The assignment contains a graded data exercise.

Optional/background materials:

Country credit risk rating

International country risk guild (ICRG) (fee required)

Emerging Markets Bonds

Introducing the J.P. Morgon Emerging Market Bond Index (EMBI)

(EMBI and EMBI+ are available from Bloomberg)

Emerging Markets Equity Index

EMDB: IFC/S&P Emerging Markets Data, which are installed on the workstations in the capital market room in the library.  Ask Frank Wilmot if you need assistance.

Assignment Sheet
Emerging Markets Finance

Class #6, Wednesday, November 2, 2005

Topic: Incorporating country risk in valuation

Case: Country Risk and the Cost of Equity, UVA-F-1392.

Reading: Lessard, Donald R., 1996, "Incorporating Country Risk in the Valuation of Offshore Projects," Journal of Applied Corporate Finance, 9 (Fall), pp. 52-63.

Assignments:

A. Study questions:

1. The first half of Lessard article gives a nice discussion of the risks and risk management issues in emerging markets. (Note the typo in Figure 1.  Country-level price risks should be placed in the third place.)  In structuring a deal, how should you determine who should bear what risks?
2. According to Lessard article, how should you incorporate currency risk exposure in emerging markets in a DCF model?
3. According to Lessard, how should you estimate the cost of equity for an investment project in an emerging market?  What are the key components?  Why should they be there?  And  how would you estimate them?
4. If you are a global investor, should you use US$ denominated cost of capital? Would you change your answer if you are a local investor in an emerging market?

B. Data exercise (Graded. Due before the class)

This data exercise is graded. You must complete this exercise individually.

The exercise is due before the class.

Please limit your answer to one printed page. You may attach your supporting analysis in an appendix.

Data File: index-spread-A.xls

This file contains the S&P/IFCI total return indices for two emerging market countries (Argentina and Russia), the MSCI world total return index, and the two countries' sovereign spreads.  For more information on the data, see the coversheet in the data file.

Assignment

1. Compute the monthly total returns on the Argentina country index, the Russia country index, and the MSCI world index.  Compute the average monthly returns and the standard deviation of the monthly returns for each of the indices.
2. Estimate the country betas for Argentina and Russia.
3. Using the Lessard formula, estimate the cost of equity for building a greenfield small aircraft engine plant in Argentina or in Russia. 
4. What account for the difference in the cost of equity between Argentina and Russia?  Why?