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MNC Chapter 13
MNC Chapter 13
MNC Chapter 13
If a firm is located in a country with illiquid and/or segmented capital markets, it can achieve this lower global cost
and greater availability of capital through a properly designed and implemented strategy.
A firm that must source its long-term debt and equity in a highly illiquid domestic securities market will probably
have a relatively high cost of capital and will face limited availability of such capital.
A national capital market is SEGMENTED The required of return on securities in this market
differs from required of return on securities of comparable expected return and risks traded in
other securities markets.
Capital markets become SEGMENTED due to such factors as excessive regulatory control,
perceived political risk, anticipated foreign exchange risk, lack of transparency, asymmetric
availability of information, cronyism, insider trading, and many other market imperfections.
The ability to turn company assets into funds that plays an important role in mandating
transaction is defined as the availability of capital.
access to capital in global markets allows an MNE to lower its cost of equity and debt compared
with most domestic firms.
Cost of capital
Cost of equity
The most common method of calculating cost of equity for a firm today is Capital Asset Pricing
Model (CAPM).
Beta is the key component of CAPM. It’s calculated as a function of the total variability of
expected returns of the firm’s stock relative to the market index and the degree to which the
variability of expected returns of the firms is correlated to the expected returns on the market
index.
Beta < 1 firm’s returns are less volatile than the market.
Beta = 1 firm’s returns are the same as the market
Beta > 1 firm’s returns are more volatile (riskier) than the market.
Beta is an indicator of the future rather than the past. Since the future is not known, Beta used
in firm’s estimate of equity cost is based on evidence from the recent past.
Cost of debt
Debts of a firm can be either 2 forms:
+ The most common form - loans from commercial banks
+ Securities sold to the debt markets such as instruments (notes/bonds)
=> Cost of debt: interest rates, the proportions of various classes of debt the firm expects to
use, CIT
The weighted average cost of capital is normally used as the risk-adjusted discount rate
whenever a firm’s new projects are in the same general risk class as its existing projects.
*The International portfolio’s market risk < that of domestic portfolio. Since the foreign stocks
are not perfectly correlated with domestic stocks.
Given the limits of the potential supply of securities, increased demand will bid up the price of
the security, resulting in a lower cost of capital for the firm. The firm issuing the security, the
sell-side, is therefore able to raise capital at a lower cost.
Both domestic and international portfolio managers are asset allocators. Their objective is to
maximize a portfolio’s rate of return for a given level of risk, or to minimize risk for a given rate
of return.
As a result, internationally diversified portfolios often have a higher expected rate of return,
and they nearly always have a lower level of portfolio risk, since national securities markets are
imperfectly correlated with one another.
The impact market liquidity & market segmentation on a firm’s cost of capital
- Liquidity
Observe market liquidity through the degree to which a firm can issue a new security without
depressing the existing market price.
A MNC can improve market liquidity by raising funds in the Euromarkets (money, bond, equity),
by selling issues abroad.
- Market segmentation
If that market is segmented, foreign investors will not be participants. Avail- ability of capital
depends on whether a firm can gain liquidity for its debt and equity securities and a price for
those securities based on international rather than national standards.
To escape illiquid or segmented national market, the firm must define a strategy to attract
international portfolio investors.
- 2 factors above can affect a firm’s marginal cost of capital & WACC
MNEs faced higher agency costs, political risk, foreign exchange risk, and asymmetric
information. These have been identified as the factors leading to lower debt ratios and even a
higher cost of long-term debt for MNEs.