This document provides a study guide and analysis for a case study on determining the appropriate discount rate for cash flows in Venezuela for Telmex's potential acquisition of shares in CANTV.
The study guide outlines the teaching objectives of understanding challenges in estimating the cost of capital in emerging markets. It also reviews different methodologies that have been used to incorporate country risk into discount rate calculations, including modified versions of the CAPM model. The analyses of these methods note their advantages and disadvantages when the perception of sovereign risk differs from private sector risk, as it does in Venezuela.
The document concludes by providing a teaching plan to analyze financial information, review risk calculation theories, consider the dilemma of what discount rate to propose,
Fisher black and the revolutionary idea of financeFuturum2
This document provides a summary of and commentary on several books related to finance and economics, linking them to Fisher Black's Capital Asset Pricing Model (CAPM). It discusses how Fisher Black was introduced to CAPM and how it became his primary focus. It then summarizes key points and relationships between the books, including how they relate to CAPM concepts like risk and equilibrium. One critique is that the book on Fisher Black barely mentions Markowitz, who was influential in the development of CAPM along with Tobin. Overall, the document analyzes how several books connect to CAPM and Fisher Black's work developing this influential idea.
This document summarizes a research paper that analyzes the life-cycle patterns of firms' financing decisions and how they interact with future growth and development decisions. It proposes a dynamic model to explain three different financing sequences (debt-debt, equity-debt, equity-equity) that firms may take on over their life cycle. The model predicts that different financing sequences will depend on project characteristics, firm characteristics, market conditions, and country characteristics. It also suggests that initial financing decisions can create path dependencies that influence future financing and expansion decisions. Lack of start-up financing may also slow firm dynamics depending on specific conditions.
Evaluation of the Development and Performance of Selected GCC and Non-GCC St...Mace Abdullah
This paper compares and contrasts the stock markets for countries of comparable size and development as and between the GCC and non-GCC countries. The paper implicitly observes what may be considered strengths and weakness as and between markets dominated by Islamic Finance principles and those that are more or less conventionally oriented.
Determinants of capital_structure_an_empR Ehan Raja
This document summarizes a research paper that investigates the determinants of capital structure for manufacturing firms in Pakistan. The paper reviews various capital structure theories and identifies firm-specific factors that may influence a firm's debt ratio. An empirical analysis is then conducted using data from 160 Pakistani manufacturing firms to determine which factors, such as profitability, size, liquidity, etc., are significantly related to the debt ratios of these firms. The findings indicate several factors predicted by trade-off theory, pecking order theory, and agency theory help explain the financing behavior of Pakistani firms, suggesting some universal applicability of capital structure models from Western settings.
This document discusses concepts of liquidity and liquidity risk within the financial system. It distinguishes between three types of liquidity: central bank liquidity, funding liquidity, and market liquidity. It analyzes linkages between these liquidity types in normal and turbulent times. In turbulent times, increased funding liquidity risk can contaminate market liquidity and necessitate central bank intervention. However, central bank liquidity alone cannot address the root causes of liquidity risk, which stem from information asymmetries and incomplete markets. Supervision and regulation are needed to minimize these issues and distinguish between solvent and insolvent institutions.
[EN] Convertible bonds offer investors equity-like returns with a risk profil...NN Investment Partners
NN Investment Partners explains how convertible bonds offer investors equity-like returns with a risk profile comparable to that of bonds, from November 2015.
SME development, constraints, credit risk & islamic banking solutionsMace Abdullah
This analytic paper examines the status of small and medium sized enterprises (SME) worldwide, provides theoretical information and explores issues regarding their development, constraints and credit risk. SME have been heralded worldwide as being the economic “engine” of economic development. Certainly, from an Islamic finance perspective, the development of SME represents a propitious opportunity, a vital step towards an epistemological response to criticism of Islamic finance and should play an indispensible role in forging a more robust Islamic capital market. Yet, SME face persistent identifiable obstacles to growth and development. This paper focuses on SME development, particularly as it relates to the so-called “credit gap” and the concomitant credit risk. The SME “credit gap” is pervasive worldwide; particularly so in emerging economies. Accordingly, this paper analyzes: the determinants and drivers of SME development; constraints on SME development; the SME “credit gap” and concomitant credit risk; and the role Islamic banking can play in meeting the challenge of SME development.
This document summarizes a study examining 125 equity mutual funds that closed to new investment between 1993 and 2004. The study tests three hypotheses about why funds close: 1) The "good steward" hypothesis argues funds close to restrict inflows and maintain performance, and will perform well after reopening. 2) The "cheap talk" hypothesis posits closing has no real cost if fees increase and existing investors contribute, compensating managers. 3) The "family spillover" hypothesis claims closing diverts attention to other funds in the same family. The study finds little support for good steward performance, but evidence managers raise fees consistent with cheap talk, and little family benefit except briefly around closure.
Fisher black and the revolutionary idea of financeFuturum2
This document provides a summary of and commentary on several books related to finance and economics, linking them to Fisher Black's Capital Asset Pricing Model (CAPM). It discusses how Fisher Black was introduced to CAPM and how it became his primary focus. It then summarizes key points and relationships between the books, including how they relate to CAPM concepts like risk and equilibrium. One critique is that the book on Fisher Black barely mentions Markowitz, who was influential in the development of CAPM along with Tobin. Overall, the document analyzes how several books connect to CAPM and Fisher Black's work developing this influential idea.
This document summarizes a research paper that analyzes the life-cycle patterns of firms' financing decisions and how they interact with future growth and development decisions. It proposes a dynamic model to explain three different financing sequences (debt-debt, equity-debt, equity-equity) that firms may take on over their life cycle. The model predicts that different financing sequences will depend on project characteristics, firm characteristics, market conditions, and country characteristics. It also suggests that initial financing decisions can create path dependencies that influence future financing and expansion decisions. Lack of start-up financing may also slow firm dynamics depending on specific conditions.
Evaluation of the Development and Performance of Selected GCC and Non-GCC St...Mace Abdullah
This paper compares and contrasts the stock markets for countries of comparable size and development as and between the GCC and non-GCC countries. The paper implicitly observes what may be considered strengths and weakness as and between markets dominated by Islamic Finance principles and those that are more or less conventionally oriented.
Determinants of capital_structure_an_empR Ehan Raja
This document summarizes a research paper that investigates the determinants of capital structure for manufacturing firms in Pakistan. The paper reviews various capital structure theories and identifies firm-specific factors that may influence a firm's debt ratio. An empirical analysis is then conducted using data from 160 Pakistani manufacturing firms to determine which factors, such as profitability, size, liquidity, etc., are significantly related to the debt ratios of these firms. The findings indicate several factors predicted by trade-off theory, pecking order theory, and agency theory help explain the financing behavior of Pakistani firms, suggesting some universal applicability of capital structure models from Western settings.
This document discusses concepts of liquidity and liquidity risk within the financial system. It distinguishes between three types of liquidity: central bank liquidity, funding liquidity, and market liquidity. It analyzes linkages between these liquidity types in normal and turbulent times. In turbulent times, increased funding liquidity risk can contaminate market liquidity and necessitate central bank intervention. However, central bank liquidity alone cannot address the root causes of liquidity risk, which stem from information asymmetries and incomplete markets. Supervision and regulation are needed to minimize these issues and distinguish between solvent and insolvent institutions.
[EN] Convertible bonds offer investors equity-like returns with a risk profil...NN Investment Partners
NN Investment Partners explains how convertible bonds offer investors equity-like returns with a risk profile comparable to that of bonds, from November 2015.
SME development, constraints, credit risk & islamic banking solutionsMace Abdullah
This analytic paper examines the status of small and medium sized enterprises (SME) worldwide, provides theoretical information and explores issues regarding their development, constraints and credit risk. SME have been heralded worldwide as being the economic “engine” of economic development. Certainly, from an Islamic finance perspective, the development of SME represents a propitious opportunity, a vital step towards an epistemological response to criticism of Islamic finance and should play an indispensible role in forging a more robust Islamic capital market. Yet, SME face persistent identifiable obstacles to growth and development. This paper focuses on SME development, particularly as it relates to the so-called “credit gap” and the concomitant credit risk. The SME “credit gap” is pervasive worldwide; particularly so in emerging economies. Accordingly, this paper analyzes: the determinants and drivers of SME development; constraints on SME development; the SME “credit gap” and concomitant credit risk; and the role Islamic banking can play in meeting the challenge of SME development.
