When we analyzed bonds with default risk, we argued that the interest rate has to be adjusted to reflect the default risk. This default-risk-adjusted interest rate can be considered the cost of debt to the investor or business borrowing the money. Since interest is tax deductible, the after-tax cost of debt is net of that tax saving. When analyzing investments with equity risk, we have to make an adjustment to the riskless rate to arrive at a discount rate, but the adjustment will be to reflect the equity risk rather than the default risk. Furthermore, since there is no longer a promised interest payment, we will term this rate a risk-adjusted discount rate rather than an interest rate. We label this adjusted discount rate the cost of equity. In Chapter 2, we looked at various approaches that can be used to estimate this value. A firm can be viewed as a collection of assets, financed partly with debt and partly with equity. The composite cost of financing, which comes from both debt and equity, is a weighted average of the costs of debt and equity, with the weights depending upon how much of each financing is used. This cost is labeled the cost of capital. For instance, consider a company that has a cost of equity of 10.54 percent and an after-tax cost of debt of 3.58 percent. Assume also that it raised 80 percent of its financing from equity and 20 percent from debt. Its cost of capital would then be: Cost of capital = 10.54%(0.80) + 3.58%(0.20) = 9.17% Thus, for this company, the cost of equity is 10.54 percent while the cost of capital is only 9.17 percent. If the cash flows that we are discounting are cash flows to equity in- vestors, as defined in the previous section, the appropriate discount rate is the cost of equity. If the cash flows are prior to debt payments and therefore to the firm, the appropriate discount rate is the cost of capital

What is the difference between correlation and dependence? Suppose that y = x2 and x is normally distributed with mean zero and standard deviation one. What is the correlation between x and y? 11.3 What is a factor model? Why are factor models useful when defining a correlation structure between large numbers of variables? 11.4 What is meant by a positive-semidefinite matrix? What are the implications of a correlation matrix not being positive-semidefinite? 11.5 Suppose that the current daily volatilities of asset A and asset B are 1.6% and 2.5%, respectively.The prices of the assets at close of trading yesterday were $20 and $40 and the estimate of the coefficient of correlation between the returns on the two assets made at that time was 0.25. The parameter ? used in the EWMA model is 0.95. (a) Calculate the current estimate of the covariance between the assets. (b) On the assumption that the prices of the assets at close of trading today are $20.50 and $40.50, update the correlation estimate. 11.6 Suppose that the current daily volatilities of asset X and asset Y are 1.0% and 1.2%, respectively.The prices of the assets at close of trading yesterday were $30 and $50 and the estimate of the coefficient of correlation between the returns on the two assets made at this time was 0.50. Correlations and volatilities are updated using a GARCH(1,1) model. The estimates of the model's parameters are ? = 0.04 and ? = 0.94. For the correlation ? = 0.000001 and for the volatilities ? = 0.000003. If the prices of the two assets at close of trading today are $31 and $51, how is the correlation estimate updated? 11.7 Suppose that in Problem 10.15 the correlation between the S&P 500 index (mea- sured in dollars) and the FTSE 100 index (measured in sterling) is 0.7, the cor- relation between the S&P 500 index (measured in dollars) and the dollar-sterling exchange rate is 0.3, and the daily volatility of the S&P 500 index is 1.6%.What is the correlation between the S&P 500 index (measured in dollars) and the FTSE 100 index when it is translated to dollars? (Hint: For three variables X, Y, and Z, the covariance between X + Y and Z equals the covariance between X and Z plus the covariance between Y and Z.)

\fIBUS 618 June 2020 3. (15) The international finance function has as its domain 1) investment decisions 2) financing decisions and 3) short term money management decisions. Discuss within the context of how these decisions are contrasted to non-international financial challenges. That is, what is different about these decisions in the international environment