1. Research capital investments in global markets. Next, analyze the main factor

ID: 429365 • Letter: 1

Question

1. Research capital investments in global markets. Next, analyze the main factors that an organization should consider in determining the required rate of return for evaluating projects in global markets and the impact that this will have on decision making.

2. Imagine that you are the Chief Financial Officer (CFO) of a U.S.-based international manufacturing company. Propose two (2) actions that you would take in order to defend the difference in the required rate of return for your company on similar projects in an established market as compared to the same investment in an emerging market. Provide a rationale for your response.

Explanation / Answer

Capital markets are financial markets for buying and selling of long-term debt or equity-backed securities. These markets route the savings of households to those who can put it to long-term productive use, such as governments or Companies that make long-term investments from these funds to a project. In capital markets money is provided for periods longer than a year. Capital market activities are overseen by financial regulators, such as the UK's Bank of England (BoE) or the U.S. Securities and Exchange Commission (SEC), to protect investors against cheats and frauds.

Capital market can be divided between primary markets and secondary markets.

Primary markets – Markets where new stocks or bond issues are sold to investors, through a mechanism known as underwriting. The main entities seeking to raise long-term funds on the primary capital markets are government and companies. Governments tend to issue only bonds, whereas companies often issue either equity or bonds.

Secondary markets – Markets existing securities are sold and bought among investors or traders, usually on an exchange, over-the-counter, or elsewhere. Secondary Market increases the willingness of investors to invest in primary markets, as they know they are likely to be able to swiftly cash out their investments if the need arises.

Global capital markets size

All figures given are in Billions of US$ and are sourced to the IMF. AGDP column is included as a comparison.

Year[17]

Stocks

Bonds

Bank assets[18]

Total of stocks, bonds and bank assets.[19]

World GDP

2013[20]

62,552.00

99,788.80

120,421.60

282,762.40

74,699.30

2012[21]

52,494.90

99,134.20

116,956.10

268,585.20

72,216.40

2011[22]

47,089.23

98,388.10

110,378.24

255,855.57

69,899.22

Data taken from Online database.

the main factors that an organization should consider in determining the required rate of return for evaluating projects in global markets and the impact that this will have on decision making are:-

1. Interest Rates - Changes in short-term interest rates results in change in the required rate of return. Usually because of U.S. Federal Reserve action. As this can lead to change in other short-term and long-term rates, including U.S. Treasury bill rates (Considered as risk free rate). Since this changes the risk-free rate this results in changes in the required rate of return as Risk free rate of return is one of the factor in determining the Rate of return.

2. Risk - Risk include business risk, project risk and market risk.

Business risk refers to industry risk and international risk. Industry risk includes a regulatory changes, evolving technologies and increase in raw material prices. International risk includes political instability and currency fluctuations. Liquidity risk means that a company could face serious financial difficulty and run out of cash. Rule is that for High Risks, Required rate of return is high, and lower when the risks are low.

3. Market Returns - Changes in market returns affect the required rate of return. Market returns depend on several factors, such as corporate profits, interest rates, geopolitical events and natural disasters. E.g. The 2011 Japanese earthquake affected Japanese stock exchanges, as well as markets in China, Europe and the United States. The 2008 financial crisis hit the United States first, but markets elsewhere soon felt the impact.

4. Economy -The economy affects the required rate of return. Corporate profits fall in a recession and rise when economic growth picks up. Economic uncertainty tends to increase the volatility of securities, which affects the beta component.