This document summarizes a study examining 125 equity mutual funds that closed to new investment between 1993 and 2004. The study tests three hypotheses about why funds close: 1) The "good steward" hypothesis argues funds close to restrict inflows and maintain performance, and will perform well after reopening. 2) The "cheap talk" hypothesis posits closing has no real cost if fees increase and existing investors contribute, compensating managers. 3) The "family spillover" hypothesis claims closing diverts attention to other funds in the same family. The study finds little support for good steward performance, but evidence managers raise fees consistent with cheap talk, and little family benefit except briefly around closure.
Using Cross Asset Information To Improve Portfolio Risk Estimationyamanote
There are obvious relationships between the various securities of a given firm that impact our expectations of risk. For example, if fixed income investors expect a corporate bond of a company to default, there must be a related bankruptcy event that would negatively impact shareholders in that firm. In this presentation, Nick will describe how to use data from bond and option markets to improve risk estimation for equity portfolios, and how to use information from the equity markets to improve estimation of credit risk in fixed income securities. The goal of the process is to create holistic risk estimation where all expectations of risk are mutually consistent across the entire capital structure of a firm, and related derivatives.
Standard & poor's 16768282 fund-factors-2009 jan1bfmresearch
This document summarizes a study by Standard & Poor's on factors that predict investment fund performance. The study analyzed both qualitative factors like fund size, expenses, and age as well as quantitative metrics like Jensen's alpha and information ratio. The key findings were:
- For developed markets, larger funds with lower expenses tended to outperform. But for emerging markets, smaller funds did better due to differences in liquidity.
- Jensen's alpha and information ratio best predicted future performance of developed market equity funds over shorter time periods.
- Past performance was informative over 2 years but less so over 1 year due to noise. Fund selection should focus on factors predicting shorter term outperformance.
This document is a thesis examining whether catastrophe bonds can provide efficient portfolio diversification. It begins with an introduction on the development of insurance-linked securities (ILS) markets in response to capacity issues following major natural disasters in the 1990s. The thesis then analyzes catastrophe bond markets and financial mechanisms. Through an empirical study of portfolios with and without catastrophe bonds from 2002-2015, the thesis finds that while volatility and risk levels remained similar, the portfolio diversified with catastrophe bonds saw improved returns and Sharpe ratio, suggesting potential benefits from their inclusion in portfolios.
The document discusses the role of economists in supporting executive management with risk analysis and resilience planning. It outlines various types of risks that infrastructure sectors face, such as event risk, macroeconomic risk, and strategic risk. It then describes the risk management process as defined by the ISO 31000 standard, including risk identification, analysis, evaluation, treatment, and monitoring. The role of economists is to help executives understand probability, risk, and uncertainty beyond just average outcomes, and account for factors like uncertainty distributions, skewness, and behavioral issues. Both quantitative methods like Monte Carlo simulation and qualitative approaches have a role to play in risk analysis.
Mb0053 international business managementsmumbahelp
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Send your semester & Specialization name to our mail id :
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Credit Market Imperfection, Inequality and Capital AccumulationMahmoud Sami Nabi
1) The document discusses a theoretical model that examines the relationship between credit market imperfections, inequality, and capital accumulation. It incorporates judicial inefficiency as an additional credit market imperfection beyond moral hazard.
2) The model finds that wealth inequality initially widens between high- and low-wealth agents, as high-wealth agents can undertake larger projects due to credit constraints. However, inequality either remains constant or widens over time, depending on interest rate policies.
3) Numerical simulations show that increasing judicial efficiency reduces the speed of convergence to the long-run inequality level and decreases the long-run level of wealth inequality.
GBS CH 6 COUNTRY EVALUATION AND SELECTION Shadina Shah
This document discusses factors to consider when evaluating and selecting countries for international business operations. It covers the importance of location, scanning countries to identify opportunities and risks, and variables to assess like sales expansion, resource acquisition, and political risk. The key steps are scanning countries broadly first before narrowing down options for more detailed analysis considering objectives, strategies, environmental factors, and flexibility as conditions can change. Opportunity variables include sales potential and accessing resources, while risk variables include political, economic, natural disaster, and competitive risks. Companies must prioritize and weigh these factors to decide where and how much to invest abroad.
Tracking Variation in Systemic Risk-2 8-3edward kane
This paper proposes a new measure of systemic risk for US banks from 1974-2013 based on Merton's model of credit risk. The measure treats deposit insurance as an implicit option where taxpayers cover bank losses. Each bank's systemic risk is its contribution to the value of this sector-wide option. The model estimates show systemic risk peaked in 2008-2009 during the financial crisis, and bank size, leverage, and risk-taking were key drivers of systemic risk over time.
This document provides an introduction to a framework for analyzing how financial factors can contribute to instability in small open economies. The framework presents a dynamic open economy model where a tradeable good is produced using internationally mobile capital and a country-specific factor, and firms face credit constraints determined by their level of financial development. The model suggests that economies at an intermediate level of financial development are most unstable, as shocks have larger and more persistent effects. Financial liberalization may also destabilize these economies by allowing boom-bust cycles driven by capital inflows and outflows. The mechanism involves investment booms raising input costs, squeezing profits, and eventually leading to output collapses.
This introduction summarizes the various articles contained in the issue of Housing Finance International. It provides context on recent economic developments in Asia and their impact on housing markets. It then previews each of the five articles, concisely summarizing their topics and key arguments. The first article examines the banking crises in Sweden and Japan in the 1990s and their effects on housing. The second reviews the impact of the financial crisis on mortgage markets in former Soviet countries. The third discusses enhancing tools to measure and manage mortgage default risk. The fourth argues for a contextual policy approach to housing challenges in Central and Eastern Europe. The fifth suggests using financial derivatives to separate the economic value and shelter value of homeownership.
Country risk management handout, diversification by Gloria Armesto, Kasey Phi...Alina_90
This document discusses country risk management in global financial markets. It recommends diversifying investments across different countries, markets (developed, emerging, frontier), and asset classes (stocks, bonds, etc.) to minimize risk. Country-specific risks like economic or political instability, natural disasters, and market volatility can be reduced through international diversification. The document also discusses hedging strategies using derivatives to counter exposure to security price movements in specific countries. Constant monitoring of a portfolio is needed as country risk levels change over time.
The document provides an overview of foreign exchange markets, including how currency exchange rates work, major currency traders, factors that influence exchange rates like interest rates and inflation, and concepts like purchasing power parity and interest rate parity. Key points covered include that foreign exchange markets facilitate international trade and investment, the US dollar and euro are the most traded currencies, and currency values can be affected by differences in inflation rates between countries.
Aitor Erce's discussion of "The Seniority Structure of Sovereign Debt"ADEMU_Project
- The paper presents two new datasets on sovereign debt: one on payment arrears by sovereign debtors to different creditor groups, and one on haircuts applied in sovereign debt restructurings to private and official creditors.
- Analyzing the datasets, the paper finds a clear pecking order among creditors, with multilateral institutions, bonds, bilateral loans, banks, and suppliers at the bottom in terms of seniority.
- The main policy conclusion is that the official sector should reconsider its approach to debt restructuring, as the analysis shows official creditors have become increasingly junior over time.
IT Top is considering expanding its business internationally by establishing a manufacturing facility in Oman. A capital budgeting analysis of the proposed project in Oman estimates a positive NPV of RM4 million, supporting the project. However, the analysis should also consider exchange rate fluctuations by performing sensitivity analysis using strengthening and weakening Omani Rial scenarios. Expanding internationally could provide competitive advantages for IT Top but the management must carefully evaluate risks and determine appropriate financing and hedging strategies.
This document discusses approaches to calculating the international cost of capital. It notes that while the capital asset pricing model (CAPM) is commonly used, it provides biased estimates in emerging markets due to unique country risks. The document evaluates 12 different models and recommends using a company's domestic cost of capital plus a country risk premium in basis points estimated through quantitative crisis signal and country rating models. It stresses the country premium should account for cyclical, exchange rate, solvency, political and business environment risks over various time horizons.
07. the determinants of capital structurenguyenviet30
This document summarizes a research paper that investigates how firms in capital market-oriented economies (UK, US) and bank-oriented economies (France, Germany, Japan) determine their capital structures. Using panel data and regression analysis, the paper finds that firm size and tangibility of assets increase leverage, while profitability, growth opportunities, and share price performance decrease leverage in both types of economies. However, the impacts of some determinants vary between countries depending on differences in institutions and traditions. The paper also finds that firms have target leverage ratios but adjust to them at different speeds across countries.
This thesis examines how policymakers should respond during times of financial sector distress. It outlines that policymakers face two critical tasks: 1) identifying and addressing the issues critical to the crisis, and 2) ensuring the financial sector reaches a new equilibrium. The importance and nature of these tasks will be illustrated using evidence from the Asian Financial Crisis and the U.S. Savings and Loans Crisis. Frameworks will also be proposed to guide policymakers in accomplishing each task.
