Reading 47: Emerging Markets Finance－LOS c class, including, capital, efficiency, emerging

tycoon

CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 17: Portfolio Management in a Global Context
Reading 47: Emerging Markets Finance
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.

deqiang

thanks.

pundit

a

tycoon

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

A) Financial market liberalization and government infrastructure.

B) Market segmentation and government infrastructure.

C) Market segmentation and privatizations.

D) Financial market liberalization and privatizations.

---

Answer and Explanation

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.

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.

tycoon

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

A) higher expected returns and lower costs of capital.

B) lower expected returns and higher costs of capital.

C) higher expected returns and higher costs of capital.

D) lower expected returns and lower costs of capital.

---

Answer and Explanation

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.

tycoon

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

A) decreases and bid-ask spreads increase.

B) increases and bid-ask spreads decrease.

C) increases and bid-ask spreads increase.

D) decreases and bid-ask spreads decrease.

---

Answer and Explanation

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.

tycoon

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

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

B) normally distributed and are subject to structural breaks.

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

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

---

Answer and Explanation

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.