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The Global CAPM and a Firm's Cost of Capital in Different Currencies
Author(s) -
O'Brien Thomas J.
Publication year - 1999
Publication title -
journal of applied corporate finance
Language(s) - English
Resource type - Journals
eISSN - 1745-6622
pISSN - 1078-1196
DOI - 10.1111/j.1745-6622.1999.tb00032.x
Subject(s) - currency , capital asset pricing model , economics , foreign exchange risk , financial economics , cost of capital , monetary economics , exchange rate , liberian dollar , foreign exchange market , microeconomics , finance , profit (economics)
In an integrated global market, a firm's cost of capital expressed in one currency should be consistent with its cost of capital expressed in another currency. This article presents and illustrates a process for estimating consistent costs of capital in different currencies for a U.K. based multinational. In so doing, it uses a simple, easy‐to‐use version of the global CAPM that attempts to incorporate the effect of uncertain exchange rates by calculating exchange rate “betas.” As argued in the previous article, at least part of a company's currency exposure is systematically related to the global market and thus should be treated as a component of the firm's systematic equity risk. For example, the U.K. firm featured in this article is shown to have an exchange rate beta of 0.20 from the perspective of a U.S. investor. This implies that a 10% return on the global market in U.S. dollars tends to be associated with a 2% change in the U.S. dollar value of the British pound. One interesting consequence of incorporating exchange risk in this fashion is that two firms with identical U.S. global betas and costs of equity will have different expected returns expressed in another currency if they have different exposures to that currency.