Impact of accounts receivable management on the profitability during the fina...Instansi
This document discusses a study examining the impact of accounts receivable management on the profitability of Serbian companies during the 2008-2011 financial crisis. The study uses a sample of 108 publicly listed Serbian companies. Descriptive statistics show the average return on total assets was 4.7% and average operating profit margin was 3.2% for the sample firms during the crisis period. The study aims to test the relationship between accounts receivables and these two measures of profitability to see if receivables management policies need to change during an economic recession.
Using Cross Asset Information To Improve Portfolio Risk Estimationyamanote
There are obvious relationships between the various securities of a given firm that impact our expectations of risk. For example, if fixed income investors expect a corporate bond of a company to default, there must be a related bankruptcy event that would negatively impact shareholders in that firm. In this presentation, Nick will describe how to use data from bond and option markets to improve risk estimation for equity portfolios, and how to use information from the equity markets to improve estimation of credit risk in fixed income securities. The goal of the process is to create holistic risk estimation where all expectations of risk are mutually consistent across the entire capital structure of a firm, and related derivatives.
Standard & poor's 16768282 fund-factors-2009 jan1bfmresearch
This document summarizes a study by Standard & Poor's on factors that predict investment fund performance. The study analyzed both qualitative factors like fund size, expenses, and age as well as quantitative metrics like Jensen's alpha and information ratio. The key findings were:
- For developed markets, larger funds with lower expenses tended to outperform. But for emerging markets, smaller funds did better due to differences in liquidity.
- Jensen's alpha and information ratio best predicted future performance of developed market equity funds over shorter time periods.
- Past performance was informative over 2 years but less so over 1 year due to noise. Fund selection should focus on factors predicting shorter term outperformance.
This document is a thesis examining whether catastrophe bonds can provide efficient portfolio diversification. It begins with an introduction on the development of insurance-linked securities (ILS) markets in response to capacity issues following major natural disasters in the 1990s. The thesis then analyzes catastrophe bond markets and financial mechanisms. Through an empirical study of portfolios with and without catastrophe bonds from 2002-2015, the thesis finds that while volatility and risk levels remained similar, the portfolio diversified with catastrophe bonds saw improved returns and Sharpe ratio, suggesting potential benefits from their inclusion in portfolios.
The document discusses the role of economists in supporting executive management with risk analysis and resilience planning. It outlines various types of risks that infrastructure sectors face, such as event risk, macroeconomic risk, and strategic risk. It then describes the risk management process as defined by the ISO 31000 standard, including risk identification, analysis, evaluation, treatment, and monitoring. The role of economists is to help executives understand probability, risk, and uncertainty beyond just average outcomes, and account for factors like uncertainty distributions, skewness, and behavioral issues. Both quantitative methods like Monte Carlo simulation and qualitative approaches have a role to play in risk analysis.
Mb0053 international business managementsmumbahelp
Dear students get fully solved assignments
Send your semester & Specialization name to our mail id :
help.mbaassignments@gmail.com
or
call us at : 08263069601
Credit Market Imperfection, Inequality and Capital AccumulationMahmoud Sami Nabi
1) The document discusses a theoretical model that examines the relationship between credit market imperfections, inequality, and capital accumulation. It incorporates judicial inefficiency as an additional credit market imperfection beyond moral hazard.
2) The model finds that wealth inequality initially widens between high- and low-wealth agents, as high-wealth agents can undertake larger projects due to credit constraints. However, inequality either remains constant or widens over time, depending on interest rate policies.
3) Numerical simulations show that increasing judicial efficiency reduces the speed of convergence to the long-run inequality level and decreases the long-run level of wealth inequality.
GBS CH 6 COUNTRY EVALUATION AND SELECTION Shadina Shah
This document discusses factors to consider when evaluating and selecting countries for international business operations. It covers the importance of location, scanning countries to identify opportunities and risks, and variables to assess like sales expansion, resource acquisition, and political risk. The key steps are scanning countries broadly first before narrowing down options for more detailed analysis considering objectives, strategies, environmental factors, and flexibility as conditions can change. Opportunity variables include sales potential and accessing resources, while risk variables include political, economic, natural disaster, and competitive risks. Companies must prioritize and weigh these factors to decide where and how much to invest abroad.
Tracking Variation in Systemic Risk-2 8-3edward kane
This paper proposes a new measure of systemic risk for US banks from 1974-2013 based on Merton's model of credit risk. The measure treats deposit insurance as an implicit option where taxpayers cover bank losses. Each bank's systemic risk is its contribution to the value of this sector-wide option. The model estimates show systemic risk peaked in 2008-2009 during the financial crisis, and bank size, leverage, and risk-taking were key drivers of systemic risk over time.
This document provides an introduction to a framework for analyzing how financial factors can contribute to instability in small open economies. The framework presents a dynamic open economy model where a tradeable good is produced using internationally mobile capital and a country-specific factor, and firms face credit constraints determined by their level of financial development. The model suggests that economies at an intermediate level of financial development are most unstable, as shocks have larger and more persistent effects. Financial liberalization may also destabilize these economies by allowing boom-bust cycles driven by capital inflows and outflows. The mechanism involves investment booms raising input costs, squeezing profits, and eventually leading to output collapses.
This introduction summarizes the various articles contained in the issue of Housing Finance International. It provides context on recent economic developments in Asia and their impact on housing markets. It then previews each of the five articles, concisely summarizing their topics and key arguments. The first article examines the banking crises in Sweden and Japan in the 1990s and their effects on housing. The second reviews the impact of the financial crisis on mortgage markets in former Soviet countries. The third discusses enhancing tools to measure and manage mortgage default risk. The fourth argues for a contextual policy approach to housing challenges in Central and Eastern Europe. The fifth suggests using financial derivatives to separate the economic value and shelter value of homeownership.
Country risk management handout, diversification by Gloria Armesto, Kasey Phi...Alina_90
This document discusses country risk management in global financial markets. It recommends diversifying investments across different countries, markets (developed, emerging, frontier), and asset classes (stocks, bonds, etc.) to minimize risk. Country-specific risks like economic or political instability, natural disasters, and market volatility can be reduced through international diversification. The document also discusses hedging strategies using derivatives to counter exposure to security price movements in specific countries. Constant monitoring of a portfolio is needed as country risk levels change over time.
The document provides an overview of foreign exchange markets, including how currency exchange rates work, major currency traders, factors that influence exchange rates like interest rates and inflation, and concepts like purchasing power parity and interest rate parity. Key points covered include that foreign exchange markets facilitate international trade and investment, the US dollar and euro are the most traded currencies, and currency values can be affected by differences in inflation rates between countries.
Aitor Erce's discussion of "The Seniority Structure of Sovereign Debt"ADEMU_Project
- The paper presents two new datasets on sovereign debt: one on payment arrears by sovereign debtors to different creditor groups, and one on haircuts applied in sovereign debt restructurings to private and official creditors.
- Analyzing the datasets, the paper finds a clear pecking order among creditors, with multilateral institutions, bonds, bilateral loans, banks, and suppliers at the bottom in terms of seniority.
- The main policy conclusion is that the official sector should reconsider its approach to debt restructuring, as the analysis shows official creditors have become increasingly junior over time.
IT Top is considering expanding its business internationally by establishing a manufacturing facility in Oman. A capital budgeting analysis of the proposed project in Oman estimates a positive NPV of RM4 million, supporting the project. However, the analysis should also consider exchange rate fluctuations by performing sensitivity analysis using strengthening and weakening Omani Rial scenarios. Expanding internationally could provide competitive advantages for IT Top but the management must carefully evaluate risks and determine appropriate financing and hedging strategies.
This document discusses approaches to calculating the international cost of capital. It notes that while the capital asset pricing model (CAPM) is commonly used, it provides biased estimates in emerging markets due to unique country risks. The document evaluates 12 different models and recommends using a company's domestic cost of capital plus a country risk premium in basis points estimated through quantitative crisis signal and country rating models. It stresses the country premium should account for cyclical, exchange rate, solvency, political and business environment risks over various time horizons.
07. the determinants of capital structurenguyenviet30
This document summarizes a research paper that investigates how firms in capital market-oriented economies (UK, US) and bank-oriented economies (France, Germany, Japan) determine their capital structures. Using panel data and regression analysis, the paper finds that firm size and tangibility of assets increase leverage, while profitability, growth opportunities, and share price performance decrease leverage in both types of economies. However, the impacts of some determinants vary between countries depending on differences in institutions and traditions. The paper also finds that firms have target leverage ratios but adjust to them at different speeds across countries.
