LOS c: Discuss the major issues confronting emerging market investors, including high correlations during times of crisis (contagion), non-normal return distributions, market efficiency, cost of capital, and corporate governance.

Q1. Which of the following best characterizes return patterns in emerging markets? The returns are:

A)   not normally distributed and are not subject to structural breaks.

B)   not normally distributed and are subject to structural breaks.

C)   normally distributed and are subject to structural breaks.

Q2. Which of the following best characterizes the relationship between privatizations, returns, and the cost of capital in emerging countries? Privatizations result in:

A)   lower expected returns and lower costs of capital.

B)   higher expected returns and lower costs of capital.

C)   lower expected returns and higher costs of capital.

Q3. Which of the following best characterizes the effect of liberalization on market microstructure in emerging markets? Liquidity:

A)   increases and bid-ask spreads decrease.

B)   increases and bid-ask spreads increase.

C)   decreases and bid-ask spreads increase.

Q4. Which of the following are most closely and directly associated with lower costs of capital in emerging countries?

A)   Market segmentation and government infrastructure.

B)   Financial market liberalization and government infrastructure.

C)   Financial market liberalization and privatizations.

LOS c: Discuss the major issues confronting emerging market investors, including high correlations during times of crisis (contagion), non-normal return distributions, market efficiency, cost of capital, and corporate governance. fficeffice" />

Q1. Which of the following best characterizes return patterns in emerging markets? The returns are:

A)   not normally distributed and are not subject to structural breaks.

B)   not normally distributed and are subject to structural breaks.

C)   normally distributed and are subject to structural breaks.

Correct answer is B)

Emerging market returns are not normally distributed. Emerging market return data often contain structural breaks (e.g., when liberalizations occur, the pattern of stock returns dramatically changes). If a country is expected to undergo a structural change in the future, then historical data are not very useful for prediction.

Q2. Which of the following best characterizes the relationship between privatizations, returns, and the cost of capital in emerging countries? Privatizations result in:

A)   lower expected returns and lower costs of capital.

B)   higher expected returns and lower costs of capital.

C)   lower expected returns and higher costs of capital.

Correct answer is A)

When firms that were formerly government owned are privatized, the government signals its intent to reduce its interference in the economy and investors become more willing to invest in risky assets. Privatizations also increase investment opportunities which allows for better performing portfolios, which also increases investors’ willingness to hold risky assets. Hence the expected returns and cost of capital fall for firms in the economy.

Q3. Which of the following best characterizes the effect of liberalization on market microstructure in emerging markets? Liquidity:

A)   increases and bid-ask spreads decrease.

B)   increases and bid-ask spreads increase.

C)   decreases and bid-ask spreads increase.

Correct answer is B)

The effect of liberalization is to increase liquidity and volume. However, bid-ask spreads increase possibly because new, less experienced foreign investors are exploited by the local dealers.

Q4. Which of the following are most closely and directly associated with lower costs of capital in emerging countries?

A)   Market segmentation and government infrastructure.

B)   Financial market liberalization and government infrastructure.

C)   Financial market liberalization and privatizations.

Correct answer is C)

When an emerging country announces a liberalization program, equity prices will increase. The rise in equity prices will result in lower expected returns and a lower cost of capital for emerging firms.

When firms that were formerly government owned are privatized, the government signals its intent to reduce its interference in the economy and investors become more willing to invest in risky assets. Privatizations also increase investment opportunities which allows for better performing portfolios, which also increases investors’ willingness to hold risky assets. Hence the expected returns and cost of capital fall in the economy.

Thx!