LOS k: Explain the effect of market segmentation on the ICAPM.

Q1. Suppose world markets are fully segmented. What will be the effect of segmentation of the international capital asset pricing model (ICAPM)? Risk will be priced:

A)   differently in each national market and the ICAPM will be valid.

B)   differently in each national market and the ICAPM breaks down.

C)   similarly in each national market and the ICAPM breaks down.

Q2. For the international capital asset pricing model (ICAPM), which of the following is TRUE regarding the integration of national markets? If international markets are:

A)   segmented, the ICAPM breaks down.

B)   integrated, there is no need for the ICAPM.

C)   integrated, the ICAPM breaks down.

Q3. If international markets are integrated, which of the following statements is FALSE?

A)   The international risk-free rate will be the appropriate base rate for asset pricing.

B)   Risk will be priced similarly in all markets.

C)   The international capital asset pricing model will be valid.

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LOS k: Explain the effect of market segmentation on the ICAPM.

Q1. Suppose world markets are fully segmented. What will be the effect of segmentation of the international capital asset pricing model (ICAPM)? Risk will be priced:

A)   differently in each national market and the ICAPM will be valid.

B)   differently in each national market and the ICAPM breaks down.

C)   similarly in each national market and the ICAPM breaks down.

Correct answer is B)

Segmentation means that risk will be priced differently in each national market, hence the ICAPM, which assumes uniform risk pricing, breaks down.

Q2. For the international capital asset pricing model (ICAPM), which of the following is TRUE regarding the integration of national markets? If international markets are:

A)   segmented, the ICAPM breaks down.

B)   integrated, there is no need for the ICAPM.

C)   integrated, the ICAPM breaks down.

Correct answer is A)

For the ICAPM to be valid, international markets must be integrated. If markets are segmented, risk will be priced differently in different national markets so the world risk premium will not be a robust comparison measure.

Q3. If international markets are integrated, which of the following statements is FALSE?

A)   The international risk-free rate will be the appropriate base rate for asset pricing.

B)   Risk will be priced similarly in all markets.

C)   The international capital asset pricing model will be valid.

Correct answer is A)

There is no such thing as an “international risk-free rate,” hence it cannot be used in asset pricing. In broad terms, both remaining answers will be correct in the presence of well-integrated world markets.

Thanks.