This thesis examines how policymakers should respond during times of financial sector distress. It outlines that policymakers face two critical tasks: 1) identifying and addressing the issues critical to the crisis, and 2) ensuring the financial sector reaches a new equilibrium. The importance and nature of these tasks will be illustrated using evidence from the Asian Financial Crisis and the U.S. Savings and Loans Crisis. Frameworks will also be proposed to guide policymakers in accomplishing each task.
Impact of accounts receivable management on the profitability during the fina...Instansi
This document discusses a study examining the impact of accounts receivable management on the profitability of Serbian companies during the 2008-2011 financial crisis. The study uses a sample of 108 publicly listed Serbian companies. Descriptive statistics show the average return on total assets was 4.7% and average operating profit margin was 3.2% for the sample firms during the crisis period. The study aims to test the relationship between accounts receivables and these two measures of profitability to see if receivables management policies need to change during an economic recession.
Market Theory, Capital Asset Pricing ModelKatie Gulley
Investment banks play an important role in capital markets by providing services to corporations and facilitating investment. They assist companies in raising capital through public offerings on stock exchanges or private placements. This process involves underwriting, wherein the investment bank takes on the risk of distributing securities if they cannot be sold. Investment banks also provide mergers and acquisitions advisory services to corporations. Their deep expertise in valuation and financing allows investment banks to effectively advise clients on major transactions.
This document summarizes a research paper that develops a dynamic stochastic general equilibrium (DSGE) model to explain how monetary policy affects risk in financial markets and the macroeconomy. The key feature of the model is that asset and goods markets are segmented because it is costly for households to transfer funds between the markets. The model generates endogenous movements in risk as the fraction of households that rebalance their portfolios varies over time in response to real and monetary shocks. Simulation results indicate the model can account for evidence that monetary policy easing reduces equity premiums and helps explain the response of stock prices to monetary shocks.
Combined Credit And Political Risk Paperathula_alwis
This document proposes two methods for modeling combined credit and political risk in emerging markets:
1. A diffusion process that sums individual credit and political risk default rates, subtracting any overlap estimated via a copula function. This provides a conservative starting point but does not fully capture the coverage.
2. A jump diffusion process that allows for sudden increases in default rates during crisis periods. This approach more accurately reflects the coverage provided by combined credit and political risk insurance.
The paper recommends the jump diffusion method and outlines using historical data on default rates, losses, and correlations to develop a stochastic model quantifying the risk-reward profile to support underwriting this line of business.
Non-monetary effects Employee performance during Financial Crises in the Kurd...AI Publications
This document summarizes a research paper on non-monetary factors affecting employee performance during financial crises in the Kurdistan region of Iraq. The researcher developed five hypotheses to test how factors like job security, training, compensation, job enrichment, and leadership style influence employee performance during crises. Simple regression analysis found that job security had the strongest positive association with performance. The document provides context on the 2014-2018 financial crisis in Iraq and reviews literature on defining and analyzing different types of financial crises, including banking crises.
Dr. Charles Calomiris "An Incentive-Robust Program for Financial Reform"Nataly Nikitina
KSE Open Lecture with Dr. Charles Calomiris (Columbia University Graduate School of Business) on "An Incentive-Robust Program for Financial Reform" was held on April 12, 2011.
The document discusses a stock valuation of McDonald's. It first examines McDonald's beta of 0.34, indicating it is a low risk stock. It then discusses three economic indicators - leading, coincident, and lagging - that are used to evaluate the financial impact of economic conditions on McDonald's performance. The document also discusses McDonald's ROIC compared to industry averages, supplier and buyer power, and the threats of substitutes and industry rivalry facing McDonald's. It concludes that health concerns will continue to increase pressure and drive for healthier options.
The document summarizes David Durand's commentary on Modigliani and Miller's 1958 propositions about capital structure and cost of capital. Durand exposed difficulties justifying Proposition I in the real world where arbitrage is usually impossible. He also commented that MM underestimated how market imperfections like restrictions on margin buying affect their arguments. In a reply, Modigliani and Miller defended their original positions and argued that Durand misinterpreted some of their assumptions. They acknowledged not providing an explicit model for how growth opportunities affect share prices.
· Respond to 3 posts listed below. Advance the conversation; provi.docxLynellBull52
· Respond to 3 posts listed below. Advance the conversation; provide a real-world application and experiential examples;
· Conceptually discuss your key [most significant] learning insight or take-away from the selected forum topic comments.
· Responses should be a minimum of 150-250 words, supported by at least one reference outside of the textbook (use academic journals), either supporting or refuting the position of the author of the forum topic response or peer response.
Topic #1: The Cost of Capital
The cost of capital refers to the “cost” a company must incur in order to use funds towards a new project or investment. The funds may come from lenders by borrowing the funds, by financing equity, or by selling bonds or assets. The cost of capital is expressed as an annual interest rate that the company will be charged on the capital funds. Therefore, this is the minimum return a company must be striving for when undertaking a new project, making a purchase, or making an investment. Otherwise, they are simply losing money.
The cost of capital is used as the minimum rate of return that the project must achieve and is also the rate that is used in a discounted cash flow analysis. If the return of future net cash flows on an investment or project are greater than the cost of capital, then the investment or project is worthwhile to the business. For example, if a project generates a return of 20% and the cost of capital was estimated at 15%, then this project has added value to the business.
In addition, the NPV formula can be used to compare multiple projects using different costs of capital. For instance, Project A and Project B compared by using 10%, 15%, and 20% costs of capital. This can allow businesses to see how investing more or less capital would affect the outcome of the NPV. Just as you can compare these different costs of capital, you can also add the element of risk into your calculations by increasing the cost of capital to reflect a riskier project or investment. Very simply put, if investment B is riskier than investment A, then you could compare them with B having a cost of capital at r = 15% and A having a cost of capital at r= 10% - therefore adjusting for one project/investment being riskier than the other.
Interestingly, there has been much discussion and debate over how companies set their cost of capital rates. In the case of large Fortune 500 companies, they spend hundreds of billions of dollars per year. If they miscalculate the cost of capital rate on an investment or project with a difference of even 1%, this could mean a gain or loss of billions of dollars depending on which way the value was incorrectly estimated. For example, if a company plans to invest $52 million dollars into a new project that is estimated to bring in $10.5 million per year over the next seven years, and the company incorrectly estimates the cost of capital by 1%, then you can see by the table below the affect this small percentage pot.
The rapid growth of the US financial sector has driven policy debate on whether it is socially desirable. I propose a heterogeneous agent model with asymmetric information and matching frictions that produces a tradeoff between finance and entrepreneurship. By becoming bankers, talented individuals efficiently match investors with entrepreneurs, but do not internalize the negative effect on the pool of talented entrepreneurs. Thus, the financial sector is inefficiently large in equilibrium, and this inefficiency increases with wealth inequality. The model explains the simultaneous growth of wealth inequality and finance in the US, and why more unequal countries have larger financial sectors.
by Kirill Shakhnov, EUI †
JOB MARKET PAPER
First version: January 2015
This version: November 2014
Read more: https://www.hhs.se/site
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2) Empirical tests on developing countries from 1984-1992 confirm monetary policy responds to higher sterilization costs by allowing greater exchange rate changes. However, other model predictions have mixed results depending on how endogeneity is treated.
3) A theoretical model shows that higher sterilization costs are incorporated into central bank decisions as they impact the consolidated public sector budget constraint. This leads central banks to limit sterilization and tolerate more exchange rate movement.
This presentation discusses the changing financial landscape after the 2008 crisis and lessons learned. It covers four main topics: 1) how the financial crisis occurred and the role of poor policy and incentives, 2) changes in regulation and the financial system, 3) key lessons on risk management and governance, and 4) focus areas including liquidity, capital, and compensation. The presentation emphasizes that while regulation is important, the underlying issues were related more to incentives and risk culture within firms.
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Proposed topic of the res an emperical analysis on interest rate risk managem...tesfatsion tefera
Risk is defined as anything that can create hindrances in the way of achievement of certain objectives. It can be because of either internal factors or external factors, depending upon the type of risk that exists within a particular situation. Exposure to that risk can make a situation more critical. A better way to deal with such a situation; is to take certain proactive measures to identify any kind of risk that can result in undesirable outcomes. In simple terms, it can be said that managing a risk in advance is far better than waiting for its occurrence. Risk Management is a measure that is used for identifying, analyzing and then responding to a particular risk. It is a process that is continuous in nature and a helpful tool in decision making process. According to the Higher Education Funding Council for England (HEFCE), Risk Management is not just used for ensuring the reduction of the probability of bad happenings but it also covers the increase in likeliness of occurring good things. A model called “Prospect Theory” states that a person is more likely to take on the risk than to suffer a sure loss.
