Currency Choices in Valuation: An Approach for Emerging Markets
12 Pages Posted: 19 Jun 2014
Date Written: June 17, 2014
One of the common decisions that multinational companies face is whether to value an investment or an acquisition in a foreign or an emerging market in the domestic currency or U.S. dollars. The choice of currency affects the inputs. Since these investments generate sales, expenses, and cash flows in domestic currency, senior management is required to express expected cash flows in a strong currency, usually U.S. dollars. Therefore, it is necessary to forecast the exchange rate for the investment horizon. In this paper, we demonstrate the equivalence value independent of the currency used in the valuation. This is done through using an arbitrage-free pricing model to obtain a fair value for the business. Users of the model assume the simultaneous fulfillment of Interest Rate Parity theory (IRP) and Purchasing Power Parity theory (PPP), which implies a constant real exchange rate (RER). This model can be extended to explore the effect on the business value as a consequence of a depreciation or appreciation of the currency.
Keywords: Valuation, emerging markets, arbitrage-free, interest parity theory, purchasing power parity, discounted cash flow, sovereign bond yield spread, forward exchange rate
JEL Classification: F23, G24, G30, G31
Suggested Citation: Suggested Citation