Whether there is an arbitrage opportunity and if so, how it can be exploited. Introduction: The price of a country’s currency in terms of another nation’s currency is called exchange rate . The rate of exchange can be either floating or fixed. The two components of the exchange rates are the foreign currency and the domestic currency. The practice of taking advantage of a price that varies between two or more countries is an arbitrage .

Question

Scenario one: Under what circumstances would it be appropriate for a firm to use different cost of capital for its different operating divisions? If the overall firm WACC was used as the hurdle rate for all divisions, would the riskier division or the more conservative divisions tend to get most of the investment projects? Why? If you were to try to estimate the appropriate cost of capital for different divisions, what problems might you encounter? What are two techniques you could use to develop a rough estimate for each division’s cost of capital?

Answer 1

Question

Chapter 21, Problem 10QP

a)

Summary Introduction

To find: Whether there is an arbitrage opportunity and if so, how it can be exploited.

Introduction:

The price of a country’s currency in terms of another nation’s currency is called exchange rate. The rate of exchange can be either floating or fixed. The two components of the exchange rates are the foreign currency and the domestic currency. The practice of taking advantage of a price that varies between two or more countries is an arbitrage.

b)

Summary Introduction

To find: The six-month forward rate to prevent arbitrage.

Introduction:

The price of a country’s currency in terms of another nation’s currency is called exchange rate. The rate of exchange can be either floating or fixed. The two components of the exchange rates are the foreign currency and the domestic currency. The practice of taking advantage of a price that varies between two or more countries is an arbitrage.

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Scenario one: Under what circumstances would it be appropriate for a firm to use different cost of capital for its different operating divisions? If the overall firm WACC was used as the hurdle rate for all divisions, would the riskier division or the more conservative divisions tend to get most of the investment projects? Why? If you were to try to estimate the appropriate cost of capital for different divisions, what problems might you encounter? What are two techniques you could use to develop a rough estimate for each division’s cost of capital?

Scenario three: If a portfolio has a positive investment in every asset, can the expected return on a portfolio be greater than that of every asset in the portfolio? Can it be less than that of every asset in the portfolio? If you answer yes to one of both of these questions, explain and give an example for your answer(s). Please Provide a Reference

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