This document provides an overview of insurance markets in Latin America and the Caribbean. It discusses how insurance facilitates economic activity by allowing individuals and businesses to manage risks. The survey presented analyzes perceptions of the insurance industry in the region to identify factors affecting its development. Key findings include that insurance penetration and availability remain low compared to other regions. The document concludes by calling for further research to inform policies to strengthen insurance markets.
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The Growth Lab at Harvard CID prepared this presentation to be shared with Namibia's High Panel for Economic Growth, established by President Hage Geingob.
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Teaching Notes/Solutions: TELMEX-CANTV: Which is the appropriate discount rate?
1. August 2009
Study Guide
STUDY GUIDE
TELMEX and CANTV:
WHICH IS THE APPROPRIATE DISCOUNT RATE?1
Carlos A. Molina and Miguel A. Santos2
Synopsis
This case presents a dilemma situation on how to determine the discount rate for cash flow in
places where the country risk perceived by investors differs considerably from the nation’s
sovereign bonds’ yield spreads.
International investment banks normally use, on advising their clients, the cost of capital that
equivalent companies obtain in the United States, plus a premium for country risk. This
premium is usually calculated, based on spreads of the pertinent country’s sovereign debt
bonds with respect to similar US bonds.
Nevertheless, Venezuela, on being compared with other Latin American nations, is an
atypical case. Until 2000, the sovereign debt of the Venezuelan market was sufficiently
correlated to the local capital market measurable to L countries of the region (65%-75%). But
this correlation changed as from 2000 on dropping from 74.59% (1997-2000) to 34.69%
(2001-April 2006). The low correlation is due, in principle, to the difference in the perception
of risk between the capital market (where it is considered high) and the sovereign risk of the
Republic (considered low, given the high oil prices and the importance of oil for the
Venezuelan economy as a whole).
1
This case study does not intend to make a value judgment on the acquisition offer made by Telmex for a block
of Cantv shares, but, simply, to outline the Venezuelan situation as an investment scenario for an international
company and to calculate the respective investment risk. The case is based strictly on public information. The
name Alfredo Ramos, and the circumstances mentioned in this study are fictitious.
2
Both authors are professors at IESA. Ave. IESA, San Bernardino, Caracas DF 1010, Venezuela. Emails:
carlos.molina@iesa.edu.ve, miguel.santos@iesa.edu.ve. The authors thank Hector Ramos and Luis A. Grau for
their assistance in research, as well as the judges of the IESA’s Case Studies Contest.
This study guide was prepared with the exclusive purpose of assisting instructors in the use of the case. It contains analysis and questions
with the aim of helping students to understand the themes examined in the case and to provoke classroom discussion. A Study Guide is
developed exclusively to serve as a basis for discussion in an educational setting. It does not constitute a support to individuals or
organizations, or illustrate whether management in an administrative situation is effective or not; neither should it be considered a primary
source of information.
1
2. This case is very useful for the calculation of cost of capital in emerging countries where the
perception of political risk differs from the Republic’s payment capacity. In general,
literature is lacking when it comes to this type of calculations for investments in emerging
markets. Due to the lack of sufficient data and companies with which to compare it, data is
collected from the North American market and the expected performance is “tropicalized”
afterwards. As research in this area is limited, investment advisors and MBA students have
resorted to formulas that have no theoretical basis. This case contributes to the literature
summarizing existing works, their advantages and disadvantages from a conceptual and
practical viewpoint, and proposes new ways of addressing this question.
We present later a class and blackboard plan with possible questions and dilemmas to be
raised in the classroom, in order to assist the instructor and to clarify the pedagogical
objectives of the case, which we outline below:
Teaching Objectives
The “TELMEX and CANTV” case is designed to introduce students to the difficulties of
estimating required rate of returns for investments in countries with high country risk and
unique market conditions. The case has the following specific pedagogical objectives:
a. Appreciate the difficulties of estimating cost of capital in emerging markets, meeting the
market requirements and dealing with the lack of consensus theories for this problem.
b. Consider and evaluate different methodologies for adapting to emerging markets theories
originally designed for the United States stock markets, such as the CAPM.
c. Dealing with the country risk impact on the cost of capital in an emerging market where
there is divergence between the perception of political risk and sovereign risk (or payment
capacity).
2
3. d. Develop negotiation strategies for an eventual transaction of a property in an emerging
market, such as Venezuela, where the discount rate can be the main issue of the
negotiation.
e. Understand how financial analysis, discount rate calculation, and the absence of literature
in the field can be used strategically in an event of negotiating a transaction in an
emerging market.
Teaching Plan and Analysis
Before addressing this case, the students should have been introduced to cost of capital and
required rate of return calculation, studying the mainstream methods such as CAPM, APT
(Arbitrage Pricing Theory) and Factor Models. The students will be then prepared to discuss
the applications and differences in a different market where CAPM and other methods cannot
be applied directly.
The following step-by-step analysis should serve to reinforce the theories for cost of capital
analysis, cash flow valuation techniques, and applications to emerging markets. We can
separate the analysis in the following four separate but related parts: (a) Analysis of financial
information, (b) Revision and discussion of the theories applied to an Emerging Market, (c)
Dilemma: what to do?, and (d) What to propose to the board of directors: negotiation plan for
a transaction.
a. Analysis of financial information
Before we prepare the students for proposing and discussing a solution to the dilemma of the
case (i.e., what cost of capital should we propose to the board of directors for an effective
negotiation), we should promote the discussion on the information we need for proposing that
solution.
Which information does the case present us with? Is that enough? Do we need to research for
more? What if we only have that information at hand? Can we still construct a proposal for
the board? These are questions the students should ask themselves. Next we present a plan
for the information analysis.
3
4. Correlation between sovereign obligations and private assets
The use of sovereign risk as an indicator of business risk derives from a very simple principle:
the development of obligations issued by the national government should maintain a very
strong correlation (positive) with the private sector’s performance; that is, the expectations of
agents who define the price of public obligations are strongly confluent with those that fix the
prices of private assets.
If correlation is weak, there will be a gap between the risk factors that contribute to the price
fixing of public obligations and those that determine the price of private assets.
Students can analyze the existing correlations between the return of public obligations and the
return of assets of the private sector, which are represented by the evolution of the asset prices
in the Stock Exchange. The magnitude of this correlation determines up to what degree is
correct to use sovereign risk as an indicator of country risk.
Alfredo Ramos, CFO of Telmex-America Móvil, has dedicated a great part of his career
presenting investment projects in Latin America, always using yield rates that incorporate
sovereign debt spreads as an indicator of country risk. This practice had caused him no
inconveniences, as in the majority of Latin American countries the existing correlation
between price movement in the sovereign debt and the local Stock Exchange is relatively
high. Appendices to this paper show two examples (Brazil and Mexico): in the Mexican case
(Appendix 10), the correlation has been relatively stable during the last ten years (66.67%),
whereas, in Brazil, the correlation between sovereign debt long term bonds and the local
securities market during the last five years has been 79.25%.
In the Venezuelan case (Appendix 6), the registered correlation in the last ten years between
the monthly price variation of the sovereign debt and the movements of the Bolsa de Valores
de Caracas – BVC (Caracas Stock Exchange) is 59.37%. But on separating this ten-year
interval into two periods, we observe a significant difference between both correlations: 1997-
2000 (74.59%) and 2001-April 2006 (34.69%). From this we observe that as from 2001 there
is a very low relation between the performance of sovereign debt and the local stock
exchange, a fact that the student has been able to prove in the spread evolution (Appendix 2)
and in the performance of the BVC in 2005 (Appendix 5).
4
5. Although the analyses of these correlations help us to form an initial idea of how close is the
sovereign risk to the private risk, the indicator used in the latter (price movements in the local
stock exchange) is far from perfect. Frequently, stock exchanges in emerging markets list few
companies, which do not exactly represent the entire private economic activity. In addition,
they do not tend to have much liquidity and exhibit some levels of volatility.
Spread Evolution of sovereign debt and the price/earnings (P/E) ratio in the local market
Further data that may give an early alert of the existence of significant differences between
sovereign risk and business risk originate from the stock exchange P/E ratios.
