Reference no: EM132879300

Arundel Partners are contemplating an investment in Colombia. They gather data to determine the appropriate return to their equity investors. Their data suggest that the Colombian equity market is 2.1 times more volatile than the US equity market; they estimate the project beta as 1.5, and the project has 100% exposure to the Colombian country risk.

• Credit Default Swap premiums on USD denominated Colombian Eurobonds are around 265 basis points. The relative volatility of Colombian equities and bonds is 1.4 times.
• Arundel partners assume that US risk-free rate is 3% and US EMRP is 5%. Arundel Partners evaluate the project-specific risks and conclude that a 200 basis point risk adjustment would be appropriate to account for project-specific risks.

Problem 1: Estimate CRP for Colombia based on the relative equity market volatility?

Problem 2: What should be the required rate of return Arundel shareholders expect in USD terms assuming 100% country risk exposure.

Problem 3: What should be the required rate of return if the country risk were scaled the same as the market risk of the asset?

Problem 4: If the Colombian credit default risk premium is 265 bp and equity market volatility to bond market volatility ratio is 1.4, what should be the Colombian Country Risk Premium and the required rate of return Arundel partners should expect under 100% exposure assumption?