CHAPTER 13
THE GLOBAL COST AND AVAILABILITY OF CAPITAL
1. Segmented Market. What are the most common challenges a firm resident in a segmented
market faces in regards to its access to capital?
A segmented market is one that is isolated or segmented from other markets and from the
global market. This segmentation may be due to restrictive government policies, such as
trade barriers and restrictions on foreign exchange and profit expatriation. There are other
reasons, such as poor communication technologies and high political and foreign exchange
risks. These governmental, non-governmental, and technological restrictions may act as
2. Dimensions of Capital. Global integration has given many firms access to new and cheaper
sources of funds beyond those available in their home markets. What are the dimensions of a
strategy to capture this lower cost and greater availability of capital?
Global integration of capital markets has given many firms access to new and cheaper
3. MNEs’ Capital. When compared to domestic firms, why do MNEs enjoy more capital
availability and lower capital costs?
Domestic firms are disadvantaged in comparison to MNEs as their sources of finance are
limited to domestic financial markets. This becomes a bigger problem if a firm resides in a
country with illiquid or segmented capital markets. MNEs differ from domestic firms in that
4. Equity Cost and Risk. What are the classifications used in defining risk in the estimation of
a firm’s cost of equity?
Systematic risk. Systematic risk is the risk of share price changes that cannot be avoided by
diversification. In other words, it is the risk that the stock market as a whole will rise or fall
and the price of shares of an individual company will rise and fall with the market.
Systematic risk is sometimes called market risk.
5. Equity risk premiums.
a. Why is equity risk premium important to investors?
b. Why is it necessary to use one consistent measurement of risk premiums?
a. In general, Treasury securities provide lower returns in comparison to corporate financial
instruments since they are usually risk-free or have considerably low credit risk. When
building a portfolio with varied returns and risk, or even when purchasing a single
financial instrument, investors typically use Treasuries as a benchmark of safe
b. There are two reasons behind the calculation differences of the equity risk premium.
First, arithmetic mean risk premiums always have higher values than geometric mean risk
premiums since the geometric change assumes reinvested compounding, whereas the
arithmetic mean only assumes point-to-point investment. Second, the proxy risk-free
6. Portfolio Management Diversification. Why do portfolio managers often add securities
issued on emerging markets in spite of the high risks associated with these markets?
Emerging markets are characterized with fast-growing economies, large markets, and low
cost of production. However, in contrast to their economic growth, their capital markets are
quite shallow and not as efficient as advanced capital markets. Moreover, emerging market
7. International Portfolio Management. What is the main advantage that international
portfolio managers have compared to portfolio managers limited to domestic-only asset
allocation?
Internationally diversified portfolios often have a higher expected rate of return, and they
nearly always have a lower level of portfolio risk because national securities markets are
imperfectly correlated with one another.
8. International CAPM. What are the fundamental distinctions which the international CAPM
tries to capture which traditional domestic CAPM does not?
In theory, the primary distinction in the estimation of the cost of equity for an individual firm
using an internationalized version of the CAPM is the definition of the “market” and a
9. Dimensions of Asset Allocation. Portfolio asset allocation can be accomplished along many
dimensions depending on the investment objective of the portfolio manager. Identify the
various dimensions.
Portfolio asset allocation can be accomplished along many dimensions depending on the
investment objective of the portfolio manager. For example, portfolios can be diversified
10. Market Liquidity. What happens to a firm’s marginal cost of capital as it expands in an
illiquid market? How can it overcome these difficulties?
Market illiquidity is witnessed in markets where the volume of trading is low, market
capitalization constitutes a small portion of GDP, and the issuance of a new security
depresses the existing market price. Firms constrained to small and illiquid domestic capital
11. Market Segmentation. What is market segmentation, and what are the six main causes of
market segmentation?
Capital market segmentation is a financial market imperfection caused mainly by
government constraints, institutional practices, and investor perceptions. The most important
imperfections are:
▪ Asymmetric information between domestic and foreign-based investors
12. Market Illiquidity and Segmentation. Explain why illiquidity and segmentation lead to
financial market imperfections. Can MNEs tackle market imperfections?
Among the various factors that could lead to financial market imperfections are government
controls, high risks, high transaction costs, cultural constraints, institutional practices, and
investor perceptions. These barriers could result in market imperfections in terms of making
financial markets illiquid or segmented. These barriers will make demand and supply for
13. MNEs Internationalizing the Cost of Capital. What are the factors that determine the
efficiency of MNEs’ strategies for internationalizing their cost of capital? Explain how such
strategies have proven to be beneficial to both global and national economies as well as
MNEs.
that investors and financers consider carefully is the P/E ratio in relation to competitors in the
sector. The high cost of capital and the scarcity of financing compel MNEs to develop a
strategy to escape their domestic limited capital markets and source capital abroad. In order
to be able to conquer global markets, the issuing MNEs should be able to meet global
standards. Some unattractive features of the new equity are political risks and foreign
exchange risks, which are beyond the scope of the firm. Hence, the MNE should focus on
improving other features and mitigating other risks. Most importantly, MNEs should increase
their financial and technical disclosure in multiple languages in order to attract foreign
portfolio investors. The following step is to cross-list its stocks. As the cost of capital falls,
14. Cost of Capital for MNEs. Do multinational firms have a higher or lower cost of capital
than their domestic counterparts? Is this surprising?
Theoretically MNEs should be in a better position than their domestic counterparts to support
higher debt ratios because their cash flows are diversified internationally. However, recent
15. Multinational Use of Debt. Do multinational firms use relatively more or less debt than
their domestic counterparts? Why?
According to empirical studies, multinational firms appear to use less debt than their
domestic counterparts. We believe it results from a variety of factors. First, despite the
16. MNEs’ Systemic Risk. Explain why emerging market MNEs have lower systemic risks in
comparison to their developed market MNEs.
Globalization has allowed emerging market MNEs to operate in more financial markets and
to access higher levels of debt. This has substantially lowered their systemic risk. This is
17. The “Paradox.” What is the paradox?
The paradox is an attempt to explain under what conditions an MNE would have a higher or
lower debt ratio and beta than its domestic counterpart. The answer to this paradox lies in the
link between the cost of capital, its availability, and the opportunity set of projects. As the
opportunity set of projects increases, eventually the firm needs to increase its capital budget
18. Emerging Market MNEs. Explain why some firms in MNEs have managed to expand their
operations outside their national borders. How can MNEs in emerging markets raise extra
funds to finance their expansions?
MNEs from emerging markets have been growing rapidly, expanding from their home
countries to international markets. There are many factors that have shaped the decisions of
these MNEs to break out of their domestic markets and operate on a larger scale. First, while
emerging market MNEs have acquired their know-how from the developed world, they
would prefer to expand their operations from mere mirror images of western-style firms to
the implementation of their own innovative technology and/or processes. Second, there could
19. Novo and Segmented Capital Markets. What were the impacts on Novo as a result of
operating in a segmented market? What were the primary causes of the market segmentation?
Novo, as a result of operating in the segmented Danish market, suffered both a higher cost of
capital and reduced capital availability. When compared to comparable international
competitors, this would prove a limitation on its ability to compete in the years to come as
20. Novo Escapes. Ultimately, what actions did Novo take to escape its segmented market?
Novo undertook a strategy for the firm involving a series of steps to internationalize its cost
and availability of capital. The first step was to close the information gap between Denmark
and the global markets. This was accomplished by increased reporting and disclosure in
English as well as Danish. This was extended by the launch of a convertible eurobond issue