In this case, Alfredo Ramos should be aware that, although rates differentials of the
Venezuelan and Mexican sovereign debt have been converging in the last three years towards
very similar values (Mexico: 1.562%, and Venezuela: 1.597%), the contrary has occurred
with the P/E ratio of their respective stock exchanges. At the close of 2005, the Caracas
Stock Exchange P/E ratio of was 7.2 times, 36.4% below the Bolsa Mexicana de Valores –
BMV (Mexican Stock Exchange). This figure is very similar to the registered figure at the
close of 2004, when the Caracas Stock Exchange presented a P/E ratio of 8.6, 31.7% below its
Mexican equal (12.8) during the same period. Although in the last two years the Venezuelan
sovereign risk has had a notably drop, the same has not occurred with the value perception of
assets listed in the BVC.
b. Revision and discussion of the theories applied to Emerging Markets
The student, on understanding that, in cases like Venezuela, sovereign risk is not a good
indicator of the risk perceived in the economy of the private sector, should then proceed to
review the literature in order to identify formulas that incorporate country risk to the cost of
capital and represent it differently to sovereign risk. Students can either propose their own
formulas or base their proposals on the previous literature. In doing so, we should encourage
the discussion on the advantages and disadvantages of each proposal.
5
6. As we review existing literature, we will find that formulas to incorporate country risk into
cost of capital calculation have little, if any, theoretical basis. Most formulas derive from
adjustments made to the CAPM, and little consideration is given to any alternative method.
This will be a good point to discuss whether CAPM is an appropriate method, and why we do
not use alternative theories such as APT or Factor Models.3
We can recommend the students to review the bibliography at the end of the Study Guide as
part of the preparation process of the case, in order to guarantee a productive discussion in the
classroom. We provide next a summary of the main advantages and disadvantages of each
method.
b.1 Original CAPM version, adjusted to sovereign risk
From the beginning, Alfredo Ramos proposed this formula that has been rejected by the
Board of Directors. Investment banks that operate in emerging markets use this version most.
Ri = R fUSA + ( R fVzla − R fUSA ) + β i ( RmUSA − R fUSA )
Ri = 5.34% + 1.60% + 1.20 * (7.50%)
Ri = 15.94%
Advantages
• Most used and most accepted method; easy to calculate and to communicate.
• Acceptable as long as there is a high correlation between perceptions of sovereign risk
and private risk.
Disadvantages
• Does not recognize the situation when sovereign debt risk can be very different to the
risk perceived by shareholders in the private sectors (exactly what happened to
Alfredo Ramos on presenting his formula to the Board of Directors).
• Assumes, on adding the sovereign risk to the CAPM formula, that all this risk is
systematic, non-diversifiable.
3
In pointing out the advantages and problems of CAPM, its simplicity should arise in the discussion.
6
7. • Disregards that not all projects or industries are subject to the same levels of country
risk.
b.2 Aswath Damodaran – Version I
Students, searching for alternative formulas in literature to calculate country risk, will soon
discover the works of Aswath Damodaran (1999a, pp. 23 and 34-43). This first version of
Damodaran only differs from the previous in that sovereign risk is included within market
premium. Consequently, if the industry in question is high-risk (high beta), the country risk
calculated would be higher.
[
E ( Ri ) = R fUSA + β i ,USA E ( RmUSA ) − R fUSA + CountrySpread ]
Ri = 5.34% + 1.20 * (7.50% + 1.60%)
Ri = 16.26%
Advantages
• Easy to calculate and communicate, although not widely used.
• Considers, to some extent, country risk in a different manner for each industry: the
higher the risk (high beta), the industry would be more exposed to country risk, and
vice versa.
• Acceptable as long as there is a high correlation between perceptions of sovereign risk
and private risk.
Disadvantages
• Does not recognize the situations when sovereign debt risk can be very different to the
risk perceived by shareholders in the private sectors (in low beta industries, this
formula does not give a solution to the problem of low correlation between sovereign
risk and private sector risk).
• Assumes, on adding the sovereign risk to the CAPM formula, that all this risk is
systematic, non-diversifiable.
• Disregards that there could be projects in low risk (low beta) industries, which does
not necessarily imply that they have low country risk (for example banks have always
7
8. been among the first to be taken over for inspection, or taken over by the state or
nationalized in developing economies, and present a beta lower than 1 in the U.S.
b.3 Aswath Damodaran – Version II
Aswath Damodaran’s second version (1999a, pp.16 & ss.) considers that a company is under
the influence of country risk (considered sovereign risk), only to the extent that its sales are
generated inside the border. Consequently, instead of the original formula (λ), sovereign risk
is multiplied by the percentage (λ) of sales generated.
[ ]
E ( Ri ) = R fUSA + β i ,USA E ( RmUSA ) − R fUSA + λCountrySpread
As exports are not common in telecommunications, this formula gives similar results to that
of the original formula (in b.1).
Advantages
• Easy to calculate and communicate.
• Acceptable as long as there is a high correlation between perceptions of sovereign risk
and private risk.
Disadvantages
• Implies that if the company exports 100% of its production (λ=0), country risk does
not exist (in which case, cost of capital results would be similar to that of the original
CAPM, without adjusting country risk).
• Does not recognize the situations when sovereign debt risk can be very different to the
risk perceived by shareholders in the private sectors.
• Assumes, on adding the sovereign risk to the CAPM formula, that all the risk is
systematic, non-diversifiable.
b.4 Jaime Sabal – Version I
In his book on financial decisions in emerging markets, Jaime Sabal (2002, ch.7, pp. 123-124)
suggests the use of the CAPM original version, but instead, the beta from the US market
8
9. should be multiplied by another beta derived from the relation between the local and the US
market. In this manner, the fact that not all the Venezuelan risk is systematic would be
corrected, and then only the fraction that cannot be diversified would be incorporated in the
country risk formula. Although Sabal opens the possibility for the company to sell in various
markets, in this case of telecommunications the formula for calculation would be as follows:
[
E ( Ri ) = R fUSA + β i ,USA β m ,USA E ( RmUSA ) − R fUSA ]
where β m,USA is the beta that exists between the local and the US market.
Now then, although the monthly performance of the Venezuelan market volatility is three
times higher than the S&P500, its correlation (31.93%) is also low and stable, as per
calculations for the last ten years (Appendix 9).
Owing to this low correlation, the value obtained from the is much lower than 1, which,
instead of being translated into an increase of the US beta because of country risk effect, it
produces a decrease in the country risk; in this manner the result obtained is definitely lower
than that of the CAPM original version without adjusting country risk.
COV (m, USA)
β m ,USA =
σ 2 USA
σ mσ USA ρ m,USA
β m ,USA =
σ 2 USA
σ m ρ m,USA
β m ,USA =
σ USA
13.36% * 0.2948
β m ,USA =
4.50%
β m ,USA = 0.87
In this case, the resulting cost of capital would be:
[
E ( Ri ) = R fUSA + β i ,USA β m ,USA E ( RmUSA ) − R fUSA ]
E ( Ri ) = 5.34% + 1.20 * 0.87 * (7.50%)
E ( Ri ) = 13.21%
9
10. Advantages
• Proposes a methodology for incorporating to the CAPM calculations as country risk,
only the fraction that is systematic in the local market.
Disadvantages
• More difficult to calculate and communicate.
• Results show lower values than the original CAPM version (if the Board of Directors
rejected the rate presented by Alfredo Ramos as they considered it low, this formula
does not help solve the mystery of how the members of the Board formed their
expectations as to the returns that an investment in Venezuela should have).
• The low beta that exists between the local market and the S&P500 can be a
consequence of the low volume of transactions on the local market.
• As the Caracas Stock Exchange Index (IBVC) covers few companies, the index
volatility and its correlation with S&P500, it is based on a very small basket of assets.
b.5 Jaime Sabal – Version II
The second option proposed by Jaime Sabal (2002, p. 124, end of page 9), suggests to
calculate the beta of local companies versus the local stock exchange index, and multiply it by
the beta that exist between the local stock markets and its North American equal (S&P500).
This formula is similar to the previous one, but goes a little further: the beta we are going to
use now for a certain industry will result from company movements of the same industry in
relation to the stock exchange index in the local market. In the telecommunications case,
Cantv represents the industry and its beta calculated in the local market is 0.93.
[
E ( Ri ) = R fUSA + β i ,VZLA β m ,USA E ( RmUSA ) − R fUSA ]
E ( Ri ) = 5.34% + 0.93 * 0.87 * (7.50%)
E ( Ri ) = 11.44%
Advantages
• Proposes a methodology for incorporating to the CAPM calculations as country risk,
only the fraction that is systematic in the local market.
10
11. Disadvantages
• More difficult to calculate and communicate.
• Local betas are really little representative; larger shares have betas near to 1 due to the
simple fact that they “are” the market, not because it represents a specific level of risk.
• There are industries that are not represented within the limited spectrum of the local
stock exchange, making it impossible to calculate “local” betas.
