. Using a scenario approach, an analyst finds that the estimated value of a company is $800.
The business–as-usual scenario forecasts a cash flow of $40 starting next year and then growing
at 6 percent forever. The cost of capital in that scenario is 10 percent. Given this information,
what is the implied risk premium to add to the cost of capital to make the analyst’s results
consistent with the country risk premium discounted cash flow (DCF) approach?
a) 0.80 percent.
b) 1.00 percent.
c) 1.20 percent.
d) 1.25 percent.
7. In a two-scenario model of an emerging market, it is recommended that the analyst create a
base-case set of forecasts and a set of forecasts associated with a period of economic distress.
Which of the following best represents the range of probability weights to assign the economic
distress scenario?
a) 5 to 10 percent.
b) 10 to 20 percent.
c) 20 to 30 percent.
d) 30 to 40 percent.
8. Which of the following is NOT an argument against the country risk premium approach?
a) Most country risks, including expropriation, devaluation, and war, are largely diversifiable.
b) Risks apply unequally to companies in a given country.
c) There is no systematic method to calculate a country risk premium.
d) It is bound to be below the growth rate, and that limits its application.
9. As long as international investors have access to an emerging market’s local investment
opportunities, local prices will be based on an international cost of capital.
10. For estimating the cost of capital in emerging markets, other models are superior to the
capital asset pricing model (CAPM).
11. In applying the CAPM in estimating the cost of capital in an emerging market, explain the
three problems in estimating an appropriate risk-free rate and the recommended solution.