11. (5 points) Interpret the figure below: According to this figure, firms can minimize the cost of capital by

a. investing more in the global markets

b. minimizing IRR (internal rate of return)

c. taking not local but only global investment projects

d. attracting more local investors

12. (5 points) The less correlated the securities in a portfolio,

A) the lower the portfolio risk.

B) the higher the portfolio risk.

C) the lower the unsystematic risk.

D) the higher the diversifiable risk.

Part II: Short Answer questions: (4 questions, 40 points) + 1 bonus question (10 points)

1. (10 points) Suppose you are an investor in the U.S. who just sold LOral shares that you had bought six months ago. You had invested $14,400 to buy LOral shares for 100 per share; the exchange rate was $1.44 per euro. You sold the stock for 120 per share and converted the euro proceeds into dollar at the exchange rate of $1.2 per euro.

(a) (5 points) Compute the rate of return on your investment in euro terms.

(Hint: Return on foreign (): )

(b) (5 points) Compute the rate of return on your investment in dollar terms ().

2. (10 points) Travelport Worldwide Limited is a U.S. firm that conducts major importing and exporting business in the U.K., whereby all transactions are invoiced in dollars. It obtained debt in the United States at an interest rate of 5 percent per year. The long-term risk-free rate in the United States is 3 percent. The stock market rate of return in the United States and the world stock market rate of return are respectively expected to be 9 percent and 13 percent annually. Travelports beta against the U.S. stock market and the beta against the world market are 1.5 and 0.5, respectively. Its target capital structure is 50 percent debt and 50 percent equity. Travelport Worldwide Limited is subject to a 20 percent corporate tax rate.

(a) (5 points) Suppose that the U.S. stock market is isolated from the world stock market. Estimate the cost of capital to Travelport Worldwide Limited using a domestic CAPM.

(b) (5 points) Now instead assume that the U.S. stock market is integrated to the world stock market. Estimate the cost of capital (WACC) to Travelport Worldwide Limited using an international CAPM.

3. (10 points) One can decompose the rate of return on foreign investments into three components. For example, the rate of return for a US investor investing in a Japanese stock can be written as follows:

Correspondingly, the volatility of the rate of return can be written as follows.

1. Briefly explain the meaning of in two sentences.

2. Briefly explain the meaning of in two sentences.

4. (10 points) What are the advantages of cross-listing shares overseas? Briefly explain why companies would benefit in such ways in your answer. (Please list at least three advantages you can think of)

5. (Bonus) (10 points) Zylon Co. is a U.S. firm that provides technology software for the government of Singapore. It will be paid S$2,750,000, S$3,025,000, and S$3,327,500, respectively at the end of each of the next three years. The entire amount of the payment represents earnings since Zylon created the technology software years ago. Zylon is subject to a 20 percent corporate income tax rate in the United States. Its other cash inflows (such as revenue) are expected to be offset by its other cash outflows (due to operating expenses) each year, so its profits on the Singapore contract represent its expected annual net cash flows. Its financing costs are not considered within its estimate of cash flows. The Singapore dollar (S$) is presently worth $.50, and Zylon uses that spot exchange rate as a forecast of future exchange rates.

The risk-free interest rate in the United States is 6 percent while the risk-free interest rate in Singapore is 10 percent. Zylons capital structure is 50 percent debt and 50 percent equity. Zylon is charged an interest rate of 10 percent on its debt. Zylons cost of equity is based on the CAPM. It expects that the U.S. annual market return will be 10 percent per year. Its beta is 1.5.

(Hint: Chapter 18 practice question: Cash flow analysis)

Quiso Co., a U.S. firm, wants to acquire Zylon and offers Zylon a price of $2,900,000. Zylons owner must decide if to sell the business at this price and hires you to make a recommendation.

(a) (5 points) Compute Zylons weighted average cost of capital (WACC).

(b) (5 points) Should Zylon accept the offer of $2,900,000? Why?

cost of capital (%) -------- K local ---------K global IRR Investment ($) Local Iglobal