• Results show values that are much lower than the original CAPM version (neither
does this formula help solve the mystery of how the members of the Board formed
their expectations as to the returns that an investment in Venezuela should have).
• The low beta that exist between the local market and the S&P500 may be a
consequence of the low volume of transactions in the local market (as in the cases of
the Provincial and Santander banks, where a great majority of the block of shares are
not negotiated in the market but remain in the hands of the home office in Spain;
consequently, the shares show a stability that hears no relation with the banking
business risks).
• As the BVC Index covers few companies, on measuring the index volatility and its
correlation with the S&P500, it is based on a very small basket of assets.
b.6 Investment banks versions
We now present three new formulas to recognize the fact that private assets in Venezuela
have some government risks, and that they are also affected by some other type of volatility.
These formulas have been also used and reported by some leading investment banks, so we
refer to them as the “investment banks versions.” First, instead of incorporating the spread of
the sovereign debt, we take into account the differential associated with the Venezuelan
qualification of the risk (B+:5.50%). Second, we multiply the market premium by a factor
equivalent to the difference between the volatilities of the corresponding markets.
[ ]
E ( Ri ) = R fUSA + CreditSpread + β i ,USA E ( RmUSA ) − R fUSA FAII
E ( Ri ) = 5.34% + 5.50% + 1.20 * (7.50%) * 2.76
E ( Ri ) = 35.67%
where
11
12. σ
FAII = ⎛ VZLA ⎞
⎜
⎝ σ USA ⎟ = 2.76
⎠
σ USA = 4.25%
σ VZLA = 11.73%
Advantages
• Recognizes that the private sector is exposed to a type of risk that is beyond sovereign
risk, and therefore incorporates not only the later within country risk, but also the local
market volatility.
Disadvantages
• More difficult to calculate and communicate.
• Incorporates the entire credit spread (5.50%) and also the difference between the
volatility of both asset portfolios without considering that they may be correlated (in
the Venezuelan case, monthly movements correlation during the last six years is
34.69% (Appendix 6)). In other words, we may be double counting the country risk
premium.
• Considers that all the sovereign risk and all the difference in volatility between asset
portfolios is systematic, and cannot be reduced or cancelled through diversification.
• Incorporates the local stock market volatility as an indicator of private risk, when
indeed that market is comprised of few companies, has little liquidity and, in general,
the spectrum of the Venezuelan private risk is little representative.
• Consequently, there is a double accounting risk and unsystematic risk, giving rise to a
cost of equity of 35.67%, which is far beyond the Board of Directors’ expectations.
b.7 Investment banks version, corrected through the correlation between movements of
sovereign debt bonds and of stocks in the local market
From the previous formula, which tends to incorporate elements of sovereign risk and also
local market volatility into country risk, arose the idea of adjusting the multiplying factor
based on the degree of correlation that exists between price movements in the Venezuelan
debt market and the stock exchanges.
12
13. [
E ( Ri ) = R fUSA + CreditSpread + β i ,USA E ( RmUSA ) − R fUSA FAI]
E ( Ri ) = 5.34% + 5.50% + 1.20 * (7.50%) * 1.77
E ( Ri ) = 26.81%
where:
σ
FAI = ⎛ VZLA
σ USA ⎟ * (1 − ρ bonosvzla , BVC ) = 2.76 * (1 − 0.357) = 1.77
⎞
⎜
⎝ ⎠
σ USA = 4.25%
σ VZLA = 11.73%
ρ bonosvzla , BVC = 0.357
This formula, if necessary, can also be used based on the spread spot of the sovereign debt
(1.60%) observed in the market, instead of the credit spread that corresponds to the
qualification of the Venezuelan debt (5.50%). That will be the same as saying that the market
has a more accurate perception of Venezuela than the risk evaluators.
[
E ( Ri ) = R fUSA + CountrySpread + β i ,USA E ( RmUSA ) − R fUSA FAI ]
E ( Ri ) = 5.34% + 1.60% + 1.20 * (7.50%) * 1.77
E ( Ri ) = 22.91%
Advantages
• Recognizes that the private sector is exposed to a type of risk that is beyond sovereign
risk.
• Eliminates double accounting risks by adjusting the difference in the volatility in the
securities markets through its correlation with the sovereign debt market.
Disadvantages
• More difficult to calculate and communicate.
• If the correlation between the movements of the local securities market and the
sovereign debt equals 1, the formula –instead of eliminating one of those factors-
completely eliminates the effect of the US beta and the market premium.
• Considers that all the sovereign risk and all the difference in volatility between the
asset portfolios is systematic, and cannot be reduced or cancelled through
diversification.
13
14. • Incorporates the local stock market volatility as an indicator of private risk, when
indeed the market is comprised of few companies, has little liquidity and, in general,
the spectrum of the Venezuelan private risk is little representative.
b.8 Version that considers country risk only as a function of volatility in the local
securities market
This formula is based on that private investment in Venezuela is subject only to market
volatility, and its relation with sovereign risk only occurs when the later actually has influence
on the volatility. The formula also takes into account that a series of factors not included in
sovereign risk has influence on volatility.
σ
FAII = ⎛ VZLA ⎞
⎜
⎝ σ USA ⎟ = 2.76
⎠
σ USA = 4.25%
σ VZLA = 11.73%
[ ]
E ( Ri ) = R fUSA + β i ,USA E ( RmUSA ) − R fUSA FAII
E ( Ri ) = 5.34% + 1.20 * (7.50%) * 2.76
E ( Ri ) = 30.16%
Advantages
• Recognizes that the private sector is exposed to a type of risk that is beyond sovereign
risk.
• Eliminates double accounting risks as it only incorporates local stock market volatility
as country risk.
• Corrects the adjustment factor effect introduced in the previous version.
Disadvantages
• More difficult to calculate and communicate.
• Considers that all the sovereign risk and all the difference in volatility between the
asset portfolios is systematic, and cannot be reduced or cancelled through
diversification.
• Incorporates the local stock market volatility as an indicator of private risk, when
indeed the market is comprised of few companies, has little liquidity and, in general,
the spectrum of the Venezuelan private risk is little representative.
14
15. • The excessive volatility of the local stock market in relation to the S&P500 produces a
cost of equity of 30.16%, which is far beyond the Board of Directors’ expectations.
From the available options, we can conclude that there are no options lacking disadvantages,
and therefore, there are no clear solutions. Nevertheless, Alfredo Ramos needs to present to
the Board of Directors, and defend before any eventual Cantv sellers, a discount rate
calculation for Venezuela.
c. Dilemma: What to do?
Venezuela is an atypical case when compared to other Latin American countries, and
consequently, poses a dilemma that can be examined in class and maybe useful for enriching
the discussion on cost of equity calculations.
The dilemma lies in the great difference between the risk perceived on investing in a country
like Venezuela with political instability and uncertainty, and the risk perceived in
international markets with respect to the payment capacity of the Republic of Venezuela. The
payment capacity of the sovereign debt issuer, i.e., the Venezuelan government, generates an
economic risk that cannot be compared with the risk of an individual investor who must leave
his money “trapped” in the country, in a certain investment, during a period of time.
When the student examines the theories and executes the practical applications used more
frequently to determine cost of equity in emerging market (Petrozuata case), the number
obtained will be much lower than the market demands for the risk perceived.
At this point, we may ask the students what the cost of equity did they obtain in the
calculations (see previous paragraph), and what rate do they expect to get on investing their
own money in Venezuela. We can also show them the following graphic, which lists, on
average, the cost of equity usually applied in four of the main industrial sectors of the
country4:
4
The authors compiled the figures via telephone interviews to industry actors and to the investment banks that
represent them.
15
16. Graphic 1
Industry Discount Rate
(in US$)
Banking 20.0%
Telecommunications 19.0%
Waste 18.5%
Mining 21.6%
To solve the dilemma, the student must average a pre-selection of the results obtained with
the theories indicated above. Each answer should have as much theoretical support as
possible, but, at the same time, the results should be within market expectations (Graphic 1).
d. What to propose to the Board of Directors: negotiation plan for a transaction
Once a series of values have been determined as an answer, we continue with the pedagogical
objective: negotiation and presentation to the Board of Directors.
The students should outline a negotiation plan, presenting a range of cost of equity duly
supported in the theories, so that the seller, present owner of Cantv, has fewer arguments to
try to reduce the rate.
This is a typical dilemma in the evaluation of a company in emerging markets. On lacking a
fixed theory or consensus, each party uses a methodology that is more fitting to its position
within the negotiation process: the seller wishes to apply the minimum cost of equity possible,
and the buyer aspires the maximum in order to obtain the lowest value.
