BUSF_A01.qxd

Appendix 3• Suggested answers to review questions

linternational Fisher effect; and

linterest rate parity.

15.4The fact that governments with known or predictable exchange rate objectives are

often major activists in the foreign exchange market means that the foreign exchange

market is not always price efficient.

15.5The three risks are:

ltransaction risk;

leconomic risk; and

ltranslation risk.

15.6A money market hedge involves either:

lborrowing in a foreign currency, converting to the home currency and using a

foreign currency receipt exactly to pay off the borrowings and interest thereon; or

lborrowing in the home currency, converting the borrowing to the foreign cur-

rency and lending this until a foreign debt becomes due for payment, by which

time the loan and the interest will exactly pay off the foreign debt.

16.1There is apparently an increasing trend towards larger businesses concentrating on

their core activities and buying in ancillary services and products from outside. This

tends to create opportunities for smaller businesses to establish and thrive.

16.2Most larger businesses could assume that their shareholders hold efficient (well-

diversified) portfolios of shares. Thus when such businesses assess projects, they can

assume that shareholders do not need to be rewarded for bearing specific risk. The

shareholders of smaller businesses are much less likely to hold efficient portfolios.

Also, the effect of capital gearing on the cost of capital is likely to be less beneficial

for smaller businesses.

16.3The key problem is finding the equivalent business. There are likely to be differences

between the two businesses in the following areas:

lactivities;

lsize;

lcapital gearing levels; and

ldividend policy (particularly relevant to the dividend yield basis of valuation).

16.4The balance sheet provides a very unreliable basis for valuing shares. The reason is

that, rightly or wrongly, the balance sheet is not intended to represent market val-

ues, either of individual assets or of the business as a whole. The balance sheet com-

prises a list of where funds came from (claims) and how those funds were deployed

(assets). Current asset balance sheet values tend to bear some relation to current

market values, albeit with a strong bias towards understatement relative to market

values. With non-current assets, there is normally little resemblance between mar-

ket and balance sheet values.

16.5The principal problem is the lack of a reliable exit route for such investors when they

wish to withdraw their funds. If there is no ready market for the shares (they cannot

be sold through the stock market), it is often a question of selling the shares to an

Chapter 16

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