international capital market equilibrium

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1、ChapterChapter1313InternationalCapitalMarketEquilibriumAmanagershouldallocatecapitaltoaninvestmentprojectwhenthepresentvalueofthenetcashflowsgeneratedbytheprojectexceedsthecurrentinvestmentoutlay.Applyingthisnetpresentvalueprinciplerequiresadiscountrate.Itisoneofthehallma

2、rksofmodernfinancethatthisdiscountrate—thecostofequitycapital—issetbyinvestorsinthecapitalmarkets.Wheninvestorsfinanceafirmbypurchasingitsequityshares,theyforgotheopportunitytoin-vestintheequitiesofmanyotherfirms.Therefore,investorsdemandtobecompensatedfortheopportunityco

3、stoftheirinvestmentwithanappropriateexpectedrateofreturn.Consequently,themanagerofafirminacapitalbudgetingsituationshouldsetthediscountrateforaprojecttobetheexpectedreturnforthefirm’sinvestorsasiftheywereinvestingdirectlyinthatproject.Chapter11showedthattheinternationalbo

4、ndmarketsetsthecostofacompany’sdebtequaltotherisk-free(government)interestrateonbondsplusariskpremiumtocompensateforthepossibilitythatthecompanymaydefaultonthedebt.Theappropriateratefordiscountingtheequitycashflowsofanyprojectsimilarlydependsonhowriskytheinvestorsinthefir

5、mviewthecashflowsfromthatparticularprojecttobe.However,thinkingaboutriskinincreas-inglyglobalequitymarketsisdifficultbecausetherearemanymorefactorsinvolved.How,then,doinvestorsdeterminetheriskinessofaninvestment,andhowdomanagersknowtherequiredrateofreturnonariskyinvestmen

6、t?Unfortunately,therearenoeasyan-swerstothesequestions,andtherearecompetingtheories.Thischapterdevelopsthetheoriesnecessarytodeterminethecostofequitycapital.Itthendemonstrateshowthesetheoriesap-plyinaninternationalcontext.Becauseinvestorssetthecostofequitycapital,westartw

7、ithadetourthroughthefascinatingworldofinternationalinvestingandthetheoryofoptimalport-foliochoice.Theideaofportfoliodiversificationfiguresprominently,andwewillarguethatinternationaldiversificationishighlydesirable.BlackRock,theworld’slargestassetmanagerwithover$3trillion,

8、hasthisadviceonitsiSharesWebsite(http://us.ishares.com/home.htm)inresponsetothequestion,“Whyinve