In mergers and acquisition process in emerging markets, often the discussions on differences
in value perception is centered on the cost of equity and not on projection hypothesis,
projected operative results, or other aspects more closely related with business operativity and
the dynamics of the markets. This is due to two closely related factors: One, a small
difference in the cost of equity can produce significant effects on the value of the company or
of the assets in question. Two, and even more important, when the theories do not have
16
17. sufficient basis to solve the dilemma of the cost of equity for emerging economies, both
parties in the negotiation table tend to manipulate the situation.
The final result will depend on the negotiation capacity of each party, it may be the case that
there are more assets or companies of similar characteristics in the market (which gives
negotiation power to the buyer), or that, in contrast, there are more buyers interested in the
assets or companies (which gives more negotiation power to the seller).
Even in such cases, the problem of determining the required performance rate that both parties
wish to obtain continues to be dilemma.
The student should, in this case, understand the situation and, consequently, present the most
adequate methodology to defend the range of values for the cost of equity. The seller will
surely try to use the most traditional methodology that only adds the sovereign debt
differential to the equivalent rate in the United States.
In such a position, the student has many contra arguments:
i. The resulting figure of the simple sum of the sovereign debt does not seem like what
the market expects (Graphic 1).
ii. Performance of sovereign debt presents a very low correlation with local stock market
returns, which evidences dissociation between political investment risk and sovereign
debt performance (Appendix 6).
iii. The Venezuelan stock market has been experiencing a heavy decline, measured in
US$, while the sovereign debt has been reducing its differential (Appendices 2, 5, 7
and 8).
The student should also present a strategy to show that the values calculated are based on
various theories, in order to reduce negotiation space and concentrate time on cash flow
projections.
Questions and suggested activities
17
18. i. What cost of equity should Alfredo Ramos propose to the Board of Directors to use in
the Cantv cash flow?
ii. Make a summary of the theories and the literature on cost of equity in emerging
markets (suggest readings from Sabal, Damodaran and the Petrozuata case in
Harvard).
iii. Do you agree with the Telmex Board of Directors?
iv. What cost of equity would you request in order to invest in Cantv, if you are offered to
participate as minority shareholder together with Telmex?
v. Would you propose any other method to value Cantv? (optional question).
vi. Establish a successful negotiation strategy on the cost of equity, from Alfredo Ramos’
position as buyer.
Suggested class and blackboard plan
This case can be used in a class of Finance Basics at MBA level, as well as in workshops for
executives that include the following points: company evaluation and projects, determination
of a cost of equity, and M&A negotiations. The financial analysis is not difficult per se, but
the conceptual points and the dilemma presented are more complex.
The following plan is designed for a MBA class. Times are approximate, for a class of 90 to
110 minutes (1:30 to 1:50 hours). The instructor should reduce the time if necessary.
• [15 minutes] Blackboard 1: Alfredo Ramos vs. the Telmex Board of Directors.
What options does Alfredo Ramos have? How should he consider country risk?
• [10 minutes] Role Representation. The instructor may suggest that a student
assumes Alfredo Ramos’ position, and another, that of the Board of Directors.
Review the positive and negative aspects of each position.
• [15 minutes] Blackboard 2: Cost of equity calculation alternatives. Quantative
topic. Ask about the theoretical investigation that the students should have conducted
(question ii).
18
19. • [5 minutes] Carry out a survey among the students as to the numbers obtained and
their perception of risk for investing their own money in Venezuela. Ask, specifically,
if they are ready to invest US$25.000 –from their own savings- in a project of a
similar industry in Venezuela. Ask about different investment alternatives and the
returns. Generate discussion.
• [5 minutes] Present market results (Graphic 1).
• [10 minutes] Blackboard 3: Quantitive calculation or “investors’ guts”. Pro’s
and Con’s of using each alternative: quantitive support is necessary in order to
negotiate a cost of equity; no one invests on being aware that risk is not compensated
with proportional returns.
• [10 minutes] Return to “Role Representations”: Alfredo Ramos vs. Board of
Directors, based on Blackboard 3.
• [10 minutes] Blackboard 4: buyer vs. seller. Prepare a negotiation strategy.
• [10 or 30 minutes] Role Representations 2: buyer vs. seller. What is the agreed
cost of equity? This exercise may be carried out with individual representation (two
students in front of the class) or in groups so as to involve the entire class. If there is
sufficient time, we recommend the following:
o Divide the class in even number groups, consisting of three students each.
Half of the groups will play the role of the seller (contrary to Alfredo Ramos),
while the rest will assume the role of the buyer (Alfredo Ramos). Each team
of buyers will get together with a selling team.
o Dedicate 7 minutes for the negotiation. Students should prioritize the search
for a consensus on a cost of equity. It must be made clear that the worst result
would be not reaching an agreement.
o During the last minutes, choose one or two groups from each side (buyer and
seller) to give a summary of the agreement reached. Take note of agreed rates
in each negotiation. Discuss the results and compare them to real situations.
19
20. What Happened
At the end of the month of April 2006, an entity jointly held by América Móvil and Teléfonos
de México (Telmex), both own by Mexican billionaire Carlos Slim, announced their interest
in pursuing Verizon’s 28.51% stake in CANTV. By July 2006 the bid was official, close to
US$ 677 million, as cited by the Economist Intelligence Unit.5 The offer corresponded to
approximately US$ 21.00 per ADR and US$ 2,361 million for the 1100% of CANTV’s
equity.
In comparison to what the case asks for a required rate of return on equity for CANTV, in the
range of 22%-24%, the implicit discount rate in that offer was much higher. If we consider the
CANTV’s projected free cash flow in Appendix 1.B of the case, and the offer for US$ 21.00
per ADR, the implicit discount rate could have been estimated in 36.17% in dollars.
For this calculation, refer to the following Graphic 2. We used the projected free cash flow
from Apendix 1.B in the case. We also estimated a perpetuity growth of 2%. The estimated
debt was US$ 620.70 million, which included non-interest labor liability for US$ 572.17 (see
Balance Sheet in Appendix 1.A), and interest bearing debt for US$ 48.53 million. The
resulting discount rate 36.17% is a reference for CANTV’s WACC, very close to its return on
equity given that CANTV hold only 1.43% Debt-to-Assets ratio.
5
The Economist Intelligence Unit, Global Technology Forum, July 21, 2006.
20
21. Graphic 2
Implicit Discount Rate Calculation
2006 2007 2008 2009 2010
Free Cash Flow (Appendix 1.A) 485.00 776.00 1,021.00 1,276.00 1,682.00
Perpetuity 5,021.17
Total Free Cash Flow 485.00 776.00 1,021.00 1,276.00 6,703.17
Discount Factor 0.73 0.54 0.40 0.29 0.21
PV Free Cash Flow 356.18 418.51 404.39 371.15 1,431.87
Implicit Discount Rate 36.17%
Perpetuity Growth 2.00%
Total Value 2,982.10
(-) Debt (Labor and Financial) 620.70
Equity Value 2,361.40
# shares 787.14
Value per share 3.00
Value per ADR (7 shares) 21.00
America Movil-TELMEX Offer 21.00
Source: Appendix 1.A and 1.B (Case Study), and public references to America Movil-TELMEX offer for Verizon’s stake in
CANTV (The Economist Intelligence Unit, July 21, 2206).
Recommended Bibliography
Damodaran, A.: “Estimating Discount Rates.” Available online: www.damodaran.com
(consulted August 11, 2006)
Damodaran, A. (1999a): Applied Corporate Finance: A User’s Manual. New York: Wiley.
Damodaran, A. (1999b): “Estimating Equity Risk Premiums”. New York University,
Leonard N. Stern School of Business Working Paper Series 99-021. Available online:
http://pages.stern.nyu.edu/~adamodar/pdfiles/papers/riskprem.pdf (consulted August 11,
2006)
Godfrey, S. and Espinosa, R. (1996): “A Practical Approach to Calculating Costs of Equity
for Investments in Emerging Markets.” Journal of Applied Corporate, vol. 9, No. 3 (autumn).
Espinosa, R.: “A Practical Approach to Calculating Emerging Market Costs of Equity”, Unit
of Global Risk Analysis, Bank of America. Available online:
http://phoenixhecht.com/treasuryresources/PDF/CostOfEquity.pdf (Consulted September 18,
2007).
Sabal, J. (2002): Financial Decisions in Emerging Markets. Oxford: Oxford University Press.
21
22. Siegel, J. (2002): Stocks for the Long Run: The Definitive Guide to Financial Market
Returns and Long-Term Investment Strategies. New York: Mc-Graw Hill.
22