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LOS g: Discuss international considerations in required return estimation.

When attempting to build a risk premium into the required returns of stocks in a developing country, an analyst should use the:

A)	modified Gordon Growth model.

B)	country’s weighted average cost of capital.

C)	country spread model.

The country spread model uses data from a developed market, then adjusts it using the difference between the bond yields for the emerging and developed markets. Neither a modified Gordon Growth model nor a weighted average cost of capital will do this job.

Candace Elwince is attempting to calculate the required return of Skeun Inc., a machine-tool manufacturer in a small Eastern European company. Elwince has solid data from the German market but is not sure how to account for the exchange-rate risk Skeun investors would face. Her best choice for creating a risk premium is the:

A)	Gordon Growth model.

B)	difference between the bond yields of both markets.

C)	difference between the inflation rates of both markets.

The country spread model suggests an analyst can approximate the risk premium between a developed market and an emerging market by subtracting the bond yields in the developed market from yields in the emerging market.

Junior analyst Quentin Haggard is struggling with a required return calculation. His main concern is compensating for exchange rate fluctuations between the country where his company is based and the home country of a portfolio of stocks he is analyzing. Haggard should calculate the return in his home country’s currency, then adjust:

A)	for expected changes in the foreign country’s inflation rate.

B)	the beta to account for exchange-rate fluctuations.

C)	for expected changes in the foreign country’s currency value.

The proper method of compensating for changes in exchange rates is to calculate the required return in the home currency, then adjust the return using forecasts for changes in the exchange rate.

A)	determines a risk premium for any foreign market.

B)	depends on forecasts of exchange rates.

C)	determines a risk premium for an emerging market.

The country risk rating model begins with a model from a developed country, then modifies that model with inputs from an emerging market to derive a risk premium for the emerging market. Forecasts of exchange rates may well be part of the model, but they